Sell for half a billion and get nothing (2021)

&gt; Lessons Learned: Build a Very Fundable Startup<p>&gt; Every founder should learn from this disastrous scenario the importance of building a very healthy, fundable startup. A healthy, vibrant startup draws more investors during fundraising. The competition gives founders the leverage to negotiate for more founder-friendly terms. Healthy startups get better valuations, better terms, and raise funds with much less effort.<p>Hmm. The lesson I learn from that is to bootstrap&#x2F;self-fund, rather than get investment in the first place.

I am currently working with a start-up where the company is incapable of meeting its capex obligations. The founder raised a good amount of capital from investors a few years ago, and that provided a decent runway, but there&#x27;s no traction, no KPIs, and whilst we&#x27;ve built some impressive technology, impressive technology does not bring in revenue. One of the problems (amongst many) is that the primary stakeholder has a perfectionist attitude to the user experience. Which in a start-up is deadly.<p>Now, as I said, the start-up cannot meet its capex obligations and the current funding round is looking grim. It is definitely going to be a down round and it ain&#x27;t going to be pretty should a term sheet get thrust under our collective noses. To get the developers motivated to stick around a little longer, &quot;generous&quot; equity packages are on offer, with a request to convert over-due back pay and future payments too, into equity .<p>When I sought transparency - &quot;Can I see the cap table?&quot; - &quot;Can I see the terms of the investors?&quot; - &quot;Can I see anything?&quot; - the answer was invariably &quot;no.&quot; Essentially, they&#x27;re asking me to make a nominal investment of over $200K in the company, accepting common stock in lieu of pay without any insight into the financials or the terms provided to other investors.<p>It&#x27;s worth noting that I had previously given the start-up a sweetheart deal, significantly discounting my usual rate and offering generous payment terms, in the spirit of support and belief in the project. This makes the current scenario even more disheartening. Compound that with what has become an overall toxic environment that I have euphemistically called &quot;challenging&quot; when asked to sum it up, and the future isn&#x27;t bright enough to wear shades.<p>Now this isn&#x27;t exactly my first rodeo. I&#x27;ve seen the beautiful side of start-ups and liquidity events. And I&#x27;ve seen the dreadfully ugly side too. Hard lessons learned. And the ugly side shows up way more than the pretty one.<p>I swear, some entrepreneurs must think I stepped off the boat yesterday.

I&#x27;ll throw out a VC&#x27;s perspective on liquidation prefs:<p>1) I think 1x is very fair and meant to protect investors from bad company behavior. If you didn&#x27;t have 1x preference, this would be an easy way for an unscrupulous founder to cash out: raise $X for 20% of the company, no liquidation preference. The next day, sell the company and its assets ($X in cash) for, say, 0.9x. If there&#x27;s no liquidation preference, the VC gets back 0.18x and the founder gets 0.72x, even though all that the founder did was sell the VC&#x27;s cash at a discount the day after getting it.<p>2) &gt;1x liquidation preferences are sometimes the founder&#x27;s fault and sometimes the VC&#x27;s fault. Sometimes it&#x27;s an investor exploiting a position of leverage just to be more extractive. That sucks. But other times it&#x27;s a founder intentionally exchanging worse terms for a higher&#x2F;vanity valuation.<p>For example, let&#x27;s say a founder raised a round at $500m, then the company didn&#x27;t do as well as hoped, and now realistically the company is worth $250m. The founder wants to raise more to try to regain momentum.<p>A VC comes and says &quot;ok, company is worth $250m, how about I put in $50m at a $250m valuation?&quot;<p>Founder says &quot;you know, I really don&#x27;t want a down round. I think it would hurt morale, upset previous investors, be bad press, etc. What would it take for you to invest at a $500m+ valuation like last time?&quot;<p>VC thinks and says &quot;ok, how about $500m valuation, 3x liquidation preference?&quot;<p>The founder can now pick between a $250m and a 1x pref, or $500m and a 3x pref. Many will pick #1, but many others will pick #2.<p>It&#x27;s a rational VC offer -- if the company is worth $250m but wants to raise at $500m, then a liquidation preference can bridge that gap. The solution is kind of elegant, IMHO. But it can also lead to situations like the one described in the article above where a company has a good exit that gets swallowed up by the liquidation preference.<p>3) generally both sides have good lawyers (esp. at later stages of funding), so the liquidation preference decision is likely made knowingly.<p>Related to #3, if you&#x27;re fundraising, please work with a good lawyer. There are a few firms that handle most tech startup financings, and they will have a much better understanding of terms and term benchmarks than everyone else. Gunderson, Goodwin, Cooley, Wilson Sonsini, and Latham Watkins are the firms I tend to see over and over.

