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Ask HN: How do founders end up broke?

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Re: Ask HN: How do founders end up broke?

#11

Post by trizk »

danshapiro wrote: post #6
jmonegro wrote: post #2

1. If you're in debt because of your startup, then when you get acquired you use that money to pay off your debts, and keep what's left over (after taxes, and all). If you're deeply in debt, then it may occupy a large sum of your money. 2. When your VCs and board own most of the company, they have the right to fire the CEO regardless of his founder status. This can be avoided as long as you keep the majority of share…

"This can be avoided as long as you keep the majority of shares." This is wrong. A board can hire or fire as it chooses. Holding a majority of common shares can mean very little, as many founders have learned the hard way. Protective provisions and board seat election procedures can, for all intents and purposes, define who controls the company.

Dan can you elaborate? If the board is company leaning with say 3 of 4 seats for the founders and 1 investor, how can a founder be fired unless in the unlikely scenario that the other two vote against him/her?

Re: Ask HN: How do founders end up broke?

#12

Post by cperciva »

trizk wrote: post #11
danshapiro wrote: post #6

Earlier quoted context omitted.

"This can be avoided as long as you keep the majority of shares." This is wrong. A board can hire or fire as it chooses. Holding a majority of common shares can mean very little, as many founders have learned the hard way. Protective provisions and board seat election procedures can, for all intents and purposes, define who controls the company.

Dan can you elaborate? If the board is company leaning with say 3 of 4 seats for the founders and 1 investor, how can a founder be fired unless in the unlikely scenario that the other two vote against him/her?

His point is that owning a majority of the shares does not necessarily imply controlling a majority of the board seats.

Re: Ask HN: How do founders end up broke?

#13

Post by dedward »

cperciva wrote: post #12
trizk wrote: post #11

Earlier quoted context omitted.

Dan can you elaborate? If the board is company leaning with say 3 of 4 seats for the founders and 1 investor, how can a founder be fired unless in the unlikely scenario that the other two vote against him/her?

His point is that owning a majority of the shares does not necessarily imply controlling a majority of the board seats.

Can you elaborate on why not? The board exists to run the company on behalf of the owners. If you are the clear majority owner (51% - heck, let's say 75%) - in what way can the board possibly be stacked against you unless you willfully let it?

Re: Ask HN: How do founders end up broke?

#14

Post by dedward »

Why would a founder give up ownership....

They would give it up because someone offers them money in exchange for that ownership.

As long as you aren't seeking investment capital and are retaining full ownership of your company, you have nothing to worry about with regards to losing your company.. buy if you want others to invest their money - you will likely have to give something up in return...

Re: Ask HN: How do founders end up broke?

#15

Post by ChristianMarks »

I've seen cases where one absolutely non-technical partner takes 75% of the initial equity, tells the other not-so technical partner to find technical people and that her 25% has to be diluted if necessary to bring them in. That's a recipe for ending up with almost nothing if the firm ever becomes profitable after a round or three of investment.

Re: Ask HN: How do founders end up broke?

#16

Post by danshapiro »

dedward wrote: post #13
cperciva wrote: post #12

Earlier quoted context omitted.

His point is that owning a majority of the shares does not necessarily imply controlling a majority of the board seats.

Can you elaborate on why not? The board exists to run the company on behalf of the owners. If you are the clear majority owner (51% - heck, let's say 75%) - in what way can the board possibly be stacked against you unless you willfully let it?

A not-uncommon scenario for a post series-A board is a CEO, a cofounder, 2 VCs, and an independent. Any 3 board members can sack the CEO and hire a replacement. To add insult to injury, the CEO seat is often attached to the job, so the replacement gets the CEO seat, and now the sacked CEO and cofounder are left to bicker over one seat.

The board composition is decided by the financing docs, and is one of many things you negotiate in the financing. You're right that you have to "let it" happen (ditto the protective provisions), but unless your round is highly competitive you will probably do that, as the alternative is not getting funded.

Finally, note that the board exists to maximize shareholder value. The CEO's share holdings, majority or otherwise, do not mean s/he is the best person to create value for the company's shares. A board member is supposed to act for the best interests of the company as a whole, not for any one person or share class.

As a side note, this sometimes leads to odd cases where someone - like a VC - will vote in favor of something as a board member, which is clearly in the best interest of the company as a whole, but then vote against it with their shares, which is their right and obligation to do, to maximize the value of their own investment. That could happen, for example, if an acquisition offer was in play that would not meet the VC's goals for the investment.

Re: Ask HN: How do founders end up broke?

#17

Post by jack7890 »

dedward wrote: post #13
cperciva wrote: post #12

Earlier quoted context omitted.

His point is that owning a majority of the shares does not necessarily imply controlling a majority of the board seats.

Can you elaborate on why not? The board exists to run the company on behalf of the owners. If you are the clear majority owner (51% - heck, let's say 75%) - in what way can the board possibly be stacked against you unless you willfully let it?

Because board seats are often given to new investors as part of term sheet "package". Shareholders can decide to grant a board seat to an incoming VC because they think the combo of the VC's money and guidance will increase the value of the company. That can lead to situations where a majority of the ownership is not represented on the board.

Re: Ask HN: How do founders end up broke?

#18

Post by danshapiro »

henryci wrote: post #8

0) Desperate 3-man startup needs capital to survival. (gone 4 years w/o salary) 1) After pitching only thing they get is an offer with 'participation'. This means a preset amount is guaranteed back to the investors in an exit event if the % gain doesn't match a specific minimum. I.e. Investors are guaranteed 1,000,000 if their equity doesn't exceed that value. 2) A partner sees the company is weak, knows the founders…

The term for first-money-out is "preference". Preference terms are almost ubiquitous in preferred stock (the similarity in names isn't entirely coincidental).

Participation means that after the investors get their preference out, they continue to share in proceeds ratably. It is also common, but less so.

The short version is: preference WITH participation means "Your money back plus your share". Preference WITHOUT participation means "Your money back OR your share, whichever is bigger".

Brad Feld's term sheet series explains this well, in depth.

Re: Ask HN: How do founders end up broke?

#19

Post by SemanticFog »

danshapiro wrote: post #16
dedward wrote: post #13

Earlier quoted context omitted.

Can you elaborate on why not? The board exists to run the company on behalf of the owners. If you are the clear majority owner (51% - heck, let's say 75%) - in what way can the board possibly be stacked against you unless you willfully let it?

A not-uncommon scenario for a post series-A board is a CEO, a cofounder, 2 VCs, and an independent. Any 3 board members can sack the CEO and hire a replacement. To add insult to injury, the CEO seat is often attached to the job, so the replacement gets the CEO seat, and now the sacked CEO and cofounder are left to bicker over one seat. The board composition is decided by the financing docs, and is one of many things…

These definitely happen all the time.

Another thing to watch out for is for unfilled seats that can change the board dynamic. If multiple parties have to agree on the board seat, then an intransigent investor can maintain an advantage by never approving any candidates. Don't put off filling these seats! Ideally, you should agree on a specific person before you sign the docs.

Re: Ask HN: How do founders end up broke?

#20

Post by bravura »

http://thefunded.com is a great community of founders and CEOs, and includes many bitter people who were burned by investors. I've seen a handful of horror stories on there.

See this post for example, even though it doesn't speak directly to your question of being broke after an exit, because it talks about investor control: http://thefunded.com/funds/item/5822

"From a purely technical standpoint, venture capitalists can't easily 'fire founders' either, yet two thirds of founding teams are eliminated. In fact, most investment agreements have more provisions to force a sale than they do to eliminate a founder. "

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