I am the ex-founder of a company that has had some moderate success, and I own a 5% equity stake. They're about to raise money at a $XX,000,000 valuation. I am skeptical of the company's future and want out. The hardball CEO offered $100k. What should I do?
- Company gets to re-concentrate their ownership among active investors/employees, and remove "dead wood" ex-founder with small stake from the cap table. This alone might make it worth their while.
- Investors get shares more cheaply than they otherwise would
- You get cash and get to wash your hands of the company
Where this might get complicated is that you likely own founders' shares/common and the investors are getting shares with a bunch of preferences.
If the latest funding round is $20mil, 5% of that would be 1mil. What's the 409(a) value on the common shares? I doubt the shares would be worth more than 500-600k given the numbers above, so with a 20% discount, you're looking at 400-500k. I have no idea what the headline valuation is but you can probably work something out. Email is in sig if you want to talk.
EDIT: Another option would be to sell a portion, but not all, of your shares as part of the funding round. That might allay any "we can't afford it" concerns from the company while still giving you a bit of upside in case the business is a real home run. Would they take 10% of your position for 100k? That might be a good option.
Also, although it doesn't help the other founders that much, if one investor sells stock to another investor, it also doesn't HARM them at all.
Why should they care if two investors trade shares between each other? If you own 5%, thats what you are. An investor.
Later on you might have to re-establish a valuation and you will have to make a lot of overhead on a relatively small transaction.
But you could still factor that in to whatever the fair market value is.
Call it a 50% discount if you like, to get to the "market value". But that still sounds like a much much better deal than what the CEO is offering
There's a reason why the 409a value is often only 10%.
If I saw a founding member trying to divest himself at a 20% discount in a funding round for petty cash, I probably would find something else to invest in.
If the company is doing well in the eyes of the CEO, the remaining shareholders and the investors this is their chance to get a larger slice of the pie at a discount.
Founders are not by law or the shareholder agreement required to stay with the company across its lifecycle, and founders being bought out during funding rounds is common and does not immediately lead to investors bolting from the deal when presented with a good enough story behind it (such as someone wanting to move on, or being tired). It's actually quite rare to see a 5 year old company where all co-founders are still active and in their original roles. Nothing worse for a company than to have a bunch of ex-founders who no longer produce anything and that are holding on to sizable blocks of shares and that do not wish to sell. In investors parlance that's called 'dead wood' and the more you have of that the harder it will be to raise money.
Now if all of the founders want to take money of the table that is known as a buy-out and tends to be looked at differently, but even those deals are made, usually at some kind of discount. The version where other employees of the company elevate themselves to the C level is called an MBO and is also quite common.
Optionally there will a bank involved to fund part of the operating capital of the company depending on the amount and liquidity of the companies' assets.
Source: veteran of a bunch of deals involving my own company and being closely involved in another 50 M&A or investment deals or so, usually on the investors / buyers side.
Even if you're not on great terms with your ex-cofounders, think of your ex-employees (and your own share value)
EDIT: I was thinking from the perspective of the company and not the individual. Getting sued is indeed the worst case (if we're being pedantic then also assuming you lose the suit of course).
Your co-shareholders could easily make a claim, whether it will stick or not is as always up to a judge but it's very dangerous territory, and you are likely operating outside your shareholder agreement (at least, all the ones that I've seen) and also likely outside of your mandate as an officer of the company (depends on your role, but usually you would be). These things have to be handled with some diplomacy and tact otherwise you could very well harm the company directly in such a way that the harm would be easy to quantify. Which is a very bad situation to be in, so make sure you play by the book when doing these things.
Second, you're a shareholder of the company. You're a big enough shareholder that they'll ask for your signature on the paperwork when they recapitalize ("raise money").
Third, any variant of "you suck. I don't want anything to do with you." is a poor opening gambit in a negotiation strategy, even it's true.
If I were you I'd ask to sell some, but not all, of your shares into this financing round. You can simply say you need some liquidity. This isn't a bizarre request. They may turn you down, but they won't think the less of you for asking.
