The Lessons Google Ventures Learned from Secret
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Crazy. Irresponsible. Negligent. Bill Maris would NEVER invest in such people. All of the Valley VCs who are outraged with Secret and the founders' cash-out would NEVER want any of those guys in their portfolios.
Too bad those crazy kids ended up building a $250B company, huh?
I always find it quite rich, and quite immature, when investors try to tell entrepreneurs how to live their lives or spend/not spend their money. The Secret founders offered their investors a deal, the investors took it, circumstances changed, and the investors got less of a bargain than they thought. This happens every day. Should Mark Cuban return the billions of dollars he made off Yahoo from selling them that epic turd of a company called Broadcast.com?
The perception that VCs should consider themselves lucky to have invested in an immature asshole's startup sums up much that is wrong with Silicon Valley. I don't wish for another burst bubble, but if it happened it might be a useful reset.
If there is a bubble in this industry, it is a bubble of amateurs; people who shouldn't be investing or working in a field that is driven by extremes, and always has been. Extreme people chasing extreme success at extreme odds. And you know, everything in those extremes is going to look weird to people on the outside. Young Gates also wrecked sports cars and nearly went to jail; maybe these are all anecdotal, but the fact remains that you've got to accept a bit of eccentricity in this industry, if you want eccentric returns.
If this whole Secret backlash thing continues, the kids in this industry might need a history lesson on why Peter Thiel called his VC firm the Founders Fund, and why it was so novel at the time. Investors always want to give founders a tough time; until Thiel and Co. came along, Valley VCs practically colluded to ensure that young entrepreneurs remained poor until an exit. I'm sure they would love for that era to return, but thankfully there's just too much capital for such a thing to happen anytime soon.
The founders parlayed multiple VCs chasing them into gaining $3m for themselves. I don't see anything wrong with that personally, it's the investors money and it was voluntary.
I agree with Bill Maris though that it was far too early in the startup to be doing that. The VC must have assumed their pull in the VC scene would take them to some sort of success later on - so why not. But that is a risky gamble.
It should be pointed out that the investors were no amateurs. Redpoint and Index are Tier 1 VCs, who know exactly what they're doing. They were investing in the next Facebook, and it turned out this was not it. That's the game VCs play.
The VCs are cold hearted capitalists until the hot second founders have negotiating power and make the VCs compete. Then they whine.
They need to grow up and, as @sama says, if you don't like the deal? Stop whining and don't buy.
Whining about how your values aren't aligned? Don't invest. Don't like founders taking cash out? Don't invest.
I personally know many successful traders and managers who live very quiet, middle class lives despite having the means to do much more (usually because they get their kicks off business success, not consumption). Cf stereotype of the Swiss billionaire in jeans driving a beaten up Volvo. The head of a derivatives desk in the London HQ of a global bank used to drive a 10 year old hatchback to the office and lived in Zone 2 or 3 in the same house he bought as an immigrant with his first years' savings. Obviously, these guys don't appear in press releases. I would argue they are also relatively rare.
However, on the work hard play hard side, you can name literally hundreds of Gordon Gekko types like S. Cohen who bought Hirst's famous $8m stuffed shark or S. Schwarzman who likes to put his name on entire museum wings around the world. Some very driven people have more intense fun on the side and the only thing that matters to the VC/FOF is a. the possible ROIs under different scenarios and b. the probability of each happening; to calculate the NPV and therefore desirability of the investment. Some of the more extreme characters from this world are documented in "Richistan" [1] and "The $12m stuffed shark" [2]. The common trait amongst the "nouveau riche" is that they are intensely focused and good at their work, not letting their fun permeate.
If I had spare capital right now, I would happily take the other side of your trade; I'm pretty sure that spending behaviour (hard fun, tendency to consumerism, whatever you want to formalize it as), all else being equal, is not predictive of success, just as with race, gender and maybe even education or age (adjusted for experience).
As for the original subject, I think a lot of people who grew up well off or have had a few years to build some security do not realize how valuable those early marginal dollars are to someone without connections and a rich daddy. A "normal" person might well take 5 years to save the $100-200k necessary for a safe bootstrap; if they fail, they're back to the grind for another 5, delaying kids and life accordingly. It is perfectly rational for the founders to attempt to circumvent that if the market generously offers the opportunity, by taking out enough cash for a few trials should this one not work out.
[1] http://www.amazon.com/Richistan-Journey-Through-American-Wea...
