StabilityAI cofounder says CEO tricked him into selling stake for $100
forbes.com
forbes.com
Soon after the transaction closed, the PE firm was able to covertly buy another 2% of voting shares from a pre-existing investor in the company, which resulted in the PE firm gaining full majority control over the company, kicked out the CEO, replaced the board of directors, the whole works.
The unfortunate part about these kinds of things is that 1) they happen all the time, and 2) founders rarely talk about it because doing so can so often destroy your ability to get funding for future endevors, etc.
I really wish there were an anonymous but vetted "yelp" type of site for people/firms who do bad business. So much business is done in bad faith and the people on the losing end rarely have the ability to warn others of their experience without killing their own reputation.
But better is to avoid swimming with the sharks at all. I have a wonderful horror story about a business deal I made where I was cheated out of about $5 mil. I didn't trust the party I was doing the deal with, so the contract negotiations took most of a year and the contract ended up being very thick as my attorney and I tried to anticipate and block every possible way that I could get screwed.
But we missed one rather obscure method.
That's what happens when you swim with sharks.
(Don't shed tears for me, though. I did very well through that deal -- just not as well as I should have.)
My mantra is "good people do good things, bad people do bad things". If you don't want bad things to happen to you, stay away from people you know to be bad regardless of how tempting it may be to associate with them.
That was another thing I learned: if you respect someone's expertise enough to pay them for it, you should probably take what they have to say very seriously.
Please share.
This is not something that should require, in any remotely sane legal system, an explicit contractual clause to prevent.
[1] https://www.hollywoodreporter.com/business/business-news/sta...
They did sell something they owned. I neglected to attach a method by which I'd get compensated for them selling that particular thing.
In the mindset of cutthroat business, they legitimately won. They 100% adhered to the terms of the sale, and it's not their fault that I left a loophole they could leverage.
My attorney did say that if I wanted to, a case could be made for a lawsuit -- but it would have been expensive and wouldn't have had high odds of success. I just wanted to move on.
This whole event was my first real business success, and the mistakes I made were legion. It taught me quite a lot -- including that I won't do business with anyone that I am nervous about doing business with. Contracts can only protect you so much.
Also, I feel the need to repeat... I did pretty well from this deal. I was angry when this happened, but with the passage of time, I see that even with this event, I came out of the deal better than I went into it. So I hesitate to even call it a "regret". It's more of a "learning experience".
1. Giving another party 49% doesn't guarantee you will have retaining control. You having 51% shares does guarantee that. So, their strategy was flawed.
2. Not sure if regulations allow this, but to make it bullet proof they should have made a contract that the PR group will not go beyond 49%.
Without either of the above, the company just did not do good diligence.
Is that still tolerated by investors? Is it still legal?
"Having your cake and eating it" is a really bad attitude
One important role of government is to set and maintain standards for listing on markets, so that customers are protected. An example of such a rule would be that all publicly traded companies have equal voting rights across all share classes: one share, one vote.
Elaborate on this, because I think I'm misreading it.
It seems to me like shareholders, generally already have a vote. Converting those shares, from voting to non-voting, would be quite illegal (at the very least breach of contract) without shareholder sign-off. Which they probably wouldn't do... y'know... because they're the shareholders.
What's being discussed is issuing different shares (with approval of the voting shareholders). And if you don't like that, you can... just not invest in that company. There are several other companies you can invest in if that's what you want.
And if the companies that offer only non-voting shares dominate (probably being driven by the founders)... most investors would probably want that. Most investors are looking for a return first and foremost.
> An example of such a rule would be that all publicly traded companies have equal voting rights across all share classes: one share, one vote.
I agree that it's an example of such a rule. Do you have an argument for why it's a good rule?
this is a pretty expansive definition of freedom, the freedom to buy unfettered options in a company.
>Your options are buy the class of stocks that the company wishes to sell, or not participate at all.
Respectfully, I think you're confused about what a "free market" is. What you're describing, where market participants can compel the sale of a firm's assets, is antithetical to a free market.
Free market: “voluntary exchange and the laws of supply and demand provide the sole basis for the economic system.”
