Posts from entrepreneurship

What Happens When A Founder Is Fully Vested?

Let’s say you are the founder and CEO of a startup and you have now been at it for four years. The company is doing great, you’ve raised several rounds of financing, you have a product in the market that is solving a real problem, you have a bunch of customers, you have a growing team, and things are stressful but largely great.

And you realize that you are now fully vested on your founder’s stock which means if you were to leave the company tomorrow, you get to keep all of it. What do you do about that?

This is a common question I hear from founders. They ask me what is standard in this situation. And I tell them that not only is there no standard answer, that this is one of the most emotionally charged issues to come between founders and their investors and boards and companies.

This situation also exists for other founders who are not the CEO, and the issues are very similar, but for the purposes of keeping this post as simple as possible, I am going to focus on the founder/CEO role.

Here are some, but not all, of the issues that come into play in thinking about this:

1/ If a founder/CEO were to leave their company after they become fully vested on their founder’s stock, the company would have to go out and hire a new CEO and that new CEO would get an equity grant that would be between 2.5% and 7.5% of the Company, depending on the value of the business. So one could certainly argue that the founder CEO ought to get similarly compensated.

2/ But that argument about how a new CEO should be compensated essentially puts on the table the question of whether the founder CEO is actually the best person to run the Company right now or if there is someone better suited to do that who could be recruited for a new market equity grant. It is often not in everyone’s best interests to have that conversation.

3/ Many founder CEOs four years in still own a lot of their companies. A typical range would be between 10% and 40% depending on if there are co-founders and how much capital had to be raised in the early years and at what valuations. For most situations, an equity grant that would be made to a new CEO is actually a relatively small percentage of the overall equity ownership of a founder CEO and in the context of that, it is not as valuable to the founder CEO as many other things.

4/ However, the founder CEO is subject to additional dilution in subsequent rounds so a new grant would at least partially offset future dilution and that is quite attractive to founder CEOs.

5/ One of the most valuable things to a founder CEO is having a large unissued equity pool from which to hire talent into their company and any allocation of that pool to the founder CEO reduces that asset.

6/ It is generally a good practice to have all executives vesting into some equity compensation. It standardizes the executive compensation program and aligns incentives.

7/ Refresh grants for executives are not usually equal to their sign-on grants. They are usually some percentage of the sign-on grant. So the same should be true of a founder CEO getting a refresh except that they never got a sign-on grant.

8/ Investors bet on the appreciation of the equity they already own not the issuance of new equity. A founder is aligned with the investors when they too are focused on making the equity they already own more valuable.

9/ When founders get diluted below double-digit ownership, they begin to see themselves as employees, not owners and that is bad for the company, the team, and the investors. For some founders, they start to feel that way at below 20% or 15%.

10/ It is hardly ever the case that what happens after a founder is completely vested is negotiated ahead of time, during the various rounds of financings, and priced in by the investors. If a founder was to pre-negotiate a new “market grant” for themselves once they are fully vested, and that was included in the size of the option pool that is set aside and baked into the pre-money valuation, investors could model that future dilution and build that into their valuation models and price that into a round. But nobody does that because founders want to maximize valuation in the financing rounds and investors assume that the founders will be happy with their initial grant or will not be around to earn it. Both parties either naively or purposefully kick the can down the road until the issue rears its head and then the emotions come out.

So what happens in practice?

It depends entirely on the situation at hand.

If the founder CEO owns a large percentage of the business, a new grant is rarely made because the value of it pales in comparison to the annual value that their founder’s equity is increasing organically.

If the founder CEO has been massively diluted and owns a small percentage of the business, a new grant is often made.

If the business is performing very well, the likelihood of a new grant is higher.

If the business is performing poorly, the introduction of the idea of a new grant can be very destabilizing and can actually precipitate a larger conversation about who should be running the company.

A common area for compromise is a new grant to the Founder CEO that is some percentage of what a “market” grant to a new CEO would be and that percentage ranges from 20% to 50% depending on the situation. The less a founder owns of the company, the higher the percentage will be and the more a founder owns, the less that percentage will be. If a Founder owns more than a quarter of the business, this is almost never done. I certainly have never seen it done for founders who own more than a quarter of the business.

I have two suggestions for how entrepreneurs should handle this issue.

The first suggestion is that you might want to raise this issue with all of your investors before you take money from them, and understand how they feel about this issue and what their expectations are so that you know that ahead of time. Do not wait until the moment to find that out.

