Sell for half a billion and get nothing (2021)

Yeah I have a small business and I sway strongly towards being contempt with letting the business grow at its own rate.

No, it won’t have a 1 bil payout, but you make your own rules and you’ll get a healthy cash out from the dividends after only 1 year or so.

It also forces you to keep pivoting and finding a cash cow rather than assuming your initial plan was any good. We’re on like plan #10 now and in hindsight if we went with any of our original plans we’d still be burning money whereas current plan was profitable after just 1 month once we figured it out.

The summary is "When the FanDuel founders raised funds, two key investors received a liquidation preference that entitled them to the first $559M in an acquisition. Founders and employees would be paid only if the acquisition exceeded $559M. Because the Paddy Power Betfair was for just $465M, the founders received nothing"

Also they raised over 400M in funding. If you exit with 465M with 400 million raised in funding AND liquidation preference entitles investors to first $559M in an aquisition, of course you are going to get nothing.

The question is why they raised 400M in funding and could only exit for 465M. This tells me it was a failed business.

That's not super useful advice for founders who (really) need some investment from the get go.

The lesson would rather be: don't raise so much at the seed stage. Google got started with a $100K grant.

FanDuel raised $400M in four years [1]

And it looks like one of the the FanDuel founders did it again [2]

This is reckless and should be a massive red flag for new joiners.

[1] https://en.wikipedia.org/wiki/FanDuel

[2] https://futurescot.com/fanduel-co-founder-secures-largest-uk...

It's still better to have 10% of a billion rather than 100% of a million. It's just that "valuation" is only one of the metrics that really matters, and selling your equity has to be done progressively and by reading the small prints in every file. It's sad that startup founders have become so good at raising money that they forget that a path to profitability + understanding the actual financials (beyond just valuation) matters.

Also, avoid that VC/Shareholder and blacklist them.

That’s like reading an article about domestic abuse, and deciding that one should just never be in a relationship because that could happen.

Dunno, the lesson I've learned is "have your lawyers look at it, and don't fucking give the VCs full priority" would also have worked.

So true. There’s only so many things you can master at once. Better to master making a product people will pay for, than playing the VC game for the first time when they’ve already mastered the rules

Are we working at the same company? :)

"Can I see the cap table?" - "Can I see the terms of the investors?"

These questions should become so normalized that founders don’t bat an eye at it. If I am an early employee, we are partners. Wanting to know my percentage and the company’s liabilities before I sign is not unreasonable. I also want to hear you talk convincingly about your plans for future investment.

I think you're in a same-same path with this.

That is, If you say "No, I don't want equity", they still owe your back pay, there are multiple ways to get it, AND if either "back pay" or "equity" is to have value, they must have more funding. Which means, out of that funding can immediately come your back pay.

So if you take the equity, or insist on pay, both are the same in the end.

In fact, by not showing you what you need to know? They're forcing you to go after any investment they get for backpay.

I've always found, in every single case, if someone doesn't want to show me something? It's because they know they're scamming you. Or selling false goods.

No one with a sensible, reasonable deal ever desires to hide what the deal is.

In fact, you should most insist and see what the founders are getting too. And the older investors. But either way, you are 100% owed salary, without dilution, and in most jurisdictions employee wages are class A, come first, before anyone gets cash -- investor or not.

Is this the case in your region?

They are unlikely to show the full cap table. Consider asking for the most recent 409a valuation, the total shares outstanding, and the size and liquidation preference of the past rounds. That’s a smaller ask that will give you the most important info.

Most likely you already know the answer.

In a fantasy scenario, you could take the stock they’re offering and demand to have a more senior stake and a 5x liquidation preference.

What is meant by "cannot meet its capex obligations"?

Leave my dude. You'll be better off

Wow, do not understand this approach some founders take. Being “radically” transparent by showing your cap table and talking through liquidation prefs/exit scenarios with every single employee is an absolute prerequisite for me. For me this has driven loyalty and paid dividends in culture and retention. I would not work for a startup where the founder wouldn’t share that info.

Working without pay is the reddest of red flags in any company. It’s not even a business at that point - it’s a volunteer gig.

It sounds like you already know, but that company is almost certainly in its final throes before bankruptcy. Do not take stock, get as much of your back pay as you can, and get out.

