How VCs Block Exits(angelblog.net)
angelblog.net
How VCs Block Exits
http://www.angelblog.net/How_VCs_Block_Exits.html
2 comments
I wonder how they'd feel about dividend checks.
That's what's so frustrating and why companies like Microsoft [1] and Apple [2] are sitting on huge cash piles. Eventually, there's nothing to reinvest the money in to unless you start a) gobbling up companies or b) expand in to unrelated markets. Once it gets to this point, and there's enough rainy day money in the bank, dividends are the way to go. Though looking at the S&P, some companies naively believe they're still growth companies.
From a startup founder's perspective, you could be pressured to compete in markets outside of what you do best. Do you want a 20% chance at $20 million or a 1% chance at $500 million? When do you start becoming risk averse?
[1] Microsoft figured this out and started issuing dividends.
[2] Something like the iPod does not happen to most companies.
That's what's so frustrating and why companies like Microsoft [1] and Apple [2] are sitting on huge cash piles. Eventually, there's nothing to reinvest the money in to unless you start a) gobbling up companies or b) expand in to unrelated markets. Once it gets to this point, and there's enough rainy day money in the bank, dividends are the way to go. Though looking at the S&P, some companies naively believe they're still growth companies.
From a startup founder's perspective, you could be pressured to compete in markets outside of what you do best. Do you want a 20% chance at $20 million or a 1% chance at $500 million? When do you start becoming risk averse?
[1] Microsoft figured this out and started issuing dividends.
[2] Something like the iPod does not happen to most companies.
> Do you want a 20% chance at $20 million or a 1% chance at $500 million?
The answer depends on whether I have $1M already. If I don't, a 20% chance at $20M is worth more to me than a 1% chance at $500M.
It also depends on how many bets I'm making. If I've got a couple of reasonably likely shots at $20M, at shot at $500M is more valuable to me than another shot at $20M. If I don't have any other big bets or only have 1% shots at $500M, a lower-risk, lower-reward bet is more valuable.
Expected value calculations don't tell the whole story. (Or, if you'd prefer, they only tell the whole story in a very constrained situation that almost none of us are in.)
BTW - Microsoft started paying dividends when that became a tax-advantaged way for Gates to get money out of Microsoft. He's the poster-child for "the rich don't pay taxes" and none of the "tax the rich" proposals affect that. (Almost none of his estate is subject to the estate tax that he supports.)
The answer depends on whether I have $1M already. If I don't, a 20% chance at $20M is worth more to me than a 1% chance at $500M.
It also depends on how many bets I'm making. If I've got a couple of reasonably likely shots at $20M, at shot at $500M is more valuable to me than another shot at $20M. If I don't have any other big bets or only have 1% shots at $500M, a lower-risk, lower-reward bet is more valuable.
Expected value calculations don't tell the whole story. (Or, if you'd prefer, they only tell the whole story in a very constrained situation that almost none of us are in.)
BTW - Microsoft started paying dividends when that became a tax-advantaged way for Gates to get money out of Microsoft. He's the poster-child for "the rich don't pay taxes" and none of the "tax the rich" proposals affect that. (Almost none of his estate is subject to the estate tax that he supports.)
This idea that the rich don't pay taxes is somewhat misleading. Yes, certain very very rich people have accountants and tax shelters, but this is not the norm. IIRC, the (income) tax burden is about 40%, this by the top 1%.
So a /few/ rich people /seem/ to not pay any taxes.
So a /few/ rich people /seem/ to not pay any taxes.
They pay some taxes, they just do it at a far lower rate because it's capital gains. It's not the ultra-wealthy paying 40%, it's the working wealthy. Surgeons, who save lives on a daily basis, pay 40%, guys who sold their startup to Yahoo (or who receive it via dividends) pay 15.
I'm not sure how the dividends helped Gates save over just selling the stock though.
I'm not sure how the dividends helped Gates save over just selling the stock though.
Don't forget Gates' charitable activities. They have significant tax consequences.
Gates can collect dividends as long as Microft pays them. He can only sell stock once.
I don't know the details of Gates' finances, but I'll bet real money that his choices make economic sense from his point of view. Maybe it's a coincidence that Microsoft didn't pay dividends until the rates changed, but ...
FWIW, the rate change was intended to increase the dividend payout rate.
Gates can collect dividends as long as Microft pays them. He can only sell stock once.
I don't know the details of Gates' finances, but I'll bet real money that his choices make economic sense from his point of view. Maybe it's a coincidence that Microsoft didn't pay dividends until the rates changed, but ...
FWIW, the rate change was intended to increase the dividend payout rate.
Well, it might be a better investment to hang on to the shares, but it's not tax advantageous when either way results in 15% tax. His charitable activities don't lower his personal tax, they lower his wealth.
Giving most of your money to charity doesn't make economic sense form anyone's point of view, and I don't think Microsoft's dividend was in any way designed to save Bill money. It was done because a company only needs so much cash on hand.
Giving most of your money to charity doesn't make economic sense form anyone's point of view, and I don't think Microsoft's dividend was in any way designed to save Bill money. It was done because a company only needs so much cash on hand.
Charitable donations definitely reduce taxes paid via the relevant deduction - that effectively shields income from being taxed.