It’s voluntary exchange, yes, but it is not a driven by supply and demand. In the same way that the 1970’s oil market driven by the OPEC cartel was not a free market either. If you don’t like the control that Zuck has, can you express that dislike by buying shares of Meta that don’t include unequal voting rights? You can’t, because this is an issuer controlled market.
That is exactly what you argued for. Your rule would force public companies to offer up for sale shares with equal voting rights, whereas today many do not want to do so.
I'm not saying it's bad. Perhaps it's a good rule. It's just that you said you want a free market, and then proposed rules that in fact detract from a free market.
1. It's not like anything is being hidden - people who buy shares without (or with less) voting share rights know what they're getting, and can adjust the amount they're willing to pay for those shares accordingly.
2. Dual share is a double edged sword: if you believe and want a visionary founder to stay in control, you're good. At the same time, you should be clear that if the visionary founder goes off his rocker, there is not much people will be able to do to oust him.
Zuckerberg pretty much shows these pros and cons perfectly. People were wringing their hands at the end of last year when Meta stock was in the toilet that there was nothing anyone could do to replace Zuckerberg. Now, though, Meta is up over 150% over the past year, and the fact that Zuckerberg could play a longer game and wasn't just ousted due to the share dip was probably ultimately good for investors.
Ray Dalio says the following in his book Principles:
“When faced with the choice between two things you need that are seemingly at odds, go slowly to figure out how you can have as much of both as possible. There is almost always a good path that you just haven't figured out yet, so look for it until you find it rather than settle for the choice that is then apparent to you.”
He credits this approach to helping his firm spearhead risk parity as well as other successes. Sometimes, trying to have your cake and eat it too leads to being able to do just that.
At an old job, I worked with an eng manager who believed software quality and time to market were mutually exclusive. You decide which one is important to you and you go for that one.
In his thinking, he then constantly failed to identify options that were both fast to build and good, usually due to significant simplification. He could never find these things because in his mind you couldn't have both.
Later on, I worked for Ray for a few years and would always think of this dude whenever I encountered this principle.
Can this ever work? The PR group can control the 2% without nominally owning it.
Having said that this is the type of thing that is likely to get dragged in front of a judge, so the more foolproof way would be to retain 51% control or dual-class shares. Once you give up majority control to third parties, you can't really prevent everyone else ganging up on you and outvoting you.
And then you can have a fun lawsuit. Did the group persuade the 2% to vote their way or did they pay to control that 2%'s votes.
Yes. In tight-control transactions, there are a number of mechanisms.
Off the top of my head: specifying Board seats in the charter and requiring a supermajority or unanimity to change that. Voting rights agreements that delegate 51% of votes to one party. Turning all shares but two into non-voting shares, the two having 51% and 49% of the votes. Making transferred shares convert to non-voting. Transfer approvals.
I know a guy who had 51% in the family company. His retired dad had, in exchange for money, deprived the 51% shares of their voting power.
His dad then sold the shares on the local stock exchange.
A couple months later, his CEO/son was fighting a hostile takeover of the family-run, but publicly traded company.
So his son bought the 51% from the local stock exchange, thinking he had a majority.
The guy who owned the actual voting shares showed up at the annual shareholder meeting with attorneys and accountants , a small number of shares, and walked out with the keys to the company.
Musk, for example, seems to me from what he says to enjoy exploiting the blind spots of other businesses; but he was counter-exploited into buying Twitter for way too much.
You are either leaving out some important details or this is just not accurate. When people say you need to have "51% of shares" to control a company it means that you need to control 51% of voting rights of shares (sometimes different share classes have different voting rights).
It would simply have been impossible for "his retired dad to have deprived the 51% shares of their voting power" if his dad didn't have voting control. So something just doesn't add up in this story.
Maybe. But something (literally) doesn't add up in the original story.
If the CEO had 51% and sold the 49%, there is no place for the PE firm to capture the 2%.
Unless there is convertible debt or some such thing. Or the story is overly-simplified in some other way.
In this case wouldn't the individual with > 50% shares need to be diluted to < 50% for another party to acquire > 50% stake?
And surely at the point of dilution the individual would realise they have < 50% shares and this was a risk?
I guess what I'm confuse at is if you own 51% of the shares, unless you sell some of that or dilute your holding there will only ever be 49% stake that can be purchased by another party.