[2] http://www.amazon.com/The-Million-Stuffed-Shark-Contemporary...
I don't know if you've ever watched the "Trader" documentary that profiled the life of thirtysomething Paul Tudor Jones, but it provides an 80s-era glimpse into world you talk about. Legend has it that PTJ bought every VHS copy and had it destroyed.
But yes. The 2 of the 2 and 20 is there because no fund manager can get the best talent without paying competitive market rates including a large part in cash to traders. Not just traders - I met a HR head in New York who told me he was taking home $440k... It's not standard of course, but I did feel (several years ago mind you) that funds raising with only the 20 part and foregoing the 2 were perceived as scammers or sub-par somehow.
The best books on the history of funds/great traders are Steve Drobny's [1] for this generation and Schwager's Market Wizards series if you want something a little further back [2]. There's a decent mix of stories - from "intrapreneurs" later backed by their own former bosses, to bootstrapping with their own capital, not everybody started with a big raise. It's also a good history of the industry and its gradual increase in sophistication.
[1] http://www.amazon.com/Steven-Drobny/e/B001JSFKO8/ref=sr_ntt_...
[2] http://www.amazon.com/Jack-D.-Schwager/e/B000AR7ZM4/ref=sr_n...
Even in the article, the GV guy tries to disown relations with the founders (even though they are ex-Googlers), as if trying to elude that Googlers wouldn't do that. Reality check: Googlers are just ordinary average people that have desires and temptations and no amount of genius will remove that fact.
I actually don't know which company you're talking about. Facebook?
There are always rules on how you are allowed to spend money that you borrow, it's never just a blank check. VC funding probably comes with the most freedom but it's still meant to be used to build the business, not cars/drugs/entertainment, regardless of the eventual outcome.
It's basic integrity.
https://medium.com/gv-notes/a-few-thoughts-on-secret-3cb50a3...
Here’s the text of an email I sent to Mike Isaac at the NY Times earlier, and thought it was important to share this context and nuance.
Hi Mike,
Regarding the article on Secret earlier today:
http://bits.blogs.nytimes.com/2015/05/05/the-lessons-google-...
I want to correct and amend a few things. I wanted to let you know how my views had evolved since we spoke. I aspire to be someone that says when that’s the case and it is here.
I hadn’t spoken to David Byttow when you and I chatted, and I should have done that. I’ve spoken to him now and have a better understanding of things.
We weren’t part of the secondary. I don’t know what the agreement was among David, Chrys Bader and those that did. And I don’t know the status now — maybe they’ve returned the money, maybe they don’t need to or can’t. But even if they returned all of the money, it wouldn’t affect GV, as we didn’t participate.
I do want to make clear that this was not a “bank heist,” and that was a poor choice of words on my part.
That implies that the founders were trying to line their pockets at the expense of others. After having a heart to heart with David, I don’t think that’s true. David rightly pointed out to me that he and Chrys worked extremely hard. They built something that captured the imagination of a lot of people and had a huge amount of users. The tone and content of my comments as printed don’t pay the appropriate respect to that fact.
As a fund, one thing remains true — we are not excited about founders selling stock early in a company’s life cycle. It provokes the question — if founder’s are sellers, why would we or others be buyers.
As for it not being “sustainable,” there is no way to ascribe that to the founders any more than the million other reasons a start up can fail. This one did. But credit to the founders for not just running out the clock and spending all the money — and instead returning some capital to investors rather than running it into the ground. That takes bravery. It doesn’t happen often.
As I now understand, David is doing a lot to make it as right as he can with his investors and employees. I’m glad your article sparked the conversation that had enough truth in it to help me evolve my opinions to some that I think are more correct.
Best,
Bill
I'm also not surprised that Byttow and Bader would feel they deserved that payout for the work they had put into the project to date. There is a unique kind of point of view I've seen when folks have dealt with a lot of negativity about what they are doing, and then suddenly it is the new hot thing. You're burning up your lifeblood into your startup, and some rich guy comes along and says "Hey, really? You going to just skim that cream for yourself?"
But what it really illustrates how the startup founders and the funding folks are not really aligned. The funders want to see a big return on their investment, the founders want (in part) to get rich, since the money involved is the same, you have two groups pulling it in two different ways. Hence the lack of alignment.