If they're raising money on a $40 mill pre-money valuation, that pegs your 5% stake's paper value at 2 megabucks. Selling a quarter of your stake into the round will get you $400K even if you give them a stiff discount. That's more than the $100K. And, you still have some upside if you're wrong about their prospects.
That being said, you're probably right about their prospects. Been there. Done that. Didn't even get a Tshirt.
The lowball offer is a good indication of how they estimate your negotiation skills.
Waiting a little longer will likely get you a (much) better offer, also consider selling only a part of your shares in case the company strikes it big down the road (made that mistake myself with something that became huge long after I left).
You might get pushback on that last point but that gives you some leverage to raise the price for all of your shares.
- Get a good lawyer, it seems expensive, but is cheap compared to getting a bad deal.
- In deciding between cash vs. equity, a useful way to re-frame is "If I had it all in cash now, how much equity would I buy at this price?"
- The CEO has much better knowledge about the company, and an offer to buy may be a signal that there's positive information unknown to you.
In my case, I refused the lowball offer though the amount of cash was tempting, figuring they were making an offer for a reason. A few months later, I was offered 4x the price as part of a funding round. I took it without further negotiation, since that was enough to make a significant lifestyle change.
5% of XX,000,000 is at least $500k; you're a fool to take less.
Furthermore, "a bird in the hand is worth two in the bush". Don't neglect the value of having money here and now you can invest in other assets: a downpayment on a home, stock market investment, etc. Many people in SF would have done better to have just purchased a modest home in 2010-2012 or bought TSLA than to have played the startup lottery over and over.
http://www.investopedia.com/terms/l/liquidation-preference.a...
Start by offering a tenth of what you would agree to pay. All you risk is that they accept your offer.
It's standard business practice. Works more often than not.
An offer of 1% is more obviously not the correct amount, and encourages people to lawyer up rather than counter offer (it screams "we're only offering this token amount because someone suggested our original plan of not giving you anything might not work")
His best bet is simply not to sell and to wait for them to make an offer.
OP is confused about the shareholder and employee roles, they are not linked other than through vesting and the shareholder agreement (which they have presumably signed).
He can easily quit as an employee while remaining a shareholder in the company. Those roles need not be connected forever and there usually are - vesting excepted - penalty free ways of stepping out of a company while you keep whatever shares you already have. Clawbacks in a situation like that are very rare.
Aside: If the co-founder is an HN reader, then they probably know the throwaway account is you. That is going to skew this negotiation.
edit: of course, parent's comment regarding the other party is still sound and valid :).
for the record, i'd probably do it if i was offered $500k.
How does that work in practice?
I would not take a lump some in most cases.
If so, you will likely need to break through that emotional barrier to get his cooperation in selling the shares to investors. Assuming his cooperation will make it easier.
Keep your shares and consult with a lawyer who can ensure you are protected further down the line. PLEASE DO THIS.
I will guarantee 100% that the type of people that offer you 20 cents on the dollar (as a founder) are the type of people that will screw you. 100%.
Tl;dr - to me, threatening to stick around as dead weight is your leverage. Your actual leverage may be something else. Work it out, use what you have to get what you want.
It might help to understand where this idea came from for me. This idea came from me thinking that, as I'm always rooting for founders on "Shark Tank" / "Makers Tank" ( whatever it's called ), to just take the offer, since they are beginning a journey, and the offer could take them to the next level, and they shall have many more chances to extract value from this down the line, whereas if they don't take it, to me anyway, their success seems less assured, while in your case, contrary to that, I thought of the inverse, where once you make the choice, you don't have any more chances to extract value. It's your last bet at the casino, make it count. So, in a way, I think this strategy I propose has something similar to the "martingale" betting method.
Investors in the round would probably buy your shares for 1/3rd - 2/3rds of their value and you should consider asking if that's an option and then negotiate from there. The only reason to let the company buyout your shares for a lowball offer is if you left the company after a short period of time without proper vesting and you want to do the right thing for the company's sake. Doesn't sound like that's the case.