Your writing style is the inspiring level kind.

I swear, some entrepreneurs must think I stepped off the boat yesterday.

Or can be bullied into accepting, even if you aren’t clueless. I do know people like that. Conflict is more painful than loss.

If you have a reasonably documented trail that you’re owed back pay, I’d take a “f#%k you; pay me” [in money, not paper] approach.

No way would I put $200K into a startup that’s facing a down round, especially not as an employee.

"Let's convert this back pay that you are legally owed and we almost certainly violated a couple state and federal laws by not paying you into equity" is a pretty ballsy suggestion, but couple that with not being allowed to see the cap table is the kind of thing you have board room fist fights over.

Sounds like they should fire that primary stakeholder, claw back his equity, hire someone who knows what the hell they're doing, and hope to god the employees don't walk or sue the hell out of them - both of which they probably should do.

If they owe you back pay and they're not being transparent about their "equity offer" you need to take steps to get in line for your money NOW. Talk to a lawyer. Assuming this is the US since you're quoting dollars: if you're an employee, a complaint to the state Dept of Labor about back pay usually puts you first in line for money. If you're on contract, you might be able to get a lein on...something of value. Seriously, don't wait on this if you expect to ever get paid.

You can at least file a wage claim without even having a lawyer https://www.calaborlaw.com/complaint/ In California, you are also entitled to more than minimum wage if you're an exempt SWE.

IIRC (depending on where it's incorporated) if you exercise an option so that you own a share, you are entitled to see the cap table.

Intrigued as hell by this comment.

But, can you clarify? You say they should know you weren't born yesterday, but your post also implies you're working with these people.

What's the missing detail?

What are you getting out of this that makes the other red flags "worth ignoring"? What keeps you showing up?

It's not just your friend: a lot of people have given up on options. Obviously they're underrepresented here on HN because this is a startup-focused forum, but I know many, many people who have concluded "options have an EV of zero, startups pay options in lieu of market-rate salary, therefore startups are a raw deal; I will only go to FAANGs". They're sort of a dark matter universe since they are only visible in their absence here, but I do think that startups don't have access to the same talent pool as they used to, and sooner or later this will catch up with the ecosystem.

I think it's worth it still. Depending a lot on the company:

  * Ask questions to founders if they raise on participating preferred (the worst). Don't take a job if they do or if they won't answer
  * Find a place with early exercise of options
  * Find a place with a healthy company culture. (I believe this correlates)

Plenty of people made millions joining series C/D deca-corns and selling in the IPO pop.

Are there really that many success stories for people other than for VCs and (maybe) founders out there anymore?

I was the employee around #300 at Atlassian, the founders didn’t dilute the employees, and my options netted $3m (minus the taxes) after working there for 3 years and waiting 6 years.

Scott Farquhar and Mike Cannon-Brookes were hell-bent on being honest, fair and giving back. There are good people out there.

I don't think startup compensation has yet to account for the wage gains in big tech since Facebook started bidding up comp. They are still operating as if it's 2009.

We'd also need a new technology as big as the PC and the Internet to open up lanes for new entrants. As it is the incumbents have locked up most of the market so that's where the money is.

The first time I was strongly considering a startup I had to essentially treat the options as worthless. Both because of the usual fact that most startups fail, but because of stuff like in the article: I couldn't convince myself in any way that there wouldn't be people ahead of me in the line if the company was sold, despite the fact that the founders themselves seemed totally honest.

Had a friend who was employee number 15 at a startup that was acquired for a large amount. Net result was that he earned approximately the same as a FAANG engineer over the same time period (7 years - total comp). He was able to parlay that startup build-to-acquisition experience into better positions in startups after and seems relatively happy about it.

I feel like the key is 1) don’t count on your options being worth anything at all, and 2) work for savvy founders that know how to get the employees taken care of. This means never taking more money than they need, not giving away multipliers, giving non-negligible percentages to employees, and focusing on making the business actually have intrinsic value instead of letting “how much can we raise” drive their sense of value.

I feel like a lot of people (founders included) buy into the idea that the VCs should be able to walk in and screw everyone out of their equity because they hold all the cards. If you work for founders that believe this, you will definitely get screwed, partially because the founders will believe screwing you is just part of the game.

