For many years, the VC world and the media have been enamoured with unicorns and the unicorn phenomenon until Bill Gurley of Benchmark Capital started speaking about the potential death of these billion-dollar+ valuation companies last year. He also made some interesting psychological and other general insights into the unicorn or rather unicorpse phenomenon last week in his blog. I previously also wrote about Mr. Gurley's POV on late stage funding bubbles and the dangers of overvaluation last July.
* Investors are lured into last round fundings when it is often a desperate last act to raise capital
* Crooked investors, "sharks" are akin to ponzi scheme con-artists who use dirty term sheets to make a guaranteed return at the expense of other investors.
* Dirty term sheets to look out for often have the following clauses: guaranteed IPO returns, ratchets, PIK (Payment-In-Kind) Dividends, series-based M&A vetoes, and superior preferences or liquidity rights
* People who have already "banked" their return cannot mentally handle a down round investment (eg, taken loans off "paper gains" or other such nonsense before a liquidity event)
Mark Suster at Upfront Ventures refers to these "sharks" as "VC seagulls". Seagulls or sharks, it appears to refer to investors who are utilising legal loopholes to operate, essentially, a ponzi scheme, in which they may receive a return on their investment via liquidity preferences or other tactics such as "guaranteed IPO returns" even if the company faces a down round and many other investors lose their investment.
A lot of these sorts of tactics seems to center around Silicon Valley, although Bill Gurley mentions in his very long essay that these are not usually the standard for NorCal. However, many instances of these sorts of "shark" tactics come to mind: most recently Square's recent late stage funding in October of last year in which investors were guaranteed a 20% return even if the IPO flopped (NYSE: SQ) although currently Square is at or just slightly above its IPO offering price after losing 3/4 of its value in February.
However, most of Mr. Gurley's post seems to me, to be directed at Uber, where he sits on the Board of Directors. Major investors in Uber received a guaranteed 25% return. In fact, Benchmark Capital, as a a series C investor in Uber (along with Google Ventures and TPG) have a liquidity preference which guarantees them a 25% return, allowing them to get their money back before the common shareholders in case if Uber were to be acquired or wound down. This is also the case with Snapchat, another Benchmark Capital backed company whose investors are also guaranteed a return via preferred stock.
In the event of this sort of liquidity event, the main people who lose out are the entrepreneurs and early investors. “The level at which employees are getting diluted is much higher than it has been in the past. In the short term there is a real risk that employees just don’t understand how little their shares are going to be worth by the time an exit event occurs.”
I found Mr. Gurley's criticisms rather perplexing or perhaps made in good conscience, in perhaps, openly speaking out against what seems to be the "shark" policies of his own VC firm as well as other prominent ones in Silicon Valley. The bottom line Mr. Gurley seems to be pointing at is really aimed towards entrepreneurs: Don't become another Travis Kalanick. Raise as little money as possible. Don't go for the billion+ valuation.
In terms of setting a new kind of equity structure, former Groupon founder Andrew Mason set up a "Progressive Equity" structure for his new company which he detailed on his blog earlier this month which protects the employees from equity dilution. He also posted his legal template- free for anyone to use . Although I haven't read through the entire legal document, this sort of equity structure seems to protect the founders and employees from such VC sharks. Instead of creating a vast income divide at startups, Andrew writes in his post that he wants to create a landscape where more people become multi-millionaires rather than the few who become billionaires.
Andrew also explained via Hacker News that "the benefit to founders of progressive equity is that at a smaller exit, they still get a big return." I think this is something definitely worth considering for entrepreneurs and founders who are setting up their equity structure.
Mark Suster also gave some practical, abeit funny advice for founders this week in Both Sides of the Table; I had hoped he would elucidate more on some of these topics such as 22. The End of the Mexican Road and 23. Beg for Forgiveness as I was rather curious about the particular scenarios and the lessons learned.
However, the Key Takeaways here are:
*Intellectual Property, Founding team members, initial product and market valuation are the most critical early in the startup
*Learn to work with lawyers, despite the fact that perhaps a lot of people have a tendency to view them negatively
*Learn to flip burgers (eg, don't outsource every function of your company) Mark writes: In some companies the CEO does not have the complete grasp of every function of his/her company. They essentially outsource the thinking on technology, sales, customer service, whatever. This is always a warning sign to me. This post covers the lessons I learned the hard way, from trying to run a burger chain without first flipping burgers.
*Don't grant equity to advisers in an advisory board unless they invest in your company
*Getting an MBA is often paradoxical to working towards launching a start-up, as MBAs typically are risk-averse
*Health and fitness are very, very important
By Sierra Choi