> what d'you mean by ex-founder and by what corporate action or process did you come to attribute this title to yourself?
> Why have you held your shares till this time?
> Why are you skeptical of the future of the company? D'you have a personal beef with the hardball CEO or is the company really doomed in your opinion?
> Who approached who (I mean you or your hardball CEO) to leave the company? To be clear, did he notify you of their intention to raise money and ask that you sell off or did you hear that they're about to raise money and then decide that you want out?
Let the hardball CEO (imo he/she is doing his/her job) know that you are open to finding a mutually beneficial agreement, but you feel the initial offer is not something that entices you to sell. Ask for the term sheet of the funding round, because you need to know what will happen to your 5% stake to evaluate your options.
I recommend viewing this as a business decision/transaction.
Step 1 is to speak to a lawyer and accountant. Get their take on what your equity is worth, the tax implications, and evaluate the impact of the term sheet on your equity if you have it.
Step 2 is to make a decision. How much equity do you want to sell? All, some? For how much? And what are the numbers behind your decision? How much of a discount are you willing to accept? If you want to sell all your stakes, the lawyer/accountant should be able to give you a valuation.
Step 3 is to negotiate. You can do this through your lawyer if you want to avoid mixing business with personal relationships. Work with the CEO if you can, because if you decide to keep some equity, it is also in your best interest that the company completes the funding round successfully.
Step 4 .. Profit!
Disclaimer: I have absolutely no prior experience with this kind of event whatsoever. :)
Say the company is trying to take on another 20mil at 100mil valuation, that's 20% of the company that will have to come out from the current shares, i.e. dilute all the current owners of the shares. That means to raise that money right now, the company is going to have to dilute you, but also all other employees and founders and investors. So you will lose ~20% of your shares, in exchange for XX-growth of the paper value of your shares.
Imagine that right now your shares are worth 1 million, but for absolutely no cost to you, those same shares will be worth 20 million tomorrow (minus the 20% that investors end up taking). This is not "exact" math, but it illustrates the point.
You can sit on your shares today, and make a ton of money overnight by doing _nothing_.
If you sell your shares today, for any amount less than what you would get in the above scenario, you're losing money. The hardball-CEO is just going to take your shares, and immediately resell them to new investors at 100X the price.
Unless you absolutely need the 100k today and can't live without it, your best bet is to hold on to the shares and take the gamble on them growing multiples. If the company does great, you win. If the company shuts down, all you lose is x-months worth of salary equivalent. If the company needs to raise more money later, then you can always offer to sell your shares at the later price.
In the same way, the hardball CEO can offer whatever she wants, but in this case the ball is completely in your court. You can ask for 10 million, if you want, or a 100.
An ass-hat CEO could technically issue a billion shares to herself and new investors and completely dilute your value in the company, as a last resort.
People that know better than me: How nuclear an option would it be to ask the investors directly?
Humorously enough, while I was reading this thread, I got an email from the CFO of that company, who I haven't heard from in a couple of years now. My heart skipped a beat. :) Alas, it was not an heads up about a liquidity event...
I assume your 5% stake is common stock. The common stock valuation will not be 10% or 20% less than the preferred price in the round. It'll be more like a 75% discount.
What this means is that even if you have long term capital gains on the appreciation of the stock, that tax rate will (at best) only apply to the delta between the common stock valuation at the time of repurchase and the price at which you bought the stock.
The delta between the common stock valuation at repurchase and the price at which the shares are actually repurchased will be treated, for tax purposes, as an employee bonus. So, it will be taxed like employment income.
Just want you to be aware of what you're potentially getting into, from a tax perspective.
You are willing to sell.
Scenario #1: Company goes out of business
Lets say you are completely right.
$100K in 2017's dollars > $0 in the future.
Verdict: Sell
Scenario #2: Company struggles/downrounds/etc
Your stock is diluted.
$100K in 2017's dollars > $100K (or less) in 20xx dollars.