1x non participating is still the standard in most venture deals for companies doing reasonably well. But every dollar spent by startups essentially builds the preference against them. If you raise and don't spend the money, the balance sheet can be used to "offset" the liquidation preference in a sale.

maybe in Silicon Valley, but in New England and other less mature markets nothing has ever changed

feel free to change my view, for anyone passing by

If you're on really shitty acquisition terms like this, to the point where you are getting no payout for your hard work, one way you can get a small payout is to negotiate your employment contract with the new parent company to be very, very good.

Make sure they give you and all employees a nice big sign on bonus and salary. They can deduct that from the proposed acquisition price.

Is it ethical? I say yes, you should get paid more than $0 for your hard work to be handed over. Should the investors get a payout too? Yes, but they shouldn't be getting 100% of it, ever.

Very enlightening thanks! I wonder if there is or could be some notion of "vesting" over time of the investment such that (1) could not happen. So if the founder tried to sell tomorrow, the investor would get back 1x, but that 1x decays to 0.2x over 5 years or something.

But I guess VCs generally have the leverage and wouldn't want such terms.

Genuine question:

For liquidation preference >= 1x, why even call it equity instead of debt?

The point of equity is that you own a part of it, and you get a proportional share. The point of debt is that the money owed to you is preferred over other owners (i.e. equity owners). It seems to me that liquidation preferences allow investors to take the best of both worlds.

Something I've seen recently is the founder thats willing to let a company die.

I suspect these founders find some way to extract as much as possible from their company after raising funds.

Without naming names, I've seen a startup go boom (raise huge money and be valued at 3x that huge money), then all the senior leadership disappear: moved out of state, only show up for pre-recorded town halls (that used to be live), no longer a part of engineering meetings, cancelling department meetings, etc.

That went on for a couple years until the founder minimized their position in the company.

I don't understand how that could happen unless that founder extracted what they wanted and were just riding the ride rather than marching towards IPO.

Great write up, thanks for sharing this.

As a founder, I'd always though that >1x was predatory with no excuses, but your #2 really clarified that an appropriate situation.

Leo does a great job explaining why VC's want liquidation preferences.

But founders/employees want them too! With all the crazy founder-friendly deals of 2021, I never heard of one in the US without a liquidation preference.

Why? Liquidation preferences allow the VC bought securities to be treated as "preferred" and reduce the common stock price in the 409a valuation report, allowing early employees to get options at low prices.

If VC's invested in common stock the strike prices would be much higher, making it less lucrative to be an early employee.

In parts of Europe there is different tax treatment for options and employees generally don't own as many shares due to it... and some of those companies don't have liquidation preferences. I believe Klarna (Sweden) doesn't have preferred shares, meaning the huge swing in valuation they had over the past few years is not as bad as it seems.

TBH the whole 409a thing is a charade & we probably need to clean up how we do accounting & taxes but until we do, preferred shares are here to stay.

Related to #2, professional investors understand that the implied valuation in a round with a >1x liquidation pref is, in a word, bullshit. As an employee, you too should keep this in mind when you are valuing your equity package.

1) I wouldn't call it "very" fair. VCs can (and almost always do?) also have a veto on such sales in the terms, so they don't need the preference to protect their investment. Which is more fair?

2) You missed the 3rd case, sometimes the business is simply a bad one (like the example in TFA), or all the oxygen is getting sucked out by the new shepherd dog, eg right now with AI. The business can die right then and there, or the founder can take the equity on the only terms they can get. Given that any decent founder is drunk on their own kool-aid, and believes their fortunes will change in just 1 quarter or even 1 year, they just need to ride it out, it often seems like a good idea, and what's the difference? Die now or die later. At least take a shot at it.

IOW it's not all villains on one side and incompetent heroes on the other.

The real downside is that now you're working for the VCs. You kind of were the entire time -- that's built-in -- but it's more pointed now. If you make it to IPO none if it matters ...

As the theme of TFA's website goes, build a "fundable" startup. Easier said then done, of course. Like so many of such self-help in the startup world, the entire site is a bit of a lie, selling false hope. They even position FanDuel as some VC abusive situation (thus selling themself as the savior), by talking only about the huge amount of money, "half a billion" dollars. No mention at all of how much FanDuel raised ...