Am I missing something?
Your understanding is correct there.
> Am I missing something?
I think you are missing that there may be one or more third parties who also own a stake. A quick example (figures plucked from the air, not a real world case) might make it clear:
Starting point:
Founder 75%, Other(s) 25%
--
New investor buys 49% from founder:
Founder 26%, Other(s) 25%, New Investor 49%
Founder no longer has overall control, but nor does the new investor
Founder+Others can block the new investor if they all agree
--
New investor buys 2% from elsewhere:
Founder 26%, Other(s) 23%, New Investor 51%
New investor now has overall control and can do pretty much what they like
If you are selling shares to a PE firm with the explicit goal of retaining control, and you have less than 50% of shares, why would you make it so easy for them to get control?
Lawyers can be an expensive rubber stamp on a deal that is absolutely not in your interest or be a chaos agent that makes you impossible to do business with. They can also make executing complex deals very simple (for you) or ward off sophisticated scammers. At least in my experience, it can be very hard to know which is which before it's too late.
I'd still suggest a lawyer for sure, but I wish I had counsel I liked.
Still was downtown rates but I got a lot of attention from the actual lawyer. And if things ever got real heavy they were my in-road to up-scale.
Despite this, throwing up your hands and saying "I don't know how to find a good helmet, I don't want to waste my money on a bad one, I'm just gonna ride my motorcycle without one" is ill advised.
A successful founder will sell 1 (maybe 2) companies in their lifetime, while PE/VC firms do these deals every day of the week.
It's like entering the ring with a pro MMA fighter and expecting to have a fair fight. You have a massive disadvantage that can't be overcome. The best you can do is take precautions and "do your best" but "your best" and "precautions" still isn't good enough if your opponent really wants to screw you over. Unfortunately this happens all the time in VC, and especially in PE.
As an example, when you sign a term sheet to sell a company, most founders assume the deal will go through at the price that was agreed. In reality, deals almost never close at the originally agreed upon price. The buyer usually waits until the very last minute, then drops the bomb on the seller "Btw, we can't do the deal anymore at this price, but we can sign tomorrow for 30% less". The sad part is it's such a common tactic and PE firms will do things like encourage founders to get their whole team excited about the transaction -before- dropping the bomb / new deal terms. At which point the founder is basically trapped with their whole team excited about an exit, which PE then exploits.
All of the lawyers in the world won't help if the PE/VC firm has the ability to spread the word "Don't do business with John Appleseed" effectively shadow-banning you from future funding from anyone. PE/VC world is very small and they have a lot of political leverage, which almost always trumps any legal leverage a founder might have.
The best defense is to have another VC/PE on your side.
That also puts bootsrapped companies at a severe disadvantage (no VC fighting on their side for the best outcome). There literally are PE firms who specialize in buying "family run bootstrapped businesses". Why? Because they're the easiest to screw over and exploit.
That's why you hire a lawyer that also does this stuff everyday of the week.
If I were a first time founder I wouldn’t know where to find the right lawyer. In all honesty I still don’t and I’ve been at it for 8 years now.
You hire a law firm to advise you on the deal.
Yes, I did learn about this from Cory Doctorow, why do you ask?
If somebody can't understand that they need to retain a majority of the voting rights to retain control of a company, then you're certainly right about them being at a massive disadvantage.
Eh, this was tried on a friend of mine selling his company. He simply said "the deal's off" and walked away. A couple weeks later, he got another call which said "ok" and he got the full price.
> That also puts bootsrapped companies at a severe disadvantage
It's very simple. Just say "no". It's an incredibly powerful tool. It's crucial to getting a proper deal on anything from selling/buying your house, your car, to your company. Be ready to walk away. Sometimes by the time you started your car and are backing out of the parking spot, they'll come running out and say "ok".
But you gotta mean it when you say "no" or you'll fail. They can smell weakness.
As soon as a counterparty knows you can't / won't, you're negotiating from a much worse position.
"You had better sell your business to us for a pittance, otherwise we'll lock you out of future deals."
"Ok, here you go. Now can you fund my new thing?"
"Ha! After we screwed you so hard last time? No way, you'll just set our money on fire out of spite. Way too risky."
