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Comment by rl3 | Hacker News Reader

I wonder what the thinking is behind deals like that (2x liquidation preference/3x liquidation cap).

On one hand, it strikes me as incredibly beneficial for the founders if the company is a runaway success.

On the other hand, the VCs are essentially throwing away their unlimited upside potential, and in doing so signalling they don't particularly believe in the company.

There's also the fact that the terms are very unfavorable for founders if they exit at anything below a stellar valuation, though one could argue the entire point of the game is to achieve an incredible exit.

Still, when incentives aren't aligned it's disconcerting.

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These are specifically in late-stage deals, like Uber's recent rounds.

The investors aren't traditional VCs, but companies like Fidelity. They don't want a 5% chance at a 100x return; they would much rather a near-guarantee of 2-3x with downside protection. That's why Sam compares them with fixed income.

it's not clear why Fidelity would want a cap on the upside, since it needs to beat an index. Most likely, it doesn't think it's giving up any upside.

I would imagine ceding the cap makes it easier to get the 2x liquidation preference.

They give up the upside because they have protection from the downside (they get their money back first).

I understand, I'm saying I don't think they believe they are giving up much upside at all

No-one wants a cap on their upside, whether or not they need to beat an index.

Perhaps it has to do with the amount of money that's being invested in these late rounds. When you're doing 10k angel rounds, you spread the money around and hope one of the companies take off. When you're investing tens of millions of dollars at nine and ten figure valuations, you do so more conservatively in a way that is more likely to guarantee a return. They're not saying they don't believe in the companies at this point - in fact, you can almost argue that they're saying these late-stage companies are definitely good for the money - but more so that the companies at this point are less likely to make astronomical gains.

Can't capped preferred still convert to common? As long as they can do that, the upside is still unlimited (though perhaps reduced compared to uncapped participating preferred).

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