Everyone comes out of this a bit wiser, and with an appreciation for what is at stake, and the next time it goes differently. Everyone's thinking "evolves." Usually though, it isn't so public.
Lesson #1 - yes you can take too much funding in a round.
Lesson #2 - nobody's perfect, and everyone is learning.
Lesson #3 - Reactions are just as important in understanding someone's character as their actions are.
You can see this on kickstarter campaigns where there are "features" that are added if they get more money, but often the features are much more costly to implement than the delta in money between not-implement and implement. If you've been in that situation before you recognize they are setting themselves up bruising.
More like realizes that working with anyone in the future is not helped by publicly throwing founders under a bus when they fail. (Even if they deserve it.)
The first reason is that you want he founders to be focused on the company, and not struggling to make ends meet. That way they can make long term decisions.
Secondly, every round the founders lose more and more control. They should be compensated for this. Yes, they have economic dilution from the investment as it is now, but some of the shares the investors buy should be founders shares. This results in less dilution for the company, and is a repayment of the sweat equity they founders have created.
One of the big problems with venture capital these days (and the reason I won't take it anymore) is that it disrespects the founders by demanding liquidation preferences for the VCs. As if the VCs who merely put up other people's money should have rights superior to the people who literally put part of their life into the company. That's not right. All shares should be equal, and if not, the founders should at least be respected. (For those firing up your keyboards to explain to me why LPs are necessary, two points: 1) I've heard a bunch of arguments for this already. 2) they've all come from VCs and are self serving. You can't really make an argument that it's better for the company or fair for the founders.)
Thirdly, too often I've seen VCs force founders to revest shares. But the value of those shares was already earned. The founder incentive to do well comes from increasing the value of the shares... and revesting the shares denies the founders crucial voting rights that they have earned already. (And makes it that much easier for the VCs to force a founder out, which is usually a bad idea in my experience.)
Pay yourself a higher salary. If you're paying yourself less than 80k, bump it up. When you're selling stock, you're usually talking about tens of thousands of value at the minimum. Founders and especially employees shouldn't seek to take money off the table because it rewards them for hitting the wrong milestones. Fundraising is not the goal -- a sustainable business is. They should get rewarded for the latter and use the former as a source of fuel to achieve it.
"Secondly, every round the founders lose more and more control. They should be compensated for this."
They are compensated for this in the form of their net worth skyrocketing come fundraising event. Really, the question is should they receive liquid compensation. Sure, it would be nice for some risk to be left off the table, but if you signal to people that you're selling your own stock, what does that do to the employees mentalities? The cost is higher than the reward.
"One of the big problems with venture capital these days (and the reason I won't take it anymore) is that it disrespects the founders by demanding liquidation preferences for the VCs."
I agree! If the stock is liquid, I see no reason why VCs should get preference... the only thought that comes to mind is that they wouldn't invest if the preferred treatment didn't exist, or that the funding market would be significantly smaller. Remember... VCs are paid a lot to mostly lose money.
Which is monopoly net worth - those billionaire charts are fantasy land when it comes to actual liquidity as we all know.
but if you signal to people that you're selling your own stock, what does that do to the employees mentalities?
Ok, fine. Then make the deal that employees have the option to liquidate a percentage of shares at the same time. Ends up looking like a dividend.
So maybe A&B rounds result in salary bumps.
When the company starts being worth something significant, like over $20M valuation, during funding founders should take some money off of the table-- if they want. It's prudent financial planning (don't have all your retirement in the stock of one company) and while they are giving up potential upside they are ensuring long term security for their family against failure of the company combine with an economic downturn. (A combination I've seen twice in my lifetime.)
And when your company is in the billions you should have the option to take some off so that you can start angel investing on the side.
Congrats, you've created a huge tax burden for options holders.
Also, how do you come up with the price for the common shares when they aren't liquid and aren't changing hands? It seems weird to give a price of $10/share for a common share when you aren't able to sell at that price.
If a company makes it beyond the seed stage, it should be capitalized well enough to allow the founders to take a reasonable salary. If there are any founders employed at venture-backed startups struggling to make ends meet, I think it's safe to say the vast majority of them are not struggling because they're not being paid well enough.
> Secondly, every round the founders lose more and more control. They should be compensated for this.
Why? If you want to maximize control, build a business that doesn't need to sell equity to raise capital. Or build such a great business that you can raise large sums of capital without having to sell much equity.
