Founded companies most of the time stay answering the wrong questions correctly. Improving products, corporate image, etc, until the day they meet a VC and discover that most of their decorational efforts are worthless through the eyes of an investor.

Adeo is offering the same educational roadmaps entrepreneurs have had for years from other sites, but this time education is given on time, right before you develop your idea. To educate entrepreneurs at early stages with a focus on going for VC, makes sense to say the least.

Yes, a lot of investors will panic in a world were founders are prepared with VC knowledge, most will prefer to hunt naive fish in the big sea, since funding the new twitter at 3x liquidation preference has its own benefits. But the sea is changing and the fish are being trained. In the comming years if you want the best fish you´ll have to settle with standard terms and open negotiations.

One clarification, any Founder can apply to the Institute, whether the Founder is planning to raise no money or a lot of money. Only one session out of 18 is focused on fundraising.

The goal is to help the broadest range of world-class companies get their start.

You are entrepreneurs! One of the marks of an entrepreneur is to find ways how to make something work. Let the rest of the world find ways for things not to work.

I remember seeing similar comments when TheFunded was being launched and subsequently getting press coverage.

Adeo does have entrepreneurs’ interests at heart. I’d apply to be a portfolio company, but I think I found a business model that will make funding unnecessary.

Venture capitalists have one problem – they are all selling the same product – money. As that industry is not doing so well today, Adeo’s timing for a proposed reform is perfect.

Thank you for your thoughtful presence in communicating on this topic!

Regards,
Lao

In the negotiation about whether a particular Class F right should survive through an investment, some preferred terms may be reduced or eliminated. Hopefully, there will be a meaningful discussion about the rights and value of common stock in this new world.

Keep in mind that many of the the most obnoxious preferred stock terms only became prevalent in the last downturn. If there is no counter-balance in this downturn, I dread the outcome.

My point about the $500,000 in lost wages is a point about opportunity cost. It’s hard to attract the best talent, when the talent can make more money elsewhere with less risk. If venture capital relies on great entrepreneurs and if the odds of making money as an entrepreneur in a venture-backed startup rival the odds of the lottery, then there is a problem…

1. Venture is more-or-less broken when you don’t have a home-run. If the above math is disheartening to the entrepreneur, look for alternatives. They exist.

2. If you raised the substantial sum of $10mm from venture capital, achieved revenues of $10mm and sold for just $50mm, you didn’t actually knock if out of the park. That potential non-optimal outcome would have been obvious to the founders before they signed the term sheet for $10mm in the first place! So, they knew this going in and must be accountable for their own upfront contract. It may be sad, but it was their choice.

3. Entrepreneurship is not really about “lost revenues” for founders. I’d be extremely hesitant to work with folks who use internal head metrics to calculate their lost income if they are building a business.

Silicon Valley has become very soft and entitled. This is risky business and risk means tolerance for exposure and loss. It cannot be engineered out of a situation. VCs knew this a long time ago, and so they pushed the risk to the common shareholders of their portfolio companies, as you accurately illustrate. Accordingly, if entrepreneurs find themselves uncomfortable with that risk dynamic, seek alternative funding structures.

The absurdity of Class F points to the displeasure with the venture model of financing in its entirety, but it is not a solution. If entrepreneurs feel this frustration, then the answer is to step out of the cycle and pursue other means to company building.

Regards,
Lao

A more practical way to protect the common shareholders is to balance the board with a mix of financial investors and independent directors who are compensated through common stock option grants. Of course, the independent directors must have domain expertise that is valuable to the company to justify the support of the financial investors.

When an issue/decision arrises that pits the interests of the common shareholders vs. the preferred shareholders, the common at least has meaningful board representation. The preferred shareholders may still have the upper hand through their associated rights, but the common will have an advocate.

Also, since warrants are not equity, but the right to buy equity, they are not -necessarily- dilutive. In fact, the Institute plans to use a portion of the warrant to make fair market value investments in participating companies.

In any case all this is meaningless until funding starts rolling again. 3.5% of $0 is $0.

Plain common stock has become largely worthless in funded companies. Preferred shareholders have increased their rights and protections, while liquidity events have become rare. Meanwhile, common stock has remained largely unchanged, having value diminished by the changing world.

Let’s look at a simplified example to identify some of the problems with common stock. A five year old company with $10 million in revenues decided to sell for $50 million in cash. The company has raised $10 million for 25% in preferred stock. The investors have a 1.5 liquidation preference that provides them with $15 MM on exit, and they also participate at 1/3 of the remaining proceed as a result of preferred dividends, providing investors with roughly $27 million of the $50 million in proceeds. If you pull 10% off the top for closing related expenses, common stockholders are left with just under $21 MM.

In this example, a CEO with 10% in common will stand to earn $2.1 MM on a 5x revenue sale for $50 MM. An investor with 10% will stand to earn $10 MM. It is likely that the CEO has taken below market compensation for years to get the company off the ground, which may average out to $500,000 of lost wages over five years, assuming that the CEO earned nothing for some period of time. It is also likely that the common shareholders, who are often management and employees, will be asked to bear the burden of an escrow, earnout, or other type of holdback. If 20%, or $10 million is held at the time of close, the CEO would walk away with $1 MM, $500,000 of which makes up for lost wages. This simplified example does not factor in the impact of having to purchase options, which diminish the value of common further.

There is an argument that creating value in common stock may help to improve returns from private equity and venture capital. Common stock is the foundation of entrepreneurship. It is the basis of management compensation, employee options, and voting control. Creating the opportunity for management to make real returns from their common holdings creates an alignment of interest with investors.

Any experienced entrepreneur, investor, or wise employee understands that an extraordinary success is required to get any value from common stock when there are investors involved today. Owning 10% in common of a company with a liquidation preference coupled with participation, dividends, redemption and other rights present is worthless, even if the company sells for tens of millions of dollars.

Sound absurd? It does share one commonality with Class F stock, and that is its completely divorced status from business reality in Silicon Valley.

Class F (or my Class G example) illustrate something that seems overlooked here in this exercise: a class of stock is only as good as its communal transference and acceptance. I believe your efforts will succeed in creating a lot of frustrated entrepreneurs who look for subsequent funding and meet the reality of historical precedent and communal non-acceptance in the form of unfavorable term sheets. They will set themselves up for a contentious discussion with future investors that will overshadow the merits of the business (which, last I checked, should be what this is all about.)

I write this as a founder, not an investor, by the way.

Regards,
Lao

I have experience both as a founder and as an angel and while I understand Adeo’s point, I think the terms Arrington highlighted would make me walk away from any such investment opportunity.

Too many times the founders of companies are visionaries but cant execute beyond a certain point. They also get blinded by their passion and personal friendships within the company.

I am all for the golden parachute. My fund would not invest in a company where the founder had an unreasonable amount of power.

Jeff Easton
Browning

I gotta admit you do have quite an incentive for your startups to raise rounds with these kind of terms. Goodluck, I really would love to see what a success coming out of this looks like.

These are the terms for the next suite of great companies, and these great companies will be started shortly.