This helped my understanding of VC/founder relation much better. Thanks for putting a broader perspective to the situation described in the original post.

This is a good explanation. However, if you do take on liquidation prefs, you should be open with other parties (employees) who are affected. I have never, ever experienced employers who have volunteered this information. I have also been told, when I asked about liquidiation prefs, that they had no way of determining whether or not that provision existed in their investment terms (!).

What if you raised 500B and still got nothing? That can happen with 2x or 3x liquidation preference.

IDK FanDuel structure (not in article), but they only raised ~ 400M. Yet the investors got every dime up to 550+M.

Except we're talking about 100% and 200% interest rates, if you read the article.

We're talking a $1G company financing $333M and getting nothing.

Gotta do it the Adam Neumann way...

You wrote that back in 2015. What, in your experience, has changed since then? 2021 would've probably, I'm guessing, been a lot more favorable for founders, but 2022/23/24 is likely a lot less favorable.

Run where? When I talk to my fellow early stage east coast founders, the majority aren’t beating away founder friendly term sheets. Even seed stage companies with revenue and traction raising relatively small amounts are giving away board seats and agreeing to multiple preferences because they have nowhere else to go.

Away from the east coast? If funding on good terms is important to your business, go somewhere you can get funding on good terms.

Gambling company should know the house always wins.

If I read crunchbase correctly FanDuel got $350M in funding by 2015, and sold for $465M 9 years later, for 33% ROI, or about 3%/yr. Founders don't deserve anything just for managing to hold on to investor capital and not lose it. Investing money at below market rates is not an achievement. Founders and employees weren't robbed.

Also, OP is just a bad ad.

Private equity firms. I’d never take money from them.

I’m a bootstrapped founder but hard disagree with this take.

Surely it can’t be the founder taking home a healthy salary from day 1 despite the company being far away from any revenue at all that is taking the risk in your book?

Yeah there's a lot of rationalizing going on here, the investors have more generous terms because they have a lot of market power compared to anybody else at the company, nothing more, nothing less. It doesn't necessarily correlate with risks.

This is a naive and simplistic view that immediately breaks down in the face of individual freedom. Founders are not forced to take investment, nor are investors force to make it. Terms must be negotiated.

You can say liquidation preference should be forbidden, but that's a slippery slope. Many founders accept a liquidation for larger valuation, and many deals would not happen without it. I'm not sure why we would draw the moral line here since the risk of founding and joining startups exists either way.

Having bootstrapped and also founded VC-backed companies, the VCs are effectively making you an employee. But you get to gamble some of your paycheck, so it's a bargain a lot of people are interested in. A lot of my friends who are in the VC space see "X person sold company Y for $500 million" and sort of assume that X made at least $100 million from that transaction, when they very often didn't.

The bootstrapping/small money path is so much more like actually starting a business, but it's a lot harder. On top of the investment, you get a lot of free publicity and some legitimate street cred from having gotten VC investment.

They are just employees on some level, but they are also typically owners with a lot of risk on the table themselves. Even if they come in with what would be “a lot” of money to most of us, it can’t compete with investment capital.

We build energy plants with investor money as an example. They don’t invest in us, but into the projects we run, so it’s a little bit different than having someone invest in us (but I’ll get to that). We don’t solely build a power plant with investor money though, we build it with a mix of investor money, loans and our own money, and that last bit just got a whole lot larger (meaning we can do much larger projects) with private equity investing into us directly. So now instead of doing a tiny mom-and-pops sort of solar plant, we can build some of the largest solar plants in the world. The payout on the other side isn’t linear either, there is much, much, more money in a single large plant than in a hundred tiny plants. Especially when you sell the product a few years after its completion.

In the current world, maybe it would’ve been better to not take private equity on board, but at the time it was done, nobody knew Putin would invade, that the global supply lines and manufacturing power would never recover from covid, or, that interest rates would go above 15% in countries where they were below 1%. Everyone knew the low interest rates wouldn’t stay, but we sure didn’t expect them to go so far above 8%.