Is this bad-faith stunt pulled after the company spent months focusing energy on the deal (rather than on the business)?
But enlighten me how a 40% odd share distribution of a now PE-owned and operated company would be a bad thing? Surely they're going to try and increase the company's value for their own self interest?
Founders often care about doing good by their customers, vendors, employees... while the average PE firm will happily screw everyone over the moment there's a monetary incentive to do so.
If a founder has the same time horizon for an exit as the PE/VC and if the founder is emotionally detached from the business/product/customers/employees, then all incentives are aligned. But that's usually not the case which is why you often see CEO's ousted and replaced by a "professional CEO" to "take the company to the next level". In reality founder-CEOs are ousted most often because their passion for the business gets in the way of maximizing profit.
In this scenario then, it might be a kick to the ego, but if the original founder retained a large minority stake in the company, this profit-driven approach should result in an increased share price (over time) right?
Some other companies like Lyft or Alphabet have similar structures, but it is very unusual.
and rightfully so
Which you prefer depends entirely on what your investment goal is.
During periods when VCs have more leverage they'll lean on founders to not issue dual class stocks, since of course it reduces their power to fire CEOs when things aren't going well.
The way most Facebook shareholders have.
> with the explicit purpose of retaining control
Why wasn't the other party contractually prohibited from obtaining control?
Back home we have this small newspaper that's been going on for 25 years. It's just a small 3 man operation, and it's just a weekly paper that covers local stuff in our small county. Most of their customers are expats and older folks.
When they started out 25 years ago, they raised funds by selling private stocks. All in all, there are maybe 100 owners, many whom probably don't even remember that they own the stock (but you can easily find them, as we have pretty transparent laws when it comes to company ownership).
But here comes the fun part: A couple of years ago some of the leading media companies in our country (Norway) started consolidating "power" by acquiring small local newspapers all over the country. Eventually they came to our local newspaper, and they started cold-calling all the listed owners, asking if they could purchase their stocks - warning that the newspaper was on the brink of bankruptcy, and that they would buy it and restructure it into a profitable paper. Some owners, thinking the stock was going to be worthless anyway, sold them their shares.
They, of course, never told the majority owners any of this. The majority owner (the workers of the newspaper) started getting worried calls from senior/old readers if the newspaper was going to close, because some investors had been calling them with bad news about an impeding bankruptcy?
The paper printed a story about this attempted takeover and the fake news regarding any potential bankruptcy, and people stopped selling their stocks.
I think in this case: don’t pick a fight in the back yard of a small town where community still exists and everyone sticks up for each other.
In a sane world, this kind of behaviour would be identified as fraudulent and the party responsible would lose their shirt.
This sounds like it should be a pretty big story. "Extremely dangerous to our democracy." On the other hand, it also sounds like it wouldn't be.
Obligatory:
Sadly no one wants to buy the papers.
If you credibly report your experience, they will know who did it, anonymous or not.
"The Funded" was an attempt to do this for VCs a decade ago. But it was astroturfed in practice.
Where's the disconnect?
Branson convinced (and lied to) his partner that no one in the company actually liked him and the union attempt would fail. Caused his co-founder to quietly quit and Branson to retain sole control.
I agree, I imagine shady shit like this is quite common just not discussed.
Source
> Richard Branson’s Losing My Virginity
> So much business is done in bad faith and the people on the losing end rarely have the ability to warn others of their experience without killing their own reputation.
The M&A world is much smaller than you think. These reputations get around and the story you're referring is an exception not the norm.
Availability bias 101.
Source - work in PE, rarely see this happen.
What the article describes is a simple case of large fraud: deceiving someone for a personal gain. That is of course if the article is truthful.
It seems like a narcissist with a very 'dynamic' relationship with the truth chased the AI hype train and ended up with a bunch of money and attention due to a stupid VC. He pissed off the teams that invented Latent Diffusion and his partners at RunwayML in the process, and now it seems like his cofounder as well. What value is there in a company that's only famous because they spent $600k in VC money training an open source model on AWS?
1: https://www.forbes.com/sites/kenrickcai/2023/06/04/stable-di...
Before that they were the Uber for x/y as a service people.