I have a friend that has given up on options. Even if he were to be #10 somewhere he would take any extra pay over any options. Stories like this show the wisdom of that. Are there really that many success stories for people other than for VCs and (maybe) founders out there anymore? Even if your options (eventually) get you 200k, how much did they cost you in years of lower pay. Even with a payout, considering interest on that missing pay was it worth it?

I wrote this in 2015 in response to Mark Suster suggesting that founders &quot;Run&quot; from liquidation preference and preference overhang in early deals:<p>&quot;Run where? When I talk to my fellow early stage east coast founders, the majority aren’t beating away founder friendly term sheets. Even seed stage companies with revenue and traction raising relatively small amounts are giving away board seats and agreeing to multiple preferences because they have nowhere else to go. For founders, these deals can be make or break. For investors they can hold out and the only downside is slightly lower yield. So there is asymmetry in needs which means founders have little leverage.&quot;<p><a href="https:&#x2F;&#x2F;medium.com&#x2F;@andrewkemendo&#x2F;first-time-founders-and-the-trouble-with-founder-friendly-terms-e804a9783b5c" rel="nofollow">https:&#x2F;&#x2F;medium.com&#x2F;@andrewkemendo&#x2F;first-time-founders-and-th...</a>

Liq prefs vanished during the ZIRP and I haven’t seen them return…yet.<p>But the founders do have some leverage. If there is no incentive to do the deal they can just… not cause the deal to happen (different from blocking it, just not working on it).<p>This is the same reasons you see big pay packets for the execs when a company is doing poorly or is bankrupt: otherwise they could just go do something else (get a different job). The poor guy on the assembly line may not have the same option.

&gt; When the FanDuel founders raised funds, two key investors received a liquidation preference that entitled them to the first $559M in an acquisition. Founders and employees would be paid only if the acquisition exceeded $559M.<p>&gt; The reality was the founders couldn’t stop the deal because they also granted the same two lead investors drag along rights. This drag along right forced the other shareholders to accept the decisions made by these two investors.<p>So they signed a funding contract that gave two investors the right to take all the money in a certain situation and force the company to go along with it. That seems pretty insane. I think the lesson is the same as any other contract. Know what you&#x27;re signing, and beware. I thought this story was going to be about some people getting screwed over somehow. This is a story about people agreeing to something that they should not have agreed to, and had to suffer the consequences.

&quot;FanDuel founders to receive no cash from sale to Paddy Power Betfair&quot;<p><a href="https:&#x2F;&#x2F;news.ycombinator.com&#x2F;item?id=17485246">https:&#x2F;&#x2F;news.ycombinator.com&#x2F;item?id=17485246</a><p>(July 8, 2018)<p>Shamrock Capital Advisers and Kohlberg Kravis Roberts are the two mentioned investors, I believe.

If I sell my company for $1T, but I financed $999B of it, should I expect to get a payout? Financing generally requires interest. Seems like the headline is trying to invoke outrage.

FanDuel was really a lose-lose-lose<p>- Investors got a meager return<p>- Company and employees got nothing from the sale<p>- Consumers got a gambling addiction

Was curious why no mention was made of their funding rounds&#x27; sizes and valuations so I hit the Google. Couldn&#x27;t find the exact rounds, but they raised over $416m and sold for $465m. That&#x27;s a fail, and you wouldn&#x27;t expect the founders to get much in any case.<p>If you raised $415k to start a restaurant, ran it for a few years at a loss, then sold it for $465k, you wouldn&#x27;t expect to pocket anything. Adding a few zeroes and calling it a tech company wouldn&#x27;t change that.<p>I don&#x27;t think the story really necessitates liquidation preferences.

I think the perception of raising venture capital has soured. You really are an employee. Many founders of well known companies make far less than you would expect. Generate and own a SAAS business that does 1M in ARR, and you can almost walk away with 5-10M. This can be done in a few years.<p>Do that with a venture backed business, they will force you to raise a series A and shoot for a 200M+ outcome. If you dont increase revenue, they want you to fail&#x2F;go to zero trying to shoot for the moon. You might spend the next 5 years at a 200k salary, while you could have reached financial security at FAANG. Also, many companies have less respect for founders than you would expect. Its not the career boost people think it will be. You are building a different skill set thats not as useful inside a high paying tech company, aside from engineering. Which even then, is very different at a startup.

