Q: My client is looking for a 5 million dollar investment from a VC firm. What can he do to protect himself if he is worried that the VCs will acquire the rights to his product and then try to fire him and keep those rights? Does this happen often?
In addition, he anticipates that the new entity will generate tax losses in the early years and wants to share them with the VC. What can he do here? Finally, he would like to be able to force the venture to buy back his shares if after 5 years the company is still private. Can any of these things be done?
A: (Jason) Reputable VCs don't engage in this type of behavior - funding and then stealing a company. For one, it's not a repeatable model. If a VC acted this way, they wouldn't have any deal flow to consummate future deals. More importantly, VCs invest in folks to run companies - we have no interest in running your company for you, as we have other investments that we monitor.
Also remember that VCs don't acquire any rights to your product, they simply invest in the company that owns the rights, presumably. So the corporate entity is what controls the rights, not any particular person. If you question is how many CEOs leave the employ the company that they've created and raised money for, it's a relatively small number. More interestingly, the vast majority of CEOs that leave companies do it by their election, not that of the VCs. Many CEOs are serial entrepreneurs and prefer starting companies, not running them after they become larger and more successful.
To answer your other couple of questions, neither of these will work. Since you will have to incorporate your entity as a c-corp, these loses won't flow through to the VCs and even if they did, VCs can't use these types of loses. As for the VC buy back - forget about it. That's a non-starter. If I fund a company and can't get liquidity, the founder certainly doesn't have the right to get me to put even more money in to buy him/her out.
Posted in: Exits | Posted by: Jason MendelsonCOMMENTS (3)
When things aren't going well, maybe revenue growth is slower than expoected and there is little outside interest by new investors, many VCs will re-invest at a lower valuation (cram-down) and can eventually wipe out common stock. And the investors might feel it is their fiduciary responsibility to replace the CEO when things aren't going well.
You right, reputable VCs certainly don't 'steal' companies. But, what's the differeence in the eyes of the founder? Importantly, what tips can you provide to distinguish reputable VCs from the alternative?
Is there a better way to contact VC if you plan is extremely good but will take a little long to produce a profit.
....."As for the VC buy back - forget about it. That's a non-starter. If I fund a company and can't get liquidity, the founder certainly doesn't have the right to get me to put even more money in to buy him/her out."
Interesting.
1) Then why on God's green earth do you require liquidation preferences if we're both in it together?
2) As much as I enjoy reading your posts I think you may be in denial. The VC model is changing. The norm at some point in the future will REQUIRE sometype of liquidity for a founder up front. Look at the new VC's such as The Founders Fund and all the other filthy rich people that are now sitting on piles of cash.