The second is that if you wait to raise this issue once you are fully vested, do it carefully and delicately. If it is seen as a demand, it will not go well. If it is seen as a discussion about what is in the best interests of the company, it will go better.

But most of all, remember that there is no “one size fits all” solution for this situation and that you and your board will have to figure it out on a case by case basis.

Broken Syndicates

One of the most challenging situations in startup/venture capital land is the broken syndicate. It is not a topic that is talked about much, but it is fairly common, particularly for companies that succeed in building a business but falter at achieving escape velocity.

A syndicate is a group of investors that come together to support a startup financially. They tend to be built over time. Some investors get involved with a company in its seed round. Others get involved in a company in the Series A round. And some get involved in the Series B round.

By the time a startup has raised three or four rounds of venture capital, it is likely to have built a syndicate of between three and five venture capital firms and other investors (corporate, strategic, individuals, family offices, etc).

The idea is that the syndicate supports the company financially until it no longer needs capital. That can happen via a sale of the company, an IPO, or achieving profitable operations.

And that is typically what happens in the best situations, when the company executes well and finds that happy financial chart that goes up and to the right with a steepening slope. In companies like that, the syndicate almost always sticks together and more investors clamor to get into it.

And then there is the company that never really figures out how to build a business. In those situations, everyone around the table, including the founders, figure out how to wind things down, either through a sale of the business, an acquihire, or a wind down. This happens all the time and is generally not a particularly painful process.

But there is a middle ground, where the team figures out how to build a business with customers, revenue, and lots of employees. But often the business stumbles and revenues flatten and losses pile up and more capital is needed, often a lot more than the existing syndicate is prepared for. This is when there are often management changes, founders depart, and there is a lot of drama.

And holding a syndicate together during the “stumble” is very hard. Some investors are managing huge funds and need exits that will produce hundreds of millions to their fund. When they see that a company will not do that, they often move on. Some investors have small funds and don’t have the capacity to fund a company round after round. Corporate and strategic investors can lose interest when a company stumbles and they no longer believe the business is strategic to them. 

Those are the “rational” reasons that syndicates break.

But there are other reasons. There is a fair bit of churn inside venture capital firms right now. Younger partners leave to start their own firms. Or are asked to leave because they are not producing the expected returns. When a partner who leads an investment inside a venture capital firm leaves, the investment is often “orphaned” and the other partners will pretend to support it but they really don’t want to and don’t.

Or even more upsetting is when a venture capital firm finds another company in the same sector that they like more and they lose interest in your company and stop supporting it.

All of these things happen to companies who stumble and they happen way more frequently than anyone talks about. It really doesn’t benefit anyone to go public with these situations. So they are worked out quietly.

Often broken syndicates lead to early exits, when the founder(s) and remaining investors realize that they are screwed and decide to find a home for the business before they run out of gas. Many times these exits are disappointing outcomes relative to the opportunity and they can make for fantastic acquisitions.

Another thing that happens with broken syndicates is the recapitalization. This is when the remaining investors reset the valuation in order to bring in new capital, either from their funds or ideally from fresh sources of capital. The losers in this situation are the early investors, founders, and investors who walked away. 

And sometimes what happens is the business shuts down, leaving people scratching their heads. Why did that company which had lots of customers, revenues, and employees suddenly close up shop? Well the answer is often that their syndicate broke and they could not put it back together.

At USV, we have worked through these stumbles and broken syndicates many times over the years. We often find ourselves in the position of trying to put Humpty Dumpty back together again. We have managed to do that many times. But we don’t manage to do it every time. 

It is incredibly difficult work, probably the hardest work we do in the venture capital business. And we often are asked why we bother.

We have found that we can make excellent returns when we stick to our conviction around an opportunity and work to restructure the team, the operations, and the syndicate (and the valuation). We also have found that we are rewarded reputationally in the market as investors who are supportive when times get tough. And we believe that it our job to support companies and the founders who create them.

We wish everyone in venture capital land saw things the way we do, but they do not. And that is the reality of the world we operate in. 

Founders need to understand all of this when they put their syndicates together. You should ask around about the investors who want to put money in your company. Look for companies that have stumbled and get to the people who know what happened in those situations and ask about how their investors behaved. That will tell you a lot.

The bottom line is that syndicates are fragile things. They break. And putting them back together is hard. So figure how to build one that is strong and will stay strong. The best way to do that is to under promise and over deliver on the business plan. But you can also do yourself a lot of good by finding resilient investors and getting them into your cap table. So do that too.

The Post-Sale Stay-Period

There is a lot of chatter on Tech Twitter and elsewhere about the Instagram founders leaving Facebook six years after selling their company to Facebook.