Incidentally, when founders cash out their shares, they're only hastening the loss of control, especially if this is done early when the company's valuation is lower.
> One of the big problems with venture capital these days (and the reason I won't take it anymore) is that it disrespects the founders by demanding liquidation preferences for the VCs. As if the VCs who merely put up other people's money should have rights superior to the people who literally put part of their life into the company. That's not right. All shares should be equal, and if not, the founders should at least be respected.
This is silly. You're not going to raise millions of dollars from professional investors who have fiduciary duties to their limited partners without said investors demanding reasonable protections. Period.
If a founder is worried about a 1x preference, which is fairly standard, it suggests the founder is not confident about the company's prospects, at least as far as investor expectations are concerned. For example, if a founder raises $5 million round at $15 million pre and is worried about a 1x preference, one would have to question whether the founder really believes the company is actually going to be able to deliver the type of growth his or her investors expect.
If an investor demands a 2x or greater preference in this market, it probably means the company is not in a good position because nobody competing for a deal is likely to demand more than a 1x preference today.
> Thirdly, too often I've seen VCs force founders to revest shares. But the value of those shares was already earned. The founder incentive to do well comes from increasing the value of the shares... and revesting the shares denies the founders crucial voting rights that they have earned already. (And makes it that much easier for the VCs to force a founder out, which is usually a bad idea in my experience.)
Revesting is negotiable and if you set up a reasonable vesting schedule when you form your company, chances are you'll be able to avoid this issue entirely. A lot of founder revesting issues arise because the founders purchased their shares for virtually nothing with no restrictions attached when they formed the company.
1) Immediately after taking the investment founders could sell the company for the value of the cash and profit handsomely while the investor loses the bulk of their money. That's clearly no good.
2) If VCs are buying common then it will push up the value of common stock much faster leading to much much higher strike prices for employees. That's clearly bad for them.
3) By ensuring downside protection VCs are willing to invest at higher valuations leading to less dilution which increases the upside reward if the company is successful. If you're focusing on downside protection instead of upside reward as a founder then what are you starting a company for in the first place?
1. To who? There is a liquidity problem here. No one would buy a company at par value that just had the founders bail - and no founders are going to bail on a company that is killing it. This is such an outlier case that it's ridiculous to assume its a primary motivator.
2. Simple, give employees vesting equity grants like the founders, not options.
3. Downside protection is anti-pattern for VC. High risk = high reward. You might get more investments, but those are inflated and skews the market toward making riskier investments if they know they have a fall back. Secret is a perfect example.
The reality is LPs are in there because that's been standard and companies who need investment would rather take the money with shitty preferences than not take it at all.
If you don't want to do investments with LP, then either be so good that people want to invest on any terms you offer or don't take VC.
2. Founders do get options. They just get them with a very low strike price because when they start the company it's worthless (essentially).
3. Secret didn't fail because it raised money at too high a valuation. It failed because it didn't achieve real product market fit. If it had achieved fit then the excellent terms on which they raised money would have been very good for them.
To your point about "invest on any terms you offer" what I'm trying to show you here is that having investors buy preferred shares is good for everyone involved.
> " Immediately after taking the investment founders could sell the company for the value of the cash and profit handsomely while the investor loses the bulk of their money."
That's nonsensical on the face of it. If the company is worth $10M and an investor puts in $2M for %20, then the remaining equity is $8M. I don't consider selling a $10M asset for $2M (and netting %80, or $1.6M) to be "profit[ing] handsomely". It's giving up %84 of the company.
Plus it's trivial to prevent this by requiring, as part of the deal terms, that a sale of the company have investor approval.
Your second point presumes that there's only one class of stock. There can be preferences, such as the anti-sale clause I mentioned that common shareholders don't have. That's completely different from liquidation preferences.
Your third point is silly, I'm focusing on being denied a fair deal in a liquidity even and you're talking about "Donswide protection". It is true that treating people fairly works better on the downside too.
But your comment "what are you starting a company for in the first place?" makes me think you're naive and reacting as if I've dared to disagree with the common wisdom of our lords and saviors the VCs.
I've been starting companies for 30 years, this is experience talking, kid.
2) If you have different classes of stock that pay out the same in a liquidation event you aren't going to be able to get a significant difference in their value.
