Sunday, July 14, 2013

Addressing the founder liquidity problem

The recent reports that Snapchat's founders each took $10 million off the table during their Series B raised the usual debate about founder liquidity:

On the pro side are the arguments espoused by one anonymous investor:
"Founders get 'rich' now, and de-risk some of the startup. Doesn't change alignment, just rewards them for their progress so far, and gives them life flexibility and security to focus on building bigger company"
Bleacher Report founder Bryan Goldberg went even further, calling for more secondaries:
"Venture capitalists have no right to encourage disgustingly irresponsible financial health any more than they have the right to encourage disgustingly irresponsible physical health. If your doctor told you that you needed to take a medication, or else risk severe physical consequences, I bet the investors would get behind that."
On the con side, PEHub's Dan Primack wrote about the signal that secondaries send:
"Why do your founders feel so strongly about banking huge checks today, if they believe in their company's future? And don't I want entrepreneurs building for the long-term, rather than ones just waiting for the first decent exit opportunity? Entrepreneurs who care as much about their vision for its own sake, as they do for the dollars that vision can represent?"
The problem is, both sides make good points.  As a founder, it seems unfair to tie my financial success to a single, completely undiversified investment, especially when my VCs spread their risk across a portfolio of more than 20 companies.  It's also the case that taking money off the table reduces the pressure to settle for an early exit.

But it is also true that secondaries can be abused.  I've heard of multiple instances where the founders at well-known companies took money off the table, and then stopped focusing on their companies.  Sudden wealth affects everyone, even founders.

I think I have a solution that addresses both issues.  What if the secondary proceeds were placed in escrow?  The funds would be released over time, say 5% per year, with a balloon payment of the final 75% after 5 years, or upon liquidity, whichever came later.

This would provide founders with financial security and some current cash, addressing the pro arguments, while keeping the founders focused on their company.  Even a smaller $5 million cashout would result in $250K/year payments for 5 years, followed by a final balloon payment.

Would this work?  Who knows.  But isn't trying something different better than trotting out the same standard arguments?

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