Don’t “Pull A Patzer” And Other Lessons Learned On Our Trip Down Sand Hill Road | Hacker News Reader

Don’t “Pull A Patzer” And Other Lessons Learned On Our Trip Down Sand Hill Road

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49 pointsedw51913 comments

This is a good contrast to those who speculated that Patzer sold because he was forced by VCs. That isn't a surprise, though: general wisdom is that if you take VC funding, you should at least be open to the idea of building-up a company and (ultimately) taking it public; VCs have the right to block an exit.

> VCs have the right to block an exit.

I don't know too much about the terms of VC funding, why is this the case?

Amongst other tigns VCs typically look for three types of rights regarding equity in a term sheet that get transferred to an Investment Agreement. Most of my transactions have been with European VCs, so some of my naming is slightly European/UK specific, but the principles are generally the same around the world:

* Drag rights - so that under certain circumstances they can force a sale even if the founders (who might own the majority of equity) don't want to. Typically this is set 3-5 years into the future. This is because the VC doesn't want to be sitting on illiquid private equity once their fund returns and the partners typically get 20% of any exit. VC funds have a target lifetime, so the VCs argue this is key to their business model.

* Approval on any sale of new/existing equity. In a UK company this would be typically enshrined in the both an investment agreement and as a class-consent within the Articles of Association. VCs normally end up controlling the board of start-ups (either in themselves or 'their' NXDs that too often follow the VCs). The VCs don't want you to sell too early, or raise new money in a market or at price they think is wrong. They would justify this by saying they are risking the capital in the business and would see this as reasonable.

* Tag-along: if anyone sells any equity they have the right to sell a proportionate amount at that price. There are typically some 'permitted transfers' e.g. VCs transferring equity between their internal funds. This basically comes out of them not wanting anyone else to get an exit (and a payday before they do).

> I don't know too much about the terms of VC funding, why is this the case?

VC model breaks down if they don't get back at least ten times more than what they've put in. With upper tier VCs, I believe that's even higher.

Angels are looking for a multiplier on their return too, but generally the money they invest is so small, they won't bother blocking most exists.

Ironically, this sort of approach might lead to more "quick flips" (which Mint acquisition wasn't) than anything: you have built a highly innovative product which is starting to pick up some traction; you can sell it for $30mm to Google (netting yourself ~$2-4mm after taxes, effectively a life changing sum) or you can get (further) VC funding and try to swing for the fences. However, your chances of any exit have now been decimated.

Why would you only net $2-4mm after selling for $30mm? (even after taxes!)

After giving money to angels + seed funding + possibly series-A VC funding, having an employee option pool (especially if "employees" include non-founder CFO/CEO/COO) and a second co-founder, you can expect at max 20% percent (usually of common stock, vested with over time). Add to that taxes and (if you took series A or serious seed funding) liquidation preferences and 10% return sounds fairly generous.

strlen, i'm not really sure you know what you're talking about here.

seed funding + series A in a reasonable case is likely to have sold 35% of the company. another 15-25% for option pool leaves 50% or more for the founding team.

similarly, a reasonable liquidation preference is 1x. i doubt you would see aggressive liquidation preferences on something hot enough to then exit quickly via acquisition anyway.

in this case, it's also possible if the founding team has done reasonably that they still control the board, thus making your explanation of "vcs can block an exit" a bit weak at this juncture, as well.

sure, it CAN go badly like you said, but i don't think that's the average case.

Upvoting, great counter point. The percentages (pre-dilution founder percentages, especially) have been what I've personally seen in start-ups I've worked in / consulted for / friends' start-ups. In one case of the founders had only 13%, other two had 20% -- rest going to funders/option pool; in another case -- where there was a "professional CEO" brought in -- one of the founders had <10% and no seat on the board (with only one founder being on the board at all). Granted these may be abnormal cases (the VCs weren't top tier either).

Not sure if this is what strlen had in mind, but it is plausible that a couple of founders have about 15-20% of the company each after an A round of VC and some angel investment. That would explain $2-4m (each) post-tax.

This is why VC's are becoming amenable to letting founders take money off the table. (See: http://www.avc.com/a_vc/2009/09/founder-liquidity.html)

I wonder if it would have helped. Patzer was probably choosing between $40 million (or whatever) today and $80 million (or whatever) in a few years. The VCs would own more and he'd own less, so even with a bigger exit he's not looking at all that much more. During that time catastrophe could strike and wipe him out completely.

He also has a good job in which Inuit is giving him some free rein to innovate.

Usually when somebody coins a new word, they pick a word that's not a word yet.

Patzer is a fairly well-used term in the chess world. It makes for some confusing headlines here on HN when you try to parse them using the meaning of the existing word.

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