It's a shame we can't get things financed without these PT Barnum clown cars
To me that means that, unlike blockchain, there is actually a viable product behind all the AI hype, and unlike Uber companies have already started selling it rather than waiting for it to become profitable through scale.
Maybe it's just me but the AI hype reminds me a lot more of the dotcom era than any of the recent hype cycles. Of course this means that for every Amazon or Google there will be 9 million failures, and unlike the dotcom era, it's likely that it'll be Google (or most likely Microsoft) who hits the jackpot, meaning it'll be even harder to find the right investment opportunities this time, but I don't think it's a fad.
The royal society and other 18th century science institutions had similar problems. Carnival barkers would shock people with leyden jars, hidden wires and do Stephen Grays flying boy experiment as an amusement to raise money to do actual legitimate science.
Some of the early Copley medal winners were impoverished borderline homeless people who couldn't afford the membership dues to scientific societies. They've got like scientific theories and galaxies named after them today
In Japan, the government has a special status for accomplished people where you get a lifetime monthly stipend so that, say fine poets can write poetry without worrying money. (人間国宝: https://en.m.wikipedia.org/wiki/Living_National_Treasure_(Ja...)
It'd be nice if things that were valued could be funded without having to hustle so much
Their schooling gives them greater freedom of action than you because they have learned to be free of pesky ethics.
Very low quality if not full on paid for “journalism”. Putting only loosely connected logos on a deck? Gimme a break, happens every day in every office in the world.
Such an agreement would not be valid in court as there wouldn't be an exchange of consideration.
Consideration is only required to enforce a contract for future performance, since otherwise there is no harm in breaking the contract.
Furthermore, consideration isn't required to enforce future performance. It's a fundamental basic requirement to have a contract in the first place. Without consideration, there is no contract.
I have other financial processes which rely upon timely processing of my completed tax filing, and every year it causes me trouble. So if something is thought to be worthless and about to fold, "just hang onto it" could cause a non-zero amount of headaches.
If you're just holding shares/options in a corporation that isn't going through ownership changes, that problem doesn't exist.
That said, there are still valid reasons to cut ties with past partners/employers.
It is not strange that tax laws favour the well healed lawyered up.
Edit: no theory needed. The lawsuit goes on to say the $100 is the price the co-founder originally paid for the shares when the company was formed.
The complaint simultaneously tries to paint the co-founder as absolutely vital to the success and creation of everything the company did, while at the same time only taking 15% of the company (the CEO started with 70%) and completely unaware of anything regarding the company's assets, income, or valuation, despite apparently negotiating multiple hundred thousand dollar funding campaigns and contributing $15k of his own money. Is it common when you're in the "getting grants from NGO's, before even seed VC funding" part of starting a company for one of three founders to be negotiating these $100k+ funding deals without any access to the company finances?
Didn't follow any public statement of the CEO, didn't have an insight or access to the books despite apparently multiple times running into funders complaining that the company appeared to be mis-managing funds, and apparently didn't even blink an eye (other than to note it I guess) that the deal that he thought was selling his shares back to the company was instead written to sell it to the CEO personally.
CEO may have been crooked as any man could be, but the co-founders own complaint really makes it seem like he walked through his entire run there with his eyes tightly shut.
My former business partner tried to pull a similar stunt. He mailed me a check for a few dollars (the original purchase price), along with a cheery matter-of-fact explanation. He assumed I'd cash the check and in doing so give away my vested shares for almost nothing, but luckily I did not. Sent a letter back explicitly stating I continued to own the stock and that the shares were not eligible for repurchase under our repurchase agreement.
Likely the CEO explains that it's worth nothing, they're re-organizing things for such and such a purpose, and the 15% stake in the cap tables is an inconvenience preventing a possible deal. Please could you do us a favor and help us clear that from the cap table.
I'm the kind of person that would fall for that.
Human nature is to trust on face value. Sometimes that trust is not warranted.
I assume I can be fooled.
I for many people including me, defence against dog eating dog business has to be learned.
I've also done what the founder in the article has done - sold equity for very little.
The reasons for doing so are various - most of those reasons being more practical or rational than you might expect.
In my case, I sold my share because I had no faith in the vision, or faith in the potential or even worth of what we pivoted to. I had enough equity that I had a fiduciary responsibility to further the goals of something I was confident would tank the company. It was either fight the board/VCs and my cofounder, risk being sued for not acting in the best interests of shareholders, or sell me stake and move on.