3) Who's to say what's fair? We're talking about capitalism not an ethics textbook. Fair is whatever you can negotiate. And providing downside protection to the people putting in the cash enables you to enhance your upside reward. If you're raising 2M on 8M pre and you're more concerned about what happens if the company liquidates at 5M than what happens if you get to 50M or 100M then I do honestly wonder why you're starting a company in the first place.
Company A has 4 founders, each with 25% share and are doing well and valued at say 4m
Scenario 1 An investor wants to enter the game and buys out one founder for 1m No change in company's value of 4m and they go on to the sunset
Scenario 2 An investor wants to enter the game and joins the other 4 founders with 1m cash New equity split is now 20% each and company has 1m cash in the bank, valuing them at 5m with each having a 20% stake
Any exit from this position should allow the assets to be paid out equally to the 5 shareholders
if it is ok for one stakeholder to negotiate to be paid out first a preagreed sum, then it should also be okay for other stakeholders to negitiate to take money off the table during funding.
I don't understand this return money to investors bit. Shouldn't it be share the money equally among all stakeholders.
Assuming that you think the company is going to increase in value, the fact that he has preferred shares won't matter in an exit so you're much better off taking 1M instead of 500k (assuming you can put the extra money to good use). And if you don't think that the company is going to increase in value then why did you start it in the first place?
VCs have their investors too, the LPs, and they need to have liquidity to sell their shares and take the profit. If you don't give liquidation preferences or drag and tag-along rights to VCs will not be able to sell and make any profit if the fund is about to close.
Not the first time either.
http://www.businessinsider.com/what-happened-between-google-...
Because the founders had taken some money off of the table, presumably now sitting in the form of a money market account + a red Ferrari, they probably didn't have to ride the Secret company all the way down to zero - they could see that the app wasn't going to be the next Snapchat or WhatsApp, and now that they had a few million dollars, their time was suddenly worth a lot more - they could take some of that money, create a prototype, and shop it around to get more funding.
Compare that to an app like Path, which has raised lots of money, but hasn't gotten traction anywhere except Indonesia. Now they're using their late round investment dollars to try to see if a GIF selfie app, a chat app, or a concierge/customer support service will take them to the next level. Of course, that's just what they've launched - presumably there are lots of mobile app prototypes that haven't seen the light of day.
Will Path's investors get their money back? I don't know. Secret's investors at least have their money back to fund more app ideas, after they've shown some promise.
If the founders take some money off of the table, then they're just selling their shares directly--- and there's less dilution. (It's not the case that they're just pocketing some of the proceeds from the investment.)
In that case the employees will be diluted less than they would be if the same investment amount was made and the founders didn't sell any of their shares. So it's better for employees.
Ideally, though, I think all employees including founders, should be able to sell some of their vested shares in each round of funding. Maybe %10?
Earlier investors don't seem happy about it, but I'm not sure how much weight that has; early investors often have to accept new terms during a fund raising round; for better or worse.
They sold $6/160 = 3.75% of the company, likely about 15% of their holdings. Seems reasonable given the valuation.
If not, then don't tut-tut founders who get a little share from a high quality product that happened to not be astronomically successful. So they took a few million off the table for their hard work -- well deserved.
Yet Google Ventures put some portion of 8.6M into them well before any of that - 2 months after launch.
I guess like everything the "traction and addressable market" pathway is only for the rest of us peons not in the bubble.
[1]http://9to5mac.com/2014/03/14/secret-app-picks-up-8-6m-in-fu...
"I want to correct and amend a few things. I wanted to let you know how my views had evolved since we spoke. I aspire to be someone that says when that’s the case and it is here. I hadn’t spoken to David Byttow when you and I chatted, and I should have done that. I’ve spoken to him now and have a better understanding of things."
[1] http://www.cnet.com/news/snapchat-founders-reportedly-pocket...
Maybe I'm just not creative when it comes to figuring out how to monetize these silly social apps.
Can anybody explain what goes through the minds of investors and founders? How do you eventually make revenue with something like Secret?
> “It’s like a bank heist,” Mr. Maris said. “That’s not how you do a start-up.”
As they say in Finnish, it's not the fool who sells, it's the fool who buys. My sympathy for VCs who signed this deal with the founders is pretty darn limited.
I do not know the whole story but it is not really cool for VCs to go to the press and slam their founders they supported.
Do not take money from Google Ventures.
the series B was in March '14 where the founders took the infamous $6m
So they wouldn't have qualified for long term cap gains right?
They likely owe ~$1.5 million in taxes on the $3m, between state and federal.