There will always be hustlers a-plenty ready to exploit entrepreneurs.
A few examples from my years working in Silicon Valley from the legal side (where, unfortunately, a lot of this crops up):
In the days when founders were generally less informed than they are today, I would often see them fall prey to "consultants" who would promise to open doors to funding and the like in exchange for a significant equity stake in their venture, only to show themselves to be nothing but B.S.ers.
I have seen lower-tier VCs who cared not a whit about their reputations take control, fire the founders and do a 100 to 1 reverse stock split in exchange for modest additional funding, reducing the entire equity holdings of the founders to less than 1% of the company in one fell swoop.
I have seen founders sell in acquisitions, take their full compensation in the form equity in the acquirer that had to vest over 4 years but without acceleration protection in the event of termination without cause, be told that "we wouldn't do this unless we wanted you to succeed," and then get fired within a few months as the acquiring company took years' worth of work from them for what amounted to a pittance.
I have seen a young founder build up incredible value in a new venture and, after a few years of devoting everything to it and building nice revenues, take in a "partner" who was a "player" in Silicon Valley, only to have that person maneuver him down from an initial 100% ownership stake to 50% to 5% and, finally, when a $30M buyout is about to happen, grant to himself massive amounts of additional stock (all for bogus reasons) to put the original founder under 1% right on the eve of the acquisition.
I could go on and on but the lesson in all of these is that entrepreneurs should always be vigilant to ensure that the deals they do are prudent and do not expose them to this sort of exploitation - it can come at you from all sides.
Very nice piece, by the way, Ryan - I find your posts consistently insightful.
I've always seen a strong analogue between systems hacking/infiltration and this kind of legal behavior. In both cases people who specialize in the arcane rules of each system (unix or specialized law) use this arcane knowledge to blatantly break the intent of the system rules without breaking the letter.
The only difference is that law hacking is totally legal. As Vito Corleone once said, "A lawyer with his briefcase can steal more than a hundred men with guns."
do a 100 to 1 reverse stock split in exchange for modest additional funding, reducing the entire equity holdings of the founders to less than 1% of the company in one fell swoop.
Isn't that how facebook re-jiggered things to make up for early equity granting "mistakes?"
Not exactly. Keep in mind that the movie "The Social Network" is not a 100% accurate telling of history. In the movie Eduardo (a co-founder of Facebook and initial source of funding) has his shares diluted from 30% down to a fraction of a percent. In reality Eduardo's shares were diluted (by issuance of new stock) from about 1/4 of the company to less than 10%. And it was probably a necessary move as well, seeing as Eduardo was no longer very connected with the company (it took him some time to even discover that his share of the company had been diluted, despite having been the CFO of the company on paper. In the end he ended up realizing something like a 6 million percent return on his initial investments (according to the value of his share of Facebook at the moment).
I have seen lower-tier VCs who cared not a whit about their reputations take control, fire the founders and do a 100 to 1 reverse stock split in exchange for modest additional funding
So... why was additional funding needed? Why were the founders not able to get it on their own?
I have seen a young founder build up incredible value in a new venture
How incredible? Maybe the partner believed the founder's estimate to be literally that...
I don't want to defend the company described in the OP, but overconfidence is endemic to the startup culture. There's plenty of companies out there with nothing more than a clever gimmick, or worse yet, an imitation of someone else's clever gimmick, and that are destined to vaporize the carefully collected funds of their investors. Is it wrong to act decisively to turn such companies around? Or to collect whatever "value" remains when the end is nigh?
It's easy to criticize the VC guys, and they certainly can act badly at times, but every entrepreneur thinks their company is the best thing in the world - or acts like they do - and can be a little blind about these things.
I will readily acknowledge that investors can exercise their legal rights as they deem appropriate, There are times, though, when it makes you want to hold your nose as you experience it, and the 100:1 reverse split was clearly one of them (over the years, I have seen many, many down rounds and I would not make that statement about the overwhelming majority of them - so I understand and don't disagree with the general point you are making).
The second situation was not only ugly but blatantly illegal and led to a major lawsuit with some pretty serious repercussions for the wrongdoing "partner" (settlement by having to pay a 7-figure sum to the founder plus later getting sued by the acquiring company for various wrongs, including the one described here).
After they have received an investment it is not their company, but a company that belongs to both them and their investors. Indeed, unless those investors are individuals, they have a fiduciary responsibility to act when the company is being mismanaged.
Just because you legally can, doesn't make it right.
There is no good excuse for maximizing your profits by suddenly changing the ownership structure of the company to your direct financial benefit. Doing so is wrong.
A few examples from my years working in Silicon Valley from the legal side (where, unfortunately, a lot of this crops up):
In the days when founders were generally less informed than they are today, I would often see them fall prey to "consultants" who would promise to open doors to funding and the like in exchange for a significant equity stake in their venture, only to show themselves to be nothing but B.S.ers.
I have seen lower-tier VCs who cared not a whit about their reputations take control, fire the founders and do a 100 to 1 reverse stock split in exchange for modest additional funding, reducing the entire equity holdings of the founders to less than 1% of the company in one fell swoop.
I have seen founders sell in acquisitions, take their full compensation in the form equity in the acquirer that had to vest over 4 years but without acceleration protection in the event of termination without cause, be told that "we wouldn't do this unless we wanted you to succeed," and then get fired within a few months as the acquiring company took years' worth of work from them for what amounted to a pittance.
I have seen a young founder build up incredible value in a new venture and, after a few years of devoting everything to it and building nice revenues, take in a "partner" who was a "player" in Silicon Valley, only to have that person maneuver him down from an initial 100% ownership stake to 50% to 5% and, finally, when a $30M buyout is about to happen, grant to himself massive amounts of additional stock (all for bogus reasons) to put the original founder under 1% right on the eve of the acquisition.
I could go on and on but the lesson in all of these is that entrepreneurs should always be vigilant to ensure that the deals they do are prudent and do not expose them to this sort of exploitation - it can come at you from all sides.
Very nice piece, by the way, Ryan - I find your posts consistently insightful.