All I can say about that situation is they gave Facebook way more of their time and energy than most founders would have.

Of course there are cases where founders stay at the buyer for many years, sometimes even rising to become CEO

But that is rare.

Way more common is the founder bailing after a year or less.

When companies that I am on the board of acquire founder-led companies, I advise them to highly incentivize the founders to stay (usually with a combination of cash and stock that is time based) but prepare for them to leave (by having a clear succession and transition plan in place right away).

The truth is that many entrepreneurs don’t make for great corporate citizens. Entrepreneurs like to be in charge, to be able to move quickly without a lot of friction, and they like to feel a deep sense of ownership in what they are working on.

That is often hard to find in a corporate environment where teamwork, collaborative decision making, and checks and balances are the norm.

I am a big believer in acquisitions as a path for wealth creation (for both the seller and buyer) and as a logical exit for most startup founders. And staying for some period of time is required to make the acquisition work for both parties.

But getting the founders to stay for six years is an amazing accomplishment and quite rare in my experience.

How Diversity Happens

Henry Ward, founder and CEO of our portfolio company Carta, wrote a post yesterday outlining the gender inequity on cap tables throughout the startup landscape.

It is a good post and I would recommend you click through and read it.

In it, Henry writes:

When I started Carta I didn’t focus on diversity because I was worrying about staying alive. Then we hit our growth phase and went from 20 employees to 400 in 48 months. I assumed diversity would happen on its own. Of course it didn’t. I didn’t realize how much deliberate focus it takes. I do now.

That is a pretty typical story.

A few years at our annual CEO summit, Scott Heiferman, founder and CEO of Meetup, told a room full of startup CEOs that you have to build diversity into your company from day one because if you don’t, it becomes so much harder later on. He explained that nobody wants to join a company where nobody looks like them. That really hit home and woke quite a few people up.

All companies and people suffer from back burnering things. You focus on what you must get done and everything else takes a back seat.

That doesn’t work when it comes to hiring and diversity. You have to prioritize it and make it intentional.

We have done that recently at USV and we are getting the desired results.

That is very exciting to me.

Marathon Man

The New York Times has a piece up on Eliud Kipchoge, the world’s best marathon runner.

I read it with interest yesterday as I like to think of startups as marathons and I am always on the lookout for ideas and insights that can help entrepreneurs and investors.

Eliud is an impressive person and, as you might expect, he is extremely disciplined.

He says in the piece:

Only the disciplined ones in life are free. If you are undisciplined, you are a slave to your moods and your passions.

That rings so true to me.

It is true in investing, where I like to have a framework and stick to it and not let my emotions get in the way.

But it is also true in building companies.

Being focused on the long game and what you want to achieve is the best way to get there.

I see many teams looking around at what others are doing and it makes them crazy.

And I see a few teams heads down, executing their plan, and it makes them calm.

In the short run, it can often seem like nothing is getting done, and your competitors are passing you by.

But, like the marathon runner, it is never the sprinter that wins the race, it is the dogged and determined that is there at the end with the trophy in hand.

Eliud just broke the world record in Berlin today. He finished in 2 hours, 1 minute and 39 seconds.

He’s an inspiration to all of us.

First Mover Disadvantage

Getting to something first has tremendous advantages but also comes with a bunch of challenges.

I was thinking about this yesterday as I was setting up a couple iPads to be used around our house as smart home controllers.

The Apple identity management and app store systems feel like they were built for a different era. Because they were.

Comparing those experiences to Google, which is not a new company either, is eye-opening.

You can also see this in crypto. Companies that were built in the age of one crypto-asset (Bitcoin) have to retool their software to make it work well in an age of multiple crypto-assets. Companies that were started in the age of multiple crypto-assets have the benefit of starting day one with a different perspective.

If I had to pick first mover or second mover, I would still pick first mover because I think it is easier to attain a dominant market position when you don’t have any competitors.

Once the market opportunity has been identified, and there are multiple companies competing for market leadership, it becomes more difficult to win.

But if you are the first mover, you need to understand a few things:

1/ Life gets harder, not easier, when you have established yourself as the market leader.

2/ You need to invest in top-notch product and engineering teams because product execution and technical debt will become significant challenges.

3/ You need to use your market leadership to build a balance sheet and a team that can allow you to manage the transition from first mover to market leader.

4/ Many of the best ideas will come from your emerging competitors. Look at their product execution for inspiration (Facebook has done an excellent job at this).

It is not a given that fast followers will beat a first mover, but that has certainly happened time and time again in the world of technology, internet, and mobile over the last thirty years.

