What Obligation (if any) Is Owed?
The recent acquisition of Gowalla by Facebook is just the latest incidence of the potential tension between investors and founders when a company is acquired primarily for the team rather than for the technology, product or business that they’ve built. People around the web will take the opportunity to observe that in situations where a company is acquired in this way, the founders typically get a package of equity to motivate them to join (and remain at) the acquiring company, while investors usually get anywherefrom zero to a small return on invested capital. Look around and you’ll find people willing to condemn the founders for unethically “selling out” their investors and you’ll find people who say the exact opposite, that such a company didn’t have saleable assets anyway, and so investors are owed nothing because the business failed.
Having been on the selling end of several of these types of acquisitions in the past few years, I can say with confidence that it’s extremely realistic to walk from these deals with both founders and investors feeling good about what happened and maintaining strong relationships. But I think some of the nuances are non-obvious, and I think it’s worth it for founders to think through the likely sequence of events that may arise before there is urgency and emotion and a deal is imminent.
Personally I think that in the specific fact pattern where a business has very little traction, cash is running out and you have exactly one acquirer willing to take on the team but unwilling to pay investors for a business in which they have no interest (which seems to be the pattern at play with Facebook/Gowalla) the ethical conundrum actually isn’t – the SV Angel perspective that there is no business and therefor no harm to investors is fairly self-apparent. But there are a whole bunch of ways to tweak the factpattern to make the ethical question far more complex and more interesting. Two that are worth considering:
· What if the company still had ten months of runway when an acquirer comes knocking on the door looking to acquire the team? What obligation, if any, does the company have to continue to try to create a positive outcome for shareholders.
· What if there was a different buyer who was willing to buy the business or its assets for a 2-3x multiple of invested capital paid back to shareholders but didn’t come with as sweet or ascompelling a deal for the management team? What obligation, if any, does the company have to consider and execute this transaction rather than one that sets the founders up in a way they like?
· Different but related (and by far the most common) – what happens when an acquisition offer is presented that is really interesting for the founders but a disappointment to investors who were hoping for a big outcome?
Each of these, taken in turn, is worth a longer discussion but they are all connected by a common question – when you take investor money, particularly venture money (whose business model is to fund plenty of companies that fail but to have a few tremendous outcomes that make up for them), do you also take on a measure of obligation to consider the best interests of yourshareholders and how important is that obligation relative to others (to yourself, to your cofounders, to your employees…).
Legally, of course, there is an obligation as set out by Delaware law. That obligation comes with the founders’ seats on the Board to consider the rights and outcomes to all shareholders. But setting that aside, in a particular and challenging set of facts, how should founders think about investors and their rights?
The answer, of course, is that it depends on the circumstances. But there are a few elements of a framework that make sense to employ if you face this decision.
1. You probably told your investors that you were trying to build something world-changing when you took their money. Sure, they know this only happens in a few cases, but don’t ignore the commitment you made to try to build a big business.
2. The world of startups is small and involves repeat interactions. You can (and should) make the decision that is best for all stakeholders, not just shareholders, but understand that there are reputational consequences to dismissing the needs (or perceived needs) of your investors.
3. You can’t possibly communicate too much with the people who have bet on you. I can cite plenty of situations where people were unhappy with an outcome not because the outcome was wrong or irrational, but simply because it was presented to them by fiat and they weren’t part of the decision process.
All of which rolls up to a simple set of guidelines, if not conclusions. The decision to accept failure (or too-modest success) is always going to be challenging. If you are a high profile startup and have raised money on the back of a big dream (as Gowalla did), recognize that you have stakeholders around your company and consider not just the outcome they will achieve in a particular transaction, but the full arc of your relationship with them, from the point of investment through the discussion you may have three years from now about your next company. Professional investors (VC’s and angels both) are adults, understand the range of outcomes and (if you chose them well) will work with you to find a good situation for the founding team. As with all things in our ecosystem, mutual respect, over communication and a view toward enduring relationships will serve you extremely well.
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