I saw the below exchange on the Seattle Tech Startups email list after one of my buddies, Nathan Kaiser re-posted it on his blog a few days back. By the way, if you are interested in a great blog, be sure to check his out, definitely one of my daily reads. You can find it here http://www.npost.com
The person answering the questions from Jeremy Irish at Groundspeak is Bill Bryant a venture partner from Draper Fisher Jurvetson, who not only has a wealth of knowledge but has been a great help to many entrepreneurs in the Northwest.
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Jeremy Irish: At the point where you received outside investment, a clock started ticking. You have no control over that clock other to ensure that you hit milestones so that, in 3-5 years, you will have an exit.
Bill Bryant: Absolutely true. When an investor (friend, family, angel, a bank, the Mafia, a loan shark, a VC – doesn’t matter) puts money into a company, they want their money back at some point in the future. As it turns out VCs have the LONGEST time horizon of any of the above classes of investor – the statistical average for exit is now 8 years, so they go into a new deal now with the expectation that this is going to be a long term investment in an effort to build a company that makes the investment, today, all worthwhile 6-10 years from now. An entrepreneur crosses the Rubicon when they take in an investor – it is a deliberate tradeoff, that they can use the capital to grow their company to a point where the value of their remaining ownership exceeds what it would be in the absence of that capital.————————————
Jeremy Irish: Investors generally have preferred shares. In a situation where there is an exit, your investor will at the very least get a multiple of what they put into the business before you get anything.
Bill Bryant: Yes investors do take preferred shares but the “multiple” can be as little as 1X their investment (more common in very early stage than later stage, where investors return is based more on the liquidation preference). Think of it as the mortgage on the home that you borrowed from the bank that needs to be paid back first before you get any upside.
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Jeremy Irish: If you run out of money, you’ll have to raise more (if you can) – there are generally no exceptions. You can’t just get a consulting gig while you figure out how to grow your business so you can continue building it.
Bill Bryant: I’m not sure what the point is here. Yes, if you’re running out of money, you’ll have to search for new capital, and you don’t have the option if you’re the CEO to start consulting to make a personal living on the side while leaving everyone else in the lurch. You certainly have the option of coverting your team into a consulting shop to buy you some time while you search for investors.
As an entrepreneur, you’ve taken on an obligation to your investors to try to do everything in your power to generate a return on their investment. No one forced you to accept money. It was your decision, and you therefore need to be accountable for that decision. Its unconscionable for an entrepreneur to burn thru investor capital and say “well, darn, that didn’t work but I’m off to do some consulting and hope that everyone has a great life” !
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Jeremy Irish: VC firms have investors that want the maximum return on their investment. If that means diluting your shares, ousting you, or forcing business decisions for near-term gains, you will be pressured to make those decisions. Good VC firms navigate these waters very carefully but these are directions that they can go.
Bill Bryant: VC firms have a fiduciary duty to maximize return on behalf of their investors. Generally, that means “making long term decisions that add to the value of the company in the long haul”. Again, we’re talking about an 8 year time horizon. VCs are not thinking about Q3 2009 results except as an indicator of progress for the company. Making good long term decisions starts with ensuring that the right leadership team is in place to continue to grow the company. All Boards, whether they are investors or not, have this as their #1 responsibility as board members. If that means ousting the founder because they have become a liability, can’t transition to the new level, can’t lead, can’t build a team, can’t make decisions, makes the wrong decisions, can’t inspire…..well, so be it. Once again, the entrepreneur crosses that Rubicon when they take in money. We’re not talking about monarchial dynasties or a sinecure here – you have to earn and continue to warrant your position.
On dilution, remember that affects everyone who is part of the cap table, investors alike. The question is whether the share price increase compensates for the dilution, such that the overall value of ownership increases. And that is in the hands of management (to create an asset that investors continuously assign higher value to).
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Jeremy Irish: Going down the investment route means you start the process of diluting your ownership and there is rarely more than one round. Raising more money means more dilution.
Bill Bryant: See above on dilution. But you’re correct that generally speaking, growth companies are going to require more than one round (or put differently, they won’t want to raise all of the money that they may need up front because the valuation won’t be there and it will be far more dilutive to do so versus raising rounds later on.
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Jeremy Irish: Investors can block a sale of your company if they want to. It is in their best interest to keep the founders happy because they are the business, but if the sale isn’t in their best interest they won’t let you.
Bill Bryant: Yes and no. In a sale, every class of preferred must vote in favor of that sale based on its affect on their own economics - they can vote their own particular special interest. As a BOARD member, however, you are obligated to consider the interests of all shareholders. Its one reason why Board members resign from contentious sales processes, so they can vote their own interests without regard to their Board duties of care. Exits are generally a time where everyone is looking after their own interests because its the last bite of the apple – this includes founders/management who will craft deals where the compensation occurs to them AFTER the deal (the acquiring company will for instance offer to pay relatively nothing for the company but agree to double the founder’s salary, double their stock option, give them 2 months vacation, etc….). My point isn’t that investors won’t act in their own interest in the event of a sale; they will. And so will everyone else. If investors do “block the sale” they oftentimes provide for liquidity to the management/founders at that price (meaning they are telling management by voting with their dollars that they believe the upside is far greater by hanging in).
According to Michael Harpster, a 30-year veteran of film finance and distribution, the producer has two responsibilities to his investors. The first one is to get the film made and the second is to make money for the people who helped get it made. Period. According to Mr. Harpster, “Many films can be made with a relatively small amount of capital if leveraged properly but a lot of attention must be paid to making money for the participants and that always involves distribution.”
The Shareholder Responsibilities Committee focuses on the responsibilities of investors both in their external role as owners of equity and their internal …
But the fact that Whole Foods has responsibilities to our community doesn't mean that we don't have any responsibilities to our investors. …
Welcome to the word of having investors, you are always looking at the
bottom line and ROI.
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