FanDuel is going to do like $6B in revenue this year. This entire story above happened for three reasons:<p>1. The CEO made terrible decisions in regards to how much and who they raised from. They got in over their hands as the company grew and the entire founding team got fired.<p>2. The CEO immediately after, who took over an unprofitable business that wasn&#x27;t growing and was in bad shape after the merger with DraftKings got called off, took a deal that was the best he could do at the time. That CEO was a non-founding CFO before taking over, and was basically put in the C-Suite by KKR as a term of their investment in the business.<p>3. That deal to PaddyPowerBetfair, now Flutter, was completed about a year before PASPA was repealed and sports betting was legalized in the US. Had #2 happened a year later, or if #2 had happened with that information in mind, the deal terms would have been insanely different and way more valuable.<p>It&#x27;s very easy in retrospect to say that the original CEO should have taken different terms, or that the following CEO should have taken a better deal. That&#x27;s all hindsight.<p>All that said, I have zero sympathy for the original CEO and founders. I feel loads of sympathy for the employees, but again, if they stayed on after the deal, they&#x27;re now sitting on an absolute gusher of cash.

If you can’t find investors who will invest at 1x preference, it’s a sign that you should seriously consider shutting down rather than raising more funding.

of course, hindsight is 20&#x2F;20, but... Why did they accept the deal with the investors?? That seems like a horrible deal? Google search shows they only raised $416mio total, roughly speaking anything above that and below $559mio the investors could have accepted, pocketed a quick and tidy profit, screw everyone else, and nobody can do anything about it. Or is that too naive of me?

It&#x27;s worth mentioning that the founders were no longer with the company, and the terms of their prior exit are not public:<p>&gt; <i>In this case, the minority shareholders are FanDuel&#x27;s original founders, Nigel and Lesley Eccles, Tom Griffiths, Rob Jones, and Chris Stafford. None of the original co-founders still work at FanDuel, and it doesn&#x27;t look like their original efforts will be rewarded — according to the deal documents, they&#x27;re not going to make any money at all off of the company&#x27;s sale. Of course, it&#x27;s not clear what the financial terms were surrounding their departures from the company, and they could have negotiated a pay package</i> [1]<p>Getting precisely zero is not terribly likely if the founders are still with the company, since they would typically be considered key to the value of the company (at least for a time).<p>There is&#x2F;was apparently also a lawsuit about this deal. [2]<p>1: <a href="https:&#x2F;&#x2F;www.businessinsider.com&#x2F;fanduel-founders-likely-to-lose-out-from-paddy-power-acquisition-2018-7" rel="nofollow">https:&#x2F;&#x2F;www.businessinsider.com&#x2F;fanduel-founders-likely-to-l...</a><p>2: <a href="https:&#x2F;&#x2F;www.wsj.com&#x2F;articles&#x2F;fanduel-founders-former-employees-sue-over-getting-nothing-in-deal-11582663343" rel="nofollow">https:&#x2F;&#x2F;www.wsj.com&#x2F;articles&#x2F;fanduel-founders-former-employe...</a>

This kind of stuff should be a reminder why startup employees skew so young. It&#x27;s not just youthful energy. It&#x27;s that they haven&#x27;t learned the expected value lesson of what their lottery ticket equity really is worth.<p>You have all the dilution &amp; liquidity issues before you even get into this liquidation preference and drag along rights stuff. 99% of kids out of college going to work on The Next Big Thing do not understand any of this.

The free money era is over. It is time for that message to sink in for both founders and investors. VC funds want founders to shoot for the moon but protect themselves by a) having a portfolio b) liquidation preference. As a founder you don’t have either. VC funds are not investors, they are middlemen who take very little risk.

It&#x27;s important to say that this isn&#x27;t in the VCs interest either. As a VC, you want to keep the founders motivated to make you money and grow the pie - or at least to stay on and continue what they are doing. Taking away their personnel incentives through over boarding liquidation preferences is in neither side&#x27;s interest.<p>This is even more true when it comes to future investments. Founders talk to each other. And articles, such as this one, get the word out. So - next time you&#x27;re choosing a VC for your promising startup, will you go with the one that forced the last company into a sale that left them with nothing - or will you go with one with a more founder friendly track record?

