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Ask HN: How do founders end up broke?

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Ask HN: How do founders end up broke?

#1

Post by Sohum »

I've recently read stories of startups that became successful and were bought out for large sums, but the founders received little from the transaction.

How does this happen?

Also, how do cases like Steve Jobs and Harry Osborn occur where they are removed from their own company? Do VC's and Investors really take that much of the company? How much influence do they hold over a company they invest in?

Why would a founder continue if they lost their ownership? Why would a founder give up ownership of their company in the first place? Isn't one of the prominent appealing aspects of the start-up world to own your own company?

Yes, i know i used the green goblin as an example. On an unrelated sidethought, it would be fairly interesting to see the corporate dynamics of LexCorp and Wayne Enterprises interact with one another ... surely they would have corporate take-overs etc.

Sorry for all the questions ..... any thoughts would be great.

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

#2

Post by jmonegro »

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 shares. Influence varies from VC to VC, but I'd say their influence is proportional to the amount of the company they own. They only take as much as you let them take.

3. Being bought out and/or burned is probably the top reason why founders leave or sell out. When you've been doing a startup for several years and you're ready to move on, and someone offers you a big fat check for your company, it's hard to turn it down unless you're really passionate about your startup and are still willing to push it forward yourself.

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

#3

Post by Stevenup7002 »

>> I've recently read stories of startups that became successful and were bought out for large sums, but the founders received little from the transaction.

It depends on what startups you're talking about, there are many reasons as to why this could happen.

>> Also, how do cases like Steve Jobs and Harry Osborn occur where they are removed from their own company? Do VC's and Investors really take that much of the company? How much influence do they hold over a company they invest in?

Apple was a public company at the time, and Steve Jobs was forced to resign by the board, just like any other employee can be forced to resign for whatever reason (unless they're in control of the majority of board, ala Mark Zuckerberg). He still owned a large share in Apple after he was fired, which I believe he mostly sold off.

>> Why would a founder continue if they lost their ownership? Why would a founder give up ownership of their company in the first place? Isn't one of the prominent appealing aspects of the start-up world to own your own company?

Most good founders don't want to give up ownership, but if you want to receive funding from investors, as far as I know there's not really any alternative to giving up equity in your business.

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

#4

Post by phamilton »

One of the big things I know about is the being "in love with the technology". Founders get replaced in their own companies because they focus on improving the technology, rather than revenue. There is a balance, but part of the reason VCs and investors get shares is because their financial interests should be represented in the company. If as a founder you aren't representing their financial interests, then of course they will replace you.

There are big dramatic forced resignations, but often there are simple restructures. A founder will be removed as CEO, but stay on as a VP of development, for example. His ownership stays intact, but the executive leadership will be more aligned with the interests of the investors.

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

#5

Post by 3pt14159 »

Liquidation preference is the number one way that founders end up with nothing. Works like this: VC invests $1m with a, say, 5x liquidation preference then if they company sells for, say $6m the VC gets the first $5m and the remaining $1m is split according to equity. http://www.gabrielweinberg.com/ has some really, really good articles on this kind of thing.

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

#6

Post by danshapiro »

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.

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

#8

Post by henryci »

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 are rockstars and rolls them up for 1.2 million.

3) Founders get jobs at company X and 200,000 split among 3 of them before taxes.

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

#9

Post by henryci »

Stevenup7002 wrote: post #3

>> I've recently read stories of startups that became successful and were bought out for large sums, but the founders received little from the transaction. It depends on what startups you're talking about, there are many reasons as to why this could happen. >> Also, how do cases like Steve Jobs and Harry Osborn occur where they are removed from their own company? Do VC's and Investors really take that much of the com…

There is also something to be said about a founder not being the right person to a grow a company. A techie might make a great CEO to impress a VC and raise a million bucks. But is he able to make the right deals, find good partners, hire superstars, etc? He is invested in the company, possibly more than most so it is in his own interest to let the VCs place a better CEO so he can focus on what he is best at.

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

#10

Post by trizk »

An interesting (albeit fictional) movie to watch on this topic is "The First $20M is always the hardest". Yes, you have to give away equity to get funded. But if you are asked for a controlling stake early in the game, then you are being setup for a big letdown.

Also, although convertible notes are very fashionable these days, consider your position if and when you need another round of financing. You may very well be forced into a bad deal under the threat of liquidation to pay your creditors with the company IP. On the other side of the table your investors got you to pour your blood, sweat and tears into the company as well as the financing, and they ended up with 100%. This is not to say that all VCs are bad, or even most. Rather, that is the substantial risk of a convertible note.

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