1. I would say that, even as of 5 years ago, it was rare for a startup to go through a Series A VC round without the VCs taking at least shared control.
2. Founders of reasonably strong startups can usually do angel rounds, also denominated Series A, without giving up board control and have been able to do so for some years now. These rounds used to be for smaller dollar amounts, often capped at $500K or so, but this has changed today in an era where founders can often turn to angels and superangels for larger fundings. VCs want to stay competitive with the angels at this early stage because, if they lose out at that level, they find themselves sitting on the sidelines as their deal-flow shrinks and they lose out on potentially strong investments made at an optimum stage in promising ventures. To stay competitive, therefore, the VCs must perforce bend a little on their traditional terms, including their former obsession with gaining board control right out the gate.
3. Founders themselves are far more savvy today, on average, than was the case a decade ago. In the bygone days, only a relatively few serial entrepreneurs had the sophistication to sit on a reputable board and still add value to it as founders. Today, the average founder is far better versed on what it takes to drive a company than was the case before. Thus, it is easier for VCs (and other investors) to accept the idea of a "founder-driven company" than it used to be. (Over the years, I have seen all too many "control-freak" founders and other variations that could only be labeled an embarrassment to sound management; based on this, I can understand the historic VC attitude, though of course this all must be counter-balanced by the many ills that the VCs themselves brought to the process when they would sometimes abuse the founders in whose startups they invested.)
4. Founders today have far more control over timing on when to do their Series A rounds. The cost of launching is far reduced today and the options for deferring larger rounds are greater, as for example by taking bridge funding from angels or F&F to allow the company to build value and minimize dilution before it goes for larger forms of funding.
When all these factors are combined, it seems clear from the trenches that a profound change is occurring by which founders have more control than ever before over their ventures. Of course, having this validated by someone such as PG, who is at the heart of this activity in Silicon Valley, goes a long way to letting the VCs themselves see it as respectable to accept as a fait accompli as they move forward.
Another observation - this is a good example of the value of YCombinator and other similar networks. In this case, some YC guy is negotiating with VCs and needs some information, so he talks to pg, who talks to some other founders, and bam there's your answer (plus the rest of us are a little more enlightened, too).
> "3. Founders themselves are far more savvy today, on average, than was the case a decade ago."
I've heard this a bunch of times. Why is this the case? Is it the information available to founders, the quality of people choosing to do startups, or something else?
I have worked closely with all sorts of founders over the years and can say that it is not the quality of the people choosing to do startups that is making the difference (though the current group is certainly as bright as any other).
It is just that founders were pretty much in the dark about how startups worked and about a lot of the business principles that tend to promote success.
Today, forums like HN (and many others as well), together with all the social networking services that connect people instantly, allow prospective founders to gather an enormous amount of information about such basic things as how companies are set up legally, how good business ideas are formed and executed upon, how marketing works, etc., etc., often tied directly to the very niche they are targeting. Founders also know a lot more about funding and funding options, where a decade ago most of them needed detailed explanations just to begin to understand what preferred stock or restricted stock or similar items even were.
People make the same types of blunders today that they always did but, with the greater information available to them (and the network of people with whom they can readily connect), the smart ones don't need to sit on the sidelines guessing or trying to get an introduction to some remote and removed VC to try to figure it all out. This has indeed made a great difference in the relative bargaining power of founders today as opposed even to a few years ago.
grellas - could you say whether these days founders can open a company quickly with these open sourced documents by YC or TechStars by filling in the blanks, or do they still need a lawyer to do it for thousands of $$? Sorry if this puts you on the spot, but I just wanted to know how much more needs to be done that is not covered by the standard docs.
I am assuming here that the investors are your friends & family and they aren't out to do a high powered negotiation -- just want to set things up correctly and keep going. Are there any specific pitfalls that could happen if one just used standard documents and a convertible note?
From your question, I assume there would be no big haggling over deal points. In that scenario, if you as a founder are pretty familiar with the pluses and minuses associated with the various early-stage startup investment options (bridge notes, common stock sales, and preferred stock sales), and if you understand securities laws and basic tax issues connected with the various options, the templates might be used in order to save costs. Even then, however, it is not wise, in my judgment, not to at least consult with a knowledgeable lawyer as a double-check on what you are doing.
I think founders get a far better deal on price from lawyers than they used to, and this is in part owing to the prevalence of templates freely available on the web. But, unless you want to fly blind in some pretty complex areas, I wouldn't recommend dispensing with formal legal help altogether.
