Wednesday, December 27, 2006

Founder payouts are now in business

Turns out The Founders Fund has started talking openly a partial buyout of founder stock by Venture Capitalists. What this means in simple terms is: When a VC firm invests in a company, they give part of the money to the founder in exchange for her stock.

Now TFF (my acronym) is a group of founders, so you would think they are biased. They've been founders that have become VCs; and perhaps they understand the nature of entrepreneurs better. They are doing something a lot of people (including me) have been talking about lately. Paul Graham mentions this in two essays. For angels he ascribes this as a plus:

Angels have a corresponding advantage, however: they're also not bound by all the rules that VC firms are. And so they can, for example, allow founders to cash out partially in a funding round, by selling some of their stock directly to the investors.
And he says it to VCs too:
..letting the founders sell a little stock early would generally be better for the company, because it would cause the founders' attitudes toward risk to be aligned with the VCs.

What he means is that founders have all eggs in one basket. VCs on the other hand revel in diversification, and a little money to the founders balances the risk a little bit.

Imagine this: You have struggled like crazy through the early years of a startup, drunk the early morning coffee by staying awake all night, had a lump in your throat when you told an employee his salary would be a week late, and in general took your health, family and personal life for granted; you have then built your idea on the grave of everything that will matter in the long run, and shown some traction, and then pitched it to a VC who's decided that yes, it *is* ok to fund.

Now this VC demands a big piece of the pie, asks more of your time to give him a weekly report, releases the money in parts based on performance so the lump in your throat is now a physical feature rather than a temporary blip, and in general, expects a lot more than you expected when he signed up.

In return, you ask for a bit of money to make it all seem worthwhile. And give up a bit of stock for it. It's not the end of the road, but believe me, you like a road a lot more if every once in a while, you were able to see something interesting.

Investors find that disgusting and they would say 'Yeah, after all, it's our money, why should we pay them and not the company? Why do they get paid when we don't?'

But the same guys wouldn't mind the startup paying a sign-on bonus to get new blood. And they wouldn't mind having the company pay a CFO mega bucks, a big-name auditor to say "yeah, this kinda looks sorta ok",and pay lawyers to rewrite the website terms and conditions at $500 an hour. Yet, a founder payoff is miserable, somehow? (Caveat: If this happens a few days before a liquidity event, it's kinda stupid, because the event may value the company far higher than you sell stock for)

Founders don't get less hungry when they get paid. If money has taught me anything, it is that a little bit of it makes you want a lot more. Heck, why only money, it's the lure of anything. Revealing dress = more attractive than the lack of dress. It seems the VCs want you to wear burqas instead.

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