I think that bad management and weak leadership of the first movers has as much to do with that as anything.

First movers can and often do maintain their market leadership. But doing so is a lot harder than people think.

Video Of The Week: Ten Ways To Be Your Own Boss

I spoke to a group of women entrepreneurs a few weeks ago, and one asked me “why do you need to raise VC?”

And the answer is “you don’t.”

The vast majority of entrepreneurs out there don’t raise VC. Many don’t raise any money to start their businesses.

As I was answering that question, I thought about a talk I gave at the 99U Conference back in 2012 called “Ten Ways To Be Your Own Boss.”

I’m sure I have posted this here before, probably back in 2012, but I thought I’d post it again.

It makes the point that you don’t need VC to be an entrepreneur pretty nicely.

I Don’t Know

An entrepreneur asked me a great question last week:

When is it OK to say I don’t know in a pitch meeting?

I told her the following things:

1/ This varies from investor to investor. Some investors are looking for founders to have all the answers.

2/ I am not one of those investors but I do want the founders to have some of the answers.

3/ If I asked her how large and valuable her publicly traded competitor is, and she said “I don’t know but I will find out and get back to you on that”, I would be fine with that answer.

4/ If I asked her what the tech stack is that her engineering team is using to build the product, I would be dissapointed if she didn’t know that answer.

In general, I believe it is critical that the founder be knowledgeable about all the details and aspects of the internal operations. They should have those answers on the tip of their tongue. That includes things like monthly burn, cash balance, headcount, etc.

And if you don’t know the answer to the question, you should be honest about it and say that you will get it and get back to the investor. And do that quickly.

Sometimes investors ask ridiculous questions and then you have to bite your tongue and be polite.

I will end with a great story. It was 1991 and we had seed funded a brilliant software engineer who was building a product for the wall street sector. I took him to see a very prestigious VC as we were looking to fill out the seed round. The company was maybe six months old and was not yet in market with the product.

The entrepreneur started in on the market, the opportunity, and the product. Maybe three or four minutes in, the VC interrupts the founder and asks, “what will your revenues and profits be next year and the year after?”

The founder was pissed. He had not even gotten to the product they were building and he was annoyed by the interruption and the question.

So he answers in his broken English “I don’t have a fucking clue.”

Our meeting ended several minutes later and we were shown the door.

We did not secure an investment from that VC but the company was successful and went public five or six years later.

So you obviously don’t need to have all of the answers in a pitch meeting to be successful. But you do need to be polite and respectful if you want to secure the funding. And there are some things you absolutely need to know the answers to.

The Long Raise

I’ve been chairing a $40 million capital campaign for NYC’s CS4All effort to bring computer science education to every school and every student in the nation’s largest school district.

We are just into year four of the ten-year CS4All effort and we are also into year four of the capital campaign.

The good news is I can see the light at the end of the tunnel. Depending on whether you count “soft circles” or not, I think we have about $10 million left to raise.

We started out with a bang, announcing $11.5mm in contributions, including those of my wife and me, at the start of the effort.

Year one went well, with another roughly eight million raised.

Year two was a struggle and year three started out similarly. We made some changes to our team and strategy and message and the second half of year three was much better and we are entering year four with great momentum.

I have learned a lot about running a capital campaign or any sort of large and long fundraising effort and I thought I would share some of the big lessons:

1/ You have to be patient. It is a marathon, not a sprint. No matter how much you want it to go quickly, it won’t.

2/ Cultivation is the name of the game. You have to work the top prospects slowly and carefully and patiently. Most eventually come through but you need to invest a lot of time and effort without any certainty of closure. I found this particularly hard as I always want to be investing my time where it is going to pay off.

3/ You need people around you who are experienced fundraisers. There is an art AND a science to qualifying, presenting, and following up that the best people in the fundraising business understand and bring to their work. Without that, you are going to flounder.

4/ Communicating and engaging your donors is critical. I thought a donor would write one check and be done. It turns out many donors like to start small and grow their committment over time as they see progress and get comfortable with the effort.

It turns out that raising a big sum of money is like a lot of other things in business and life. Slow and steady is a virtue, great people make all of the difference, your best prospects are the people you have already closed, and frequent communication fixes a lot of problems.

I think all of these lessons I have learned in the last three years are applicable to raising capital for your business. Fundraising is a process not a campaign and it needs to be part of a CEO’s daily cadence and calendar.

You are never not raising money when you are running a company or any sort of business endeavor that requires capital, which is basically everything.