Specific pitfalls will vary with the type of funding you may be doing but usually they involve securities law and tax issues or just not understanding the range of things that can happen (e.g., with a convertible note, if the note converts automatically into preferred stock at a pricing discount and subject to a valuation cap, all well and good, but what happens if the startup never does such a funding and gets acquired at a premium with the notes never having converted? does your dad or other family member then get his money back with a couple percent interest while others get a 10x return even though he took the biggest risk of all in being early in the game with hard cash needed by the company - this is just one item that founders often fail to consider in structuring the seemingly simple convertible bridge notes - and the issues and contingencies get much more complex when preferred stock is involved).
My advice: even in simple cases, double-check with a lawyer but make sure it is one who will approach the simple funding in the spirit of a simple funding and keep the costs in line accordingly.
BTW, if by "open a company," you mean do the initial company set-up itself on their own, of course founders can but here too they can easily get into trouble by not understanding the range of issues they need to deal with (see, e.g., my comment to a post entitled "how I incorporated myself" from a few weeks ago: http://news.ycombinator.com/item?id=1924719).
On the flip side, I've seen founders cling too tightly to control. Sometimes the guy that is really good at getting a version 1 out of the garage is not the same guy that is good at calling the shots once it's a 60 person company. Taking the stance that "I want to retain control," is obstinate and egotistical. The proper stance is, "I want to retain control until someone better comes along." That may be never. But it's the right attitude to have. In the end, it's not about who controls what, it's about who's more likely to make all the time and money that's gone into the company worth more.
Non-founders having board control means that you don't get to make the choice to replace/augment yourself as manager.
You're absolutely right, but what you're talking about has very little to do with board control. Taking the stance that "I want to retain BOARD control" isn't obstinate and egotistical-- it's basically just saying, "As the guy who works on this company for 60 hours a week, I trust myself to know when it's time to bring in professional management".
Is it really possible to get VC funding when all you have is a version 1 out of the garage? I was under the impression that investors wanted to see traction before putting in serious money.
It is, but it's less likely. I should have phrased that better. What I meant by out "of the garage" was the end of the really dynamic period of the company. You can be physically out of the garage with an angel investment but still be constantly changing your mind on macro decisions. By the time you're at a series A, you're generally more certain of your direction.
From what I've seen, the person who is good at the really dynamic thinking part is not necessarily good at the focus and execute part and vice versa. Being a CEO of a larger company can actually be really boring for a dynamic, hyper-inventive type. I used to fancy myself as a technical CEO until I got a better understanding of the role. A great CEO is priceless and a great inventor is priceless. If it's the same person, then great. But there is no need to force it if it's not.
10 years ago, we had a "2 VC, 2 founders, tiebreaker CEO" board structure that I think was probably more common than simply "conceding the board to the VC". (I'm aware of the pitfalls in that structure, too).
My sense of it --- and someone with more recent experience please correct me if I'm wrong --- is that the shareholders agreements matter as much as the board structure does. Point being, you wouldn't want to see "founder control" becoming cosmetic, a fig leaf around the real power the VCs wield.
I wish PG would go into the details of structuring a board control. Perhaps that's an essay for a another day.
Some context:
Founder of Magna International, Frank Stronach, who started his business some 30 years ago made a lot headlines this past summer due to the sale of his "special" founder-class shares. I found it remarkable that even though the company is public, he still had majority interest over the board due to his share structure. EDIT: Every 1 of his B shares converted to 100 Common Stock (and he had over 700 Class B shares, before he decided to give up control and convert)
Wikipidia explains:
Stronach, who is currently the non-executive chairman of
Magna International, holds multiple-voting shares of the
company, which gives him majority voting power over
issues brought to shareholder vote. Although he controls
the voting power among Magna's shareholders, Stronach
owns only 4% of Magna's equity.
Is this happening because start-ups are getting series A financing later in the life of the company? It used to be that you needed VC just to build and launch a business, but these days the business can be much more real and the founders more proven by the time they're ready for VC.
Startups are getting further and further on seed and angel funding due to advancing technology.
I wish PG would write more about painting and hacking and education and lisp and history and psychology and philosophy and literature and politics and a bit less about investments. Seriously, quite a dry topic..
Great video -- but how exactly did the Marks (Pincus and Zuckerberg) manage to retain control of their boards? What are the specific things that need to be done in the negotiation phase that will lead to that outcome?
Perhaps the ycfounders list is a selected sample: it produces or selects above-average quality founders that are more likely to get a good Series A price (in terms of both control and pre$). I suspect that YCombinator's focus on founders for investment decisions also results in start-ups with assets closely tied to the individuals who run things (rather than say a patent). This leaves future VCs with less bargaining power when forming boards.
