I've heard variations on this sentiment repeated a lot. The exact message varies, but it's usually some variation of: early investors always lose, small investors always lose, and/or non-preferred shareholders always lose. I've seen and lived a small number of personal anecdotes that seem to back this up, and I'd like to better understand what underlying pathology causes this.
I understand that early investors are taking the most risk, and clearly there's a lot of downside. But what prevents them from being able to realize or capture the upside?
I've heard a theory, a few different times now, that bigger, later investors effectively collude (descriptive term, not value judgment) with founders to squeeze out early founders and employees (common shareholders) via unfair terms, such as excessive dilution (accepting too low a valuation for larger investment), excessive liquidation preferences (2x or more), etc., and then topping the founders up via side deals. I've heard that, by virtue of squeezing out passive participants, they're able to offer more to the founders, and that incentivizes the founders to take their deal over other alternatives. Does anyone know more specifics about how this happens? In particular, how is this not a breach of fiduciary duty to passive participants?
It's definitely possible to write anti-dilution clauses, etc. But, I've heard that more or less no one writes them, and more importantly no one accepts them. If this is a pretty well-known game, why haven't countermeasures become popular?
For my personal anecdote, I was once an early engineer - the first hire after their Series A - at a small startup that never found product-market fit. The economy was bad, and they were running out of money, and they took - as I understood it - a dubious Series B led by a dubious investor. The founders were very vague about the terms of the round. In particular, the founders revealed that the investors took liquidation preference, that it was greater than 1x, but absolutely refused to say how much. That always left a bad taste in my mouth. When I left, I didn't exercise my options. In the end, the company floundered, and is a zombie to this day. In that regard, I suppose that the particulars of that round don't really matter - none of us were seeing anything regardless.
I'd really appreciate if anyone closer to the money part of this industry could weigh in.
> later investors effectively collude with founders
> a small startup that never found product-market fit. The economy was bad, and they were running out of money, and they took - as I understood it - a dubious Series B led by a dubious investor
The unfortunate reality is that if a startup cannot survive for long on its own, the economy is bad, and investment interest is low - then past invested effort from founders and employees and money from early investors is a sunk cost. They have together created something with almost no independent economic value.
The later investors can buy the assets created so far at near zero cost (the alternative is a bankruptcy auction). They can reasonably argue that the future value of the business is all from their investment, together with a deal to hire the founders and current employees to invest future effort into it.
I mean, yes, that's exactly the argument that the bigger, later investors make, and their lawyers are happy to back them up on that for money.
But consider this. If that were truly the case, why would the later investors work so hard to maneuver their way into this allegedly worthless startup? Why not hire an entirely separate team to build an entirely separate app, and they can own the whole thing with no fuss? If they value the founding team, why not tempt them away to a new venture, and shed all the baggage? Economics has an idea called "revealed preferences" - that words can be deceiving, but costly behaviors are honest - and this does look to be the revealed preferences of the investors.
In other words, just because the later investors can use the threat of insolvency to get their way doesn't mean what's already there doesn't have value.
It's people who lose, which is most, complaining about structural issues when actually they just suck at investing. It's a competitive game, they lost.
I mean, multiple things can be true at once, no? They could have made bad choices or had bad luck. Simultaneously, the system could be rigged for and against certain categories of participants. From what I've heard, there's a lot of both of these going around; startups are highly volatile, but also a lot of the people in the space not only don't play fair, but actively deride playing fair.
You are hearing the voices of failed investors. There are successful angel investors. There are guys in the NBA finals getting paid $50m a year. There are movie stars.
In extremely competitive pursuits with insanely good outcomes, you are going to find an enormous number of people trying to make it and fail.
If hollywood was really truly rigged, how does Brad Pitt make it?
Some things are rigged - most competitive "winner takes all" or close to it are just insanely difficult. Startup investing is probably the least rigged thing in the world, it's just crazy difficult.
I understand that early investors are taking the most risk, and clearly there's a lot of downside. But what prevents them from being able to realize or capture the upside?
I've heard a theory, a few different times now, that bigger, later investors effectively collude (descriptive term, not value judgment) with founders to squeeze out early founders and employees (common shareholders) via unfair terms, such as excessive dilution (accepting too low a valuation for larger investment), excessive liquidation preferences (2x or more), etc., and then topping the founders up via side deals. I've heard that, by virtue of squeezing out passive participants, they're able to offer more to the founders, and that incentivizes the founders to take their deal over other alternatives. Does anyone know more specifics about how this happens? In particular, how is this not a breach of fiduciary duty to passive participants?
It's definitely possible to write anti-dilution clauses, etc. But, I've heard that more or less no one writes them, and more importantly no one accepts them. If this is a pretty well-known game, why haven't countermeasures become popular?
For my personal anecdote, I was once an early engineer - the first hire after their Series A - at a small startup that never found product-market fit. The economy was bad, and they were running out of money, and they took - as I understood it - a dubious Series B led by a dubious investor. The founders were very vague about the terms of the round. In particular, the founders revealed that the investors took liquidation preference, that it was greater than 1x, but absolutely refused to say how much. That always left a bad taste in my mouth. When I left, I didn't exercise my options. In the end, the company floundered, and is a zombie to this day. In that regard, I suppose that the particulars of that round don't really matter - none of us were seeing anything regardless.
I'd really appreciate if anyone closer to the money part of this industry could weigh in.