If you donate stock held for longer than a year, you can deduct the full market value. According to http://money.cnn.com/2001/12/07/taxes/q_appreciated/index.ht... the deduction goes against ordinary income, which is taxed at a much higher rate than long term capital gains.
If you donate stock held for longer than a year, you can deduct the full market value. According to http://money.cnn.com/2001/12/07/taxes/q_appreciated/index.ht... the deduction goes against ordinary income, which is taxed at a much higher rate than long term capital gains.
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Agreed.
Didn't know about the Gates thing, but I'm pretty sure shareholders were pressuring them as well.
Didn't know about the Gates thing, but I'm pretty sure shareholders were pressuring them as well.
Paul, but the YC sample docs give YC a veto over change of control as well. It's not just the VCs who want that power. Now, you may never have - and state that you never will - exercise that right, but if so, then why is it in there?
The docs he linked to are the Series AA docs we commissioned for YC alumni to use to when raising money from later stage investors. They're not the docs YC itself uses.
In our agreement the clause about change of control is more limited. We only have a veto over selling the company for less than 3x the valuation we invest at. The point of that kind of clause is not to ensure returns (on average, a 3x exit would make us the massive sum of $35k) but to prevent abuse-- e.g. someone selling the company to his brother for $1. Any subscription agreement will have at least that kind of restriction in it.
In our agreement the clause about change of control is more limited. We only have a veto over selling the company for less than 3x the valuation we invest at. The point of that kind of clause is not to ensure returns (on average, a 3x exit would make us the massive sum of $35k) but to prevent abuse-- e.g. someone selling the company to his brother for $1. Any subscription agreement will have at least that kind of restriction in it.
That's more than fair; I appreciate the note. Good to know what to expect when I apply after we exit from Dawdle. :)
What's to stop you from taking YC's money, then selling the company to your wife for $1, assets included, and then shutting down?
YC is very lax in what they allow. There are definitely some deals they've approved that I suspect a normal angel would have blocked in order to hold out for more. But they still need protection from unscrupulous founders.
YC is very lax in what they allow. There are definitely some deals they've approved that I suspect a normal angel would have blocked in order to hold out for more. But they still need protection from unscrupulous founders.
Relationships. Why would you go through applying, having smart enough things to say to get chosen, and then "run off" with a "bounty" of 10-15k, while at the same time burning bridges to an extremely helpful and influential network of people (and possible future investors)? YC's benefits are scarcely about the money.
You have a fiduciary duty to your minority investors. They can sue your ass if you try this.
Look, I understand - if I was going to do it all over again, I'd go through the YC process. But I still do not understand what the purpose of that term is if they're never going to exercise it.
Look, I understand - if I was going to do it all over again, I'd go through the YC process. But I still do not understand what the purpose of that term is if they're never going to exercise it.
Fiduciary duties are murky, and what exactly would Y Combinator sue for? They'd spend 20x more in legal fees than they invested, and after they won, what would they get? None of their $15-20k back (would be gone in legal fees from the startup they sued, if it weren't already wasted) and control of a company that was comprised of 2 or 3 founders who are now gone for obvious reasons. In the end they'd end up spending a couple hundred grand on a mediocre domain name. Doesn't it seem far better to just have that provision?
I have no doubt they'll exercise that provision if they have to. Having that provision ensures they won't. It's like mutually assured destruction, in that having a large nuclear arsenal prevents both sides from ever using it.
I have no doubt they'll exercise that provision if they have to. Having that provision ensures they won't. It's like mutually assured destruction, in that having a large nuclear arsenal prevents both sides from ever using it.
The YC application allowed for a veto at less than 3x. I haven't looked at the sample docs, but that seemed reasonable.
An IPO does not guarantee an exit.
In the UK - typically founders will be explicitly locked in to 2 years service before they can sell any shares - and even then they will only be allowed to sell through the company's main broker and not directly to the market.
At the top of a market you may get away with selling some shares during the IPO itself but in leaner times this is seen as a negative action and discouraged.
In the UK - typically founders will be explicitly locked in to 2 years service before they can sell any shares - and even then they will only be allowed to sell through the company's main broker and not directly to the market.
At the top of a market you may get away with selling some shares during the IPO itself but in leaner times this is seen as a negative action and discouraged.
They wouldn't, you guys do a great job of this. (Though actually, anyone who even bothered to read your website would get much of the same benefit.)
Paul - I agree with you. No VC backed company should be surprised, but in my experience, many are. I believe most entrepreneurs don't really understand share classes and the practical implications of many terms in their investment agreements. Others may understand the terms but are surprised by how they are applied. I applaud your outstanding work in helping to maket this clear to entrepreneurs everywhere. Keep up the great work!
If you sign up for VC, you're signing up to take over the world-- to at least try to get IPO huge (even though IPOs themselves have currently disappeared). This is ok with founders who were planning to anyway. Founders who aren't sure, or are sure they aren't, should only take angel money.
Though nearly all later stage investors want a veto on acquisitions, the point where they'll exercise it varies a lot. It depends mostly on the valuation. As a rule no investor is happy with less than a 5x return, unless the valuation was huge (e.g. in mezzanine round) or the company is in trouble. Over 5x they may still grumble, but most will let you sell the company if you really want to. Or they'll arrange for founders to sell some of their shares privately. Over 10x they'll generally be pretty happy.