While I would like to believe it's because YC-funded startups are better, the fact is that for any startup to raise Series A, the VCs have to believe they're so good they could one day go public. So my guess is that the reason so many YC alumni have been able to retain control is that they are so well connected. They have the other alumni (many of whom are very sophisticated about fundraising) to give them advice, they get hooked up with the best lawyers, etc.
Now that is one area the academic literature on venture capital and entrepreneurship hasn't studied: the social networks of entrepreneurs and bargaining power. Putting that on my list.
All these things that YC-funded startups have going for them (screened teams and ideas, network, support, etc) probably create more demand for them from VCs, giving them better leverage than non-YC-funded ones.
It's an excellent point that YC founders' experience may not be typical ... a different way of looking at this, though, is that YC and other tech incubators have changed the dynamic to give founders in general a much better shot at keeping control.
Which, as a serial entrepreneur, I see as a very good thing.
I think YC is also responsible (with others) for radically improving the information disparity between, e.g., fresh college graduates with a gleam in their eye and partners at firms with 9 figures under management.
Considering that not all YC companies who want VC funding get it, it would be surprising for all of the YC companies that do get it to be above average in whatever metric drives board control. I think this has to be a trend that goes beyond YC.
Some anecdotal evidence that its not just YC startups. My company, NewsCred, raised a seed round of approx 1M this summer. We raised it from "top tier" super angel funds. We are not YC, and were not even based in the US. We also were not serial entrepreneurs, although I'd like to think that we're "above average founders!"
Long story short: we did not give up any board control but did not worry too much about price. We got a fair valuation, but nothing crazy.
Can someone explain the power dynamics of a board, vs that of the shareholders? I always assumed that retaining a majority of shares between the founders would keep them in control of the company, but is it the case that the board has more actual power.
For instance; 2 founders hold 60% of the shares of their company collectively after a Series A. The investors hold 40% (lets ignore option pools etc). Now if each side had 2 board seats (plus a 5th seat held by a brought in CEO), does that mean the founders can in fact be outvoted?
Yup. Shareholdership only matters in so much as your shareholders agreement dictates that it does. I could have 1 share of your company and control a hundred board seats, it doesn't matter. There are some things in law that make ownership of a certain % of shares important, but really its all about the shareholders agreement.
As I'm reading this article and nodding my head, I realized that I don't understand what controlling a board actually means.
It sounds like its written in the term sheet somewhere--what does that look like? Joe Startup will maintain control of the board...? Would it be correct for a founder to say "I have control of the board so..." or is it more of a perceived power as a result of other negotiated terms?
Usually, important decisions in a company require a majority vote of the board of directors to approve them.
Control of the board is then defined as a majority voting ability for an individual or aligned group of individuals. For example, 2 founders with equal equity stake will usually have the same incentives. Therefore, a board that has 2 founders and 1 investor is "founder controlled".
Between being completely founder controlled and completely investor controlled, there is a "split board". That means equal number of founders to investors, and one mutually agreed upon independent party that could technically vote either way -- often times a person previously very successful in business with insight into the startup's market.
In practice, a split board usually means investor-controlled, for a couple reasons:
- The independent board member is usually suggested by the investor
- The independent board member usually has a stronger incentive to side with a powerful investor
This essay makes VC's seem like a necessary evil that founders have to tolerate through gritted teeth, as opposed to something more benevolent like, say, YC.
A lot of VCs are good guys. The difference between us is largely that we're in different situations. VCs invest 100x as much as us. Larger amounts of money will inevitably have more constraints attached.
Two dozen is only about 10% of the 208 YC startups to date. I'm surprised that that few have done a Series A. I would have thought it would be a much higher percentage.
With an equal number of founder elected Directors and VC elected Directors, if your outside tiebreaker director is brought in by the VC's you will be in danger of losing control because you cannot control the situation.
Especially if the tie breaker is planning on doing some additional business with the VC in the future, you may not have a truly neutral person casting the vote.
So, how is founder control typically structured?
For instance, do founder Stockholders get 2 votes per share to elect Directors with, and VC's get 1 vote per share with a guaranteed VC director seat on the board? Or are Directors elected by founders getting 2 votes on a particular decision item A and 1 vote on decision item B, and VC Directors get 1 vote on A and B?
Does anyone know what is currently going on with this?
Are there cases where a non-CEO founder controls the board?
What are the mechanics whereby the minority stake founder(s) control the board? Some sort of skewed voting system? If so, what sort of legal entities allow this structure?
I'm not sure if this is universal, but Stronach (a non-executive chairman of Magna Int.) had control over the board because of his Class B share structure. Every 1 of his B share converted to 100 Common Stock (and he had over 700 Class B shares, before he decided to give up control and convert)
That's quite remarkable, considering Magna is a publicly traded company.