Verdict: Sell
Scenario #3: Company is moderately more successful than expected
$100K in 2017's dollars ==(approximately) $150K in 2020 dollars
Verdict: Sell
Scenario #4: You are completely wrong
$100K in 2017's dollars < $1MM in 2020 dollars.
--------------------------
You left the company for a reason. Has any of those reasons changed?
Maybe sell part and keep part to reduce regret possibilities?
Question: What number will you be emotionally o.k. with no matter the result?
Not for most people here, though
$100k liquid good if their valuation is less than 2M, otherwise it makes fiscal sense to hold onto it (or sell once it hits open market), unless you think that it is not a reasonable investment.
Really, though, if you are not interested in the future of the company, sell it to someone who is working on it. Figure out what it's worth at valuation and take 20-70% of that, if you need some range parameters. And like I said sentence one: $100k liquid good.
As far as a rabbit in your hand now versus 10 in the bushes provided the hunt goes well, consider your own situation and what the 100K would mean. Would you be able obtain a better ROI with 100K in your own hand versus say, staying with the company? Are you young young or young at heart?
Good luck!
For example, if XX is 10, 5% of $10 million is $500K.
If you do need the money, maybe you should make a counter offer that is a better deal for you.
And don't forget you have to pay income tax this year if you do sell. If you wait, obviously you also delay the tax.
If you believe in the company, the consider not selling.
If you do not believe in the company then make sure you get this cash - you might end up the only person to actually make money from the company (this happened to me).
I have been thinking of Yishan-style CEOs for a while now. I wonder if the ex-founder selected the CEO in this case.
take the money and run! learn from mistakes. they will burn through the cash and fold, but you will have a headstart.
https://news.ycombinator.com/item?id=14417758
4 days ago
https://news.ycombinator.com/item?id=14357379
12 days ago
In that light, are your existing shares worth more than $100k at the current FMV?
The bad point is that the OP will then have to do all the hard work on the transaction whereas right now there are willing buyers.
I'm not saying you should do this. Nor am I suggesting it's a good tactic. But it may provide leverage if you need some.
People paying good money for shares will jump at the chance to buy them cheaper.
A CEO closing an investment round may have very different incentives, like not frightening the horses.
[edit, clarity]
Equity is a market. The CEO is offering a price. Maybe the investors are willing to offer a higher price.
Of course this could be wrong too, depends on the non-money terms the other investor got.
If the CEO offered the last 409A valuation as a price, then there's little you can do if you're inclined to take an offer because the 409A is the "fair market value" of the common stock. Usually the 409A is a huge discount, like 60-80% less at the stage you've implied the company is at, under the preferred price.
How will the investors feel if they know that you would sell 5% of the company for $100k? Maybe this is your leverage: the investors will know the price of the buyout and since the investors know that you are very familiar with the company, then they will invest less. Therefore, the CEO should offer you a fair price for your shares.
Most people here have no idea what they're talking about.
The CEO is offering you a price. Other investors will probably be willing to offer you a better price.
I mean, why wouldn't they? They've paid good money to get the shares that they bought. Why wouldn't they want to buy other shares at a cheaper price?
If you offer your stake at any discount, they are irrational if they don't take it. Don't worry if you are bound to a non transfer-ability clause. Getting around that is always possible with a bit of lawyering.
Also get someone else to handle the transaction on your behalf. You don't sound like the best negotiator. No offense intended.
Mark Zuckerberg was on the buy side of a few of these type of deals. That's a "moderately successful" company.
The shareholders agreement, even if 'boilerplate', may only give the company the right of first refusal on the sale of shares. Even if unauthorized sales are completely disallowed, if you find an interested buyer there are still ways to craft a legal agreement where you for all practical purposes have 'sold' the shares.
But if the company isn't very successful, there may not be any investor interest, which would make the legal details pretty irrelevant.
I'd recommend getting an attorney to read over your agreements, and also try and gauge investor interest by listing your shares on one of the secondary market marketplaces.
Please expand on this.