Said company went out of business 2 months later as it pursued its unviable, worthless pivot.
I'm no way rich, but I would not even bother taking the time to go to a lawyer or whatever and do all this kind of paperwork for such a ridiculous amount of money, I'd just ride it however it goes and not care.
My feeling is that the guy also got some favors or something under the table, and the $100 was purely nominal. If that's the case, it could be that whatever he was promised didn't actually pan out, and now he's suing in retaliation.
In any case, "$100 for a 15% stake" simply cannot be the whole story.
no kidding. i wouldn’t sell a 15% stake in a lemonade stand for $100. that doesn’t even cover the hassle of reviewing the contract and signing a bunch of notarized paperwork
Suppose you made it very easy for them to sign it over, with the contracts ready and someone in person ready to guide you through signing them. You could apply guilt and some made up scenario about needing those shares back so that the company can move forwards. Enough spin and pressure could do it.
In retrospect, perhaps I came out the winner?
This was it: https://dudefactory.com/
I went on to turn that £500 into approx $13.5m: https://torrentfreak.com/major-tv-torrent-site-thebox-bz-cal...
(Obligatory congrats)
Edit: and was running that site related to why you went to jail?
(also all the money is long gone, First Wife has what's left of it, I am broke once again lol)
Even if you know what you're doing and you watch it like a hawk it's pretty easy for other parties to pull any number of shady but technically legal moves to significantly devalue yours/others while protecting their own.
If this proves to have merit it's one of the more shocking (yet straightforward) instances of this kind of unfortunately routine behavior.
That said it's a little hard to believe anyone would take $100 instead of holding on to it to see what happens. Depending on personal circumstances I can see how $100k or more could be tempting but $100 is ridiculous.
Stable Diffusion has had a very large impact on the entire arts industry, far more people have used SD than have Claude or pi. If another open source startup can reach that level of industry shaking fame and intense user interest, they could have easily be valued at 1B.
If SDXL works out, that'll be another large leap forward. Midjourney's models are stronger, but they can't compete against a legion of 1000 fine-tunes for every purpose.
Having an open foundation model for image-generation is a service to the world. It just isn't exactly obvious how it could possibly lead to profit.
Isn’t a VC investment dead equity?
Dead equity does none of the these things. Think of it as spent or no longer in play.
I don't know why some people are so touchy about the term. It's not a value judgment on the contributor. Furthermore, I would argue that a lot of the time Angel investment or friends and family investment is dead Equity too
They were raising a new round and my old grant was a sticking point because the new investors weren't content with the company not having a record of my exercise.
I signed because it helped them out, cost me nothing and seemed like the right thing to do. Just think it was funny that a VC was so averse to dead equity that they made the company make sure someone who wasn't on the cap table agreed that they weren't on the cap table.
We still had majority ownership until he decided he didn’t give a ** about our ownership claims and openly did his own thing.
The problem is, no lawyer is going to take the case because the $$ is too small and we would be risking our own capital vs the company capital.
The worst part…it’s an LLC and the manager remains kind enough to send the tax statement each year, so I pay for the privilege of having a company stolen from me.
Choose your business partners carefully. :(
(Also, I didn’t research this author, but a reminder that for $500 or so, you too can become a writer for Forbes. They have a massive credibility issue and I suspect are cashing out what little name they have left)
Even if the company would be indeed worthless, I would not bother selling my shares for $100. I would just watch them go to 0.
Who would sell anything like that for 100 dollars in 2 transactions? If it really was worth nearly nothing I'd probably not ask my cofounder to pay me 100 bucks for it either.
It is best understood by modelling it as an international criminal conspiracy.
All models are wrong.....
However, if he refused to sell his 15% stake, there's absolutely no reason why you wouldn't incorporate a separate business all together, especially if you were on the cusp of fundraising a massive round.
Summary: Bad business by the CEO, poor thinking by the stakeholder, Bad due-diligence by the VC firms. /end
Or some variant of the same recipe…,
https://en.wikipedia.org/wiki/Eduardo_Saverin
I'd say nothing like giving up a stake for $100