I think one of the main factors pushing the trend in the direction of more founders retaining control is the increased availability of angel money.
If it came down to my cofounders and I having to give up control to raise a Series A (or any series for that matter) I'm sure we'd turn to Angel List to raise a similar amount from well connected and useful investors, without having to give up control - if that were a viable option.
Increasingly it seems like raising a large angel round is an option, which is great for entrepreneurs.
"VCs will still be able to convince; they just won't be able to compel. And the startups where they have to resort of compulsion are not the ones that matter anyway. "
I excepted some sort of footnote for this one. It's not immediately obvious to me this is true.
Hypothetically, the founders are the ones that know their business the best, and hence tend to have a longer term vision. Given that the founder executes on the long term vision, those are the companies that matter. Is that the line of thinking?
If an investor disagrees with a founder so much that they are willing to take actions that force that founder to act against his/her own will, then things must be in pretty bad shape. When a company is doing great, nobody picks fights with its leaders.
On the other hand, there may be cases where a generally positive opportunity, such as a possible sale, is valued very differently by a founder and VCs. I'm not sure how common these cases are, or whether there are existing rules about the board's obligations to shareholders that reduce the likelihood of conflict.
I definitely would like to control my own company.
That said, my philosophy is simple: Your first company should SUCCEED. You should be prepare to give up control, equity, etc. as long as it succeeds.
That gives you a track record AND money. Think about it. If you had $10 million dollars 2 years from now, and a 5% stake in your first venture, contacts lots of happy people and a reputation for succeeding with your first venture, don't you think you could own the shit out of your next company? Like 100% ownership in pretty much anything you want, with $5 million of your own money in it. You could try 30 different ideas or set up a nice lab.
Wanting to own your first venture is kind of like saying this will be your only idea, ever.
It might sound unproductive, but my advice to fellow entrepreneurs would be: listen to what investors want, and then give it to them. Put together a great team. Find VC firms who like to invest in your kind of thing. Develop just enough to get them interested. Set up appointments. Get funded. Exit with $10m or more in the bank. Do your own thing. Your first business can be all about the $$ exit.
It seems I myself am going a different route, though.
"Founders retaining control after a series A is clearly heard-of. And barring financial catastrophe, I think in the coming year it will become the norm."
Would a financial catastrophe simply stop new series A rounds, or would it rather change their terms? Are there any examples of changes related to the adventures in 2007--2008?
The switch to the new norm may be surprisingly fast, because the startups that can retain control tend to be the best ones. They're the ones that set the trends, both for other startups and for VCs.
Are they the best ones because they can retain control or can they retain control because they are the best ones?
1. I would say that, even as of 5 years ago, it was rare for a startup to go through a Series A VC round without the VCs taking at least shared control.
2. Founders of reasonably strong startups can usually do angel rounds, also denominated Series A, without giving up board control and have been able to do so for some years now. These rounds used to be for smaller dollar amounts, often capped at $500K or so, but this has changed today in an era where founders can often turn to angels and superangels for larger fundings. VCs want to stay competitive with the angels at this early stage because, if they lose out at that level, they find themselves sitting on the sidelines as their deal-flow shrinks and they lose out on potentially strong investments made at an optimum stage in promising ventures. To stay competitive, therefore, the VCs must perforce bend a little on their traditional terms, including their former obsession with gaining board control right out the gate.
3. Founders themselves are far more savvy today, on average, than was the case a decade ago. In the bygone days, only a relatively few serial entrepreneurs had the sophistication to sit on a reputable board and still add value to it as founders. Today, the average founder is far better versed on what it takes to drive a company than was the case before. Thus, it is easier for VCs (and other investors) to accept the idea of a "founder-driven company" than it used to be. (Over the years, I have seen all too many "control-freak" founders and other variations that could only be labeled an embarrassment to sound management; based on this, I can understand the historic VC attitude, though of course this all must be counter-balanced by the many ills that the VCs themselves brought to the process when they would sometimes abuse the founders in whose startups they invested.)
4. Founders today have far more control over timing on when to do their Series A rounds. The cost of launching is far reduced today and the options for deferring larger rounds are greater, as for example by taking bridge funding from angels or F&F to allow the company to build value and minimize dilution before it goes for larger forms of funding.
When all these factors are combined, it seems clear from the trenches that a profound change is occurring by which founders have more control than ever before over their ventures. Of course, having this validated by someone such as PG, who is at the heart of this activity in Silicon Valley, goes a long way to letting the VCs themselves see it as respectable to accept as a fait accompli as they move forward.