Suppose I were evaluating a startup as a potential employee. What would I ask to get more insight into how funding is structured? I realize the terms can change in future rounds, but I&#x27;d like to at least get a sense of where things are now.

I’ve always wondered what it means to be a “founder” when it is done with everyone else’s money. Are they not just effectively employees at that point?<p>I fear such abuse of such just feeds a narcissistic species that focuses mainly on executive headshots and snazzy websites.<p>Too many startup websites scream, “look, we have a website, $$$ millions, and an executive board — we’re all grown up now!” without actually having much clue. Medium sized business are more self confident and don’t bother.<p>The small business founder that starts as employee #1 and grows organically is an entirely different animal and fully deserves the title.

Value creation and value capture are often misaligned for founders. In a nutshell, stories like these are why we&#x27;re building out TXF - a fund for founders to invest with their equity. Structured as a fund with a diligence process to ensure quality. Hoping to make venture capital a little fairer for founders.<p>If anyone&#x27;s interested...<a href="https:&#x2F;&#x2F;docsend.com&#x2F;view&#x2F;dtrtu8y7eczki9dz" rel="nofollow">https:&#x2F;&#x2F;docsend.com&#x2F;view&#x2F;dtrtu8y7eczki9dz</a>

This sort thing is uncommon only in that there was eventually a high dollar liquidity event. When negotiating offers, I always try to get some idea of the financing and the liquidation preferences, if only so I can get some idea of what we&#x27;d have to pull in for shares to be &quot;in the money&quot; and quite often the number would be something insane like this. You just value the shares at zero. :&#x2F;

The valuable lesson you should all take away.<p>If the company is not public ask for a &quot;cap table&quot;, if the answer isn&#x27;t &quot;it&#x27;s in your inbox&quot;... Then your response is: If you don not have a cap table then the shares are more or less toilet paper. You are going to take them but they are worth nothing in this deal, say &quot;more cash please&quot;, and as salary.

The concept that you can sell for X, and X is large and you get nothing shouldn&#x27;t be a surprise in itself. Investors wouldn&#x27;t make money if they made every founder rich regardless of the risk they take. That said, in this case sounds like the founders were f&#x27;d over. Why did they accept those terms, why didn&#x27;t a lawyer or advocate advise against it?

Being the devil&#x27;s advocate here.<p>These liquidation things are happening when the company does badly. The founders (and the investors) were probably hoping to do a lot better than what they settled for. Half a billion dollar is great, but not so great if you thought you were going for 10bn...<p>Without knowing the amount of the investment that the two investors made, the multiplier and the participation, and how the company was actually doing, all argument is moot. Who knows how much the investors put on the table in the first place. They took a risk, tried to have their ass covered should things turn bad, everybody agreed. Then shit happened and these guys managed to sell the thing before losing it all.<p>Also, the founders probably got paid pretty decently in all their founding rounds, so I don&#x27;t feel too sorry for them...

As a founder, this is painful to read because the founders+employees did everything they could to make sure the business was successful and by all accounts, it was.<p>This might be the one case where I personally would accept the business failing is a better outcome.

It&#x27;s not great from the employee side, either. I got 150,000 options for Reddit very early after it was spun out. With the current target price, that&#x27;s $4.6M, but I didn&#x27;t get all 4 years of vesting, the pay was below-average, and my money is tied up. During the same decade, the faangs were up 12x on average, but the pay, even at Amazon, was better, and my money would be liquid. Reddit might not hold up for 6 months, either. The IPO feels like a cash-out because the company&#x27;s profitability metrics have never been great, and the LLM hype is the best shot at getting something.

The CEO who signed all of those term sheets is STILL crying, like five years later, about how badly he supposedly got hosed, as if someone else’s signature is on all of those documents. It’s pathetic.

I think all this is OK. The problem is when it&#x27;s not transparent. Then you have early employees (even some naive founders) with a lot of stock&#x2F;options who assume they are going to be compensated with the exit. Then it&#x27;s quite a shock when they aren&#x27;t. As a veteran of such things (both successful and unsuccessful exits), I make sure to educate my fellow engineers on how these things work and what their realistic expectations should be.

I hate advocating for new laws but we need something to fix this imbalance that really screws over the worker more than anyone else. I recently left a company due to investors wanting to sell the company and a statement in the original RSU documents stating that I forfeit my shares upon leaving at the price the CEO sets really screwed me. The CEO decided my 4 years of shares were worth 2 cents a piece.