Anyway, even if the world hadn’t gone to shit, our company would still have been 10-20 people and not in the hundreds if we hadn’t acquired the massive amount of funds. Since while our founders are rather rich, they aren’t that rich, and this would’ve limited the company growth to such a significant degree that even two years of economic turmoil has us at a level we would’ve likely never reached. It’s not all gloom and doom either, people still need power after all.

So you’re both right and wrong, founders sort of become employees, but not really. How much they lean toward the employee “title” typically depends on their deals.

It is a story of people getting screwed.

Having layers working for them and using the knowledge asymmetry between them and working people is how institutional money screws people.

I suspect the founders were told that no one was going to invest in gambling companies and they should take their deal.

What you say sounds reasonable. Can you provide any anecdotal evidence or case study that would make your comment less random-dude-on-HN-said-this and more grounded in fact/evidence.

Edit: I mean specifically something like this article that was linked in another comment on this thread, https://medium.com/@andrewkemendo/first-time-founders-and-th... Just to help ground what you suggest in your comment to something concrete.

Or raise at 3x preference and take millions in secondary

Not knowing anything about this my first thought was what the hell did they spend that investment on to justify it in the first place? Were they just in a user acquisition war with draft kings and spending a ton on ads?

Easy to say they’re sitting on a gusher of cash that was bought with hundreds of millions of ZIRP dollars worth of ads and a time when fantasy everything was nascent. They were in an absolute dogfight with Draftkings and losing iirc. I’m sure things look rosy now but back then there wasn’t really any way to say if they’d win and that’s reflected in the terms they raised at.

You know #3 is curious to me. I wonder what sort of optics the investors had on this, and if there were side deals after the forced sale.

Because the founders assumed they'd be able to turn the money invested into more than a 2x return

Time value of money. You don't get paid to sit on money. You ar paid of you grow the money.

The founders wasted investor money on a non profitable enterprise. Employees got paid for doing non profitable work for investors. No one screwed anyone,they just flopped at their business and got rescued by a buyer.

And why would the technicalities of the contract make any difference to the sentiment of not being paid for your work?

Situations evolve. You hope you get the contracts right, but you also hope you have trust to work with people as they do.

You're the only person in this thread so far who seems to have a clear understanding of who is the one to blame in this story.

Great document, but I could not find any mention of "drag along".

Right, I suspect many people (including me) wouldn't even know what terms look up to research such things. I get a lot of my knowledge by osmosis from the hn comment section, for better or worse :P

When founders get hit by this, well, it is their job to understand what they're getting into. They're the ones who can hire lawyers to tell them what it means, who cana ccept or turn down investment, and pivot the company where it should go.

For the employees who get stock options though, it's a despicable move that should get you blacklisted. If you fuck over early employees like that, I will avoid you for life, and tell everyone else to do so too.

If you are interviewing for an early employee position maybe you can ask them directly, but otherwise I doubt you'll have much luck. Sites like crunchbase [0] offer some information, much of it paywalled, but I'm not sure how detailed they can possibly get on liquidation preference / drag along rights.

[0] https://www.crunchbase.com/organization/fanduel/company_fina...

It’s not a great time to be a VC investor either. Megacap tech stocks have outperformed most VC funds as of late.

Isn't there a funny saying about this kind of situation? Something about two economists shitting their pants...?

Economist-A offered his friend, Economist-B, $20 to shit his pants. Then the deal was reciprocated, with Economist-B offering Economist-A $20 if he shat his pants. At the end, Economist-B turns to his friend and says, "does it feel like we both just shat our pants for nothing?," to which Economist-A replied, "no, we created $40 of value."

A million here, a million there. What’s the difference?

Like you said - the difference is a million here, a million there.

They’ll still be impossibly wealthy even if everything goes tits up.

They will millions less impossibly wealthy

Those folks should not make the big bucks in a deal.

Why? Why is it wrong for them to make the big bucks in a mutually beneficial deal?

They haven’t risked anything

They literally risked millions

but I see it as _the primary_ problem with either capitalism, or ultra wealth

I don't completely understand what exactly the problem is

and the people with the most money control the system.

This is literally one of the strengths of capitalism over any other system: even people with the most money don't have control over the system.