The founders likely took some money off the table in those huge rounds. They didn&#x27;t end up with &quot;nothing&quot;.

Why would they sign on to this gamble though? It seems like idiocy or mis-selling. The article is frustrating as it merely explains the outcome and not how an obvious mistake was made. Basically <i>nobody</i> in their right mind would sign on to this and work for free.

The book &#x27;Billion Dollar Fantasy&#x27; covers the whole story of FanDuel vs DraftKings. It&#x27;s clear why they &#x27;needed&#x27; funding for this to work, how they came to these terms however is not detailed in the book or clear other than they had no other option.

Am I understand right that your definition of nothing is $94M?

&gt; Because they take on significant risks, investors expect to get “VIP” head-of-line privileges to be paid upon a liquidation event such as an acquisition.<p>I’d like to challenge this notion. Risk comes from one factor and one factor only: how much skin do you have in the game?<p>Skin isn’t money. Skin is how much are you in for. How much would this hurt if you lost.<p>The ultra rich, when investing, have actually very little skin in the game. A million here, a million there. What’s the difference? They’ll still be impossibly wealthy even if everything goes tits up.<p>Those folks should not make the big bucks in a deal. They haven’t risked anything, even some notion that they “risked” investing their money in this vs that: they picked the winner in this case.<p>It’s fanciful thinking I know, but I see it as _the primary_ problem with either capitalism, or ultra wealth. The system favors people with the most money, and the people with the most money control the system.

this could have been easily solved by letting the investor know that this is happening and that they stop working for the startup immediately, this would have resulted in them pulling out the funding because nobody will put money in a company without the founders. You need to on the same level as the investors and lower your ethical and moral level to understand that for them this is a money game...

It&#x27;s almost like there are 2 worlds. One is this and the other is my world where I&#x27;m taking home 4 million a year bootstrapped.

This article is a great advertisement for bootstrapping your business, rather than taking funding (not suitable in every case though).

LOL @ the idea that the investors are the ones who take on the largest risks. Investors barely deserve 1x, never mind anything higher.

This is happening more now.<p>Liquidation preference was included in 20% of all Series B-E Silicon Valley venture financings in Q3 last year.<p>When a company is not doing well and there are no other investors who will finance the next stage of the company, investors have the leverage and can include a liq pref and drag along to force other shareholders to sell.<p><a href="https:&#x2F;&#x2F;assets.fenwick.com&#x2F;banner-images&#x2F;Silicon-Valley-Venture-Capital-Survey-Third-Quarter-2023-Updated.pdf" rel="nofollow">https:&#x2F;&#x2F;assets.fenwick.com&#x2F;banner-images&#x2F;Silicon-Valley-Vent...</a>

That’s why I have my lawyer cross out bullshit in contracts I sign, and if it’s not removable, at least explain, in layman terms, the ramifications to me. My first early startup job offer (from the people I “trusted”) had so many land mines in it that it took 2 weeks of back and forth and a board decision to get it to the point where fucking me over closer to the acquisition (which did eventually occur) wasn’t lucrative. And there were multiple such clauses in the initial version. Eg work for us for a few years and then we’ll get you into a situation where you will inevitably fuck up and strip you of vested equity by firing you “for cause”, just to give one example<p>As to these folks - I pass no judgement here, could be they just didn’t read the fine print or this was the best possible outcome. Hire a good lawyer next time.

&gt;&gt; Because they take on significant risks, investors expect to get “VIP” head-of-line privileges to be paid upon a liquidation event such as an acquisition.<p>What a crock of shit. I understand that employees might be considered &quot;lower risk&quot; because they get a paycheck. But if you&#x27;re going offer them shares as an incentive then those should be full shares, Same as the others. They are probably led to believe that is the case unless they dig a little deeper themselves. So read that stuff!

Who were the investors?

Who are these VCs?

ahhh fucking ad

tldr: the founders gave their compagny to a couple of people. Some time later, those two people sold the compagny and got the cash. The founders got nothing, because it was no longer their compagny.

They got time, salaries, and a credit line while they developed and tried to grow the product, and I imagine they had a pretty great time with $350m over the years. It&#x27;s not as though they intentionally undercut them by a dollar, their sale was $94m short.<p>If the story was what the headline leads you to believe and you 10x&#x27;d someone&#x27;s investment and they did you over, why wouldn&#x27;t you see red and scuttle your product?