In the six seasons of Silicon Valley, the Pied Piper squad was busy laughing, scolding, gagging, ridiculing Google, Apple and Twitter with IT slang, and also busy stepping through every pit in the life cycle of a startup with their own strength. .
In the six seasons of Silicon Valley, the Pied Piper squad was busy laughing, scolding, gagging, ridiculing Google, Apple and Twitter with IT slang, and also busy stepping through every pit in the life cycle of a startup with their own strength. .
1. Runaway Valuation (out of control valuation) and Down Round (discount financing)
In S2E1, the Pied Piper team relied on its outstanding performance at the TechCrunch conference, and major VCs rushed to throw an olive branch, and their valuations also increased, from 25 million U.S. dollars to 100 million U.S. dollars. When the true commercial value of Pied Piper is far from the valuation, it has actually formed a Runaway Valuation, and Pied Piper has become a pig flying in the air.
For startups, is the higher the valuation the better? It seems that a high valuation can bring more cash, greater development opportunities, and a higher value for the founders, but in fact, there is no free lunch in the world, and the founders also need to pay a potential price:
(1) Higher valuation means higher performance indicators
PE/VCs pay higher valuations and of course also hope for higher returns. Therefore, higher valuation often means higher indicators for the company's future profits and performance. PE/VCs often set gambling clauses. If the company does not achieve the established performance indicators, the founders will need to lose money and lose shares. Richard’s friend Javeed also suffered from the failure of his business. He could only sigh in the bar: “If I don’t raise so much money, I can reach a more realistic target, and even achieve a cash flow balance...”
(2) Higher valuation means the next potential Down Round (discount financing)
Just as Monica suggested to Richard, if the valuation of a startup company is out of control in a certain round of financing, resulting in an inflated valuation, then the startup company is likely to face the next round of discounted financing, that is, the next round of financing is lower than the previous round. Round financing price. From the perspective of external investors, discount financing often means that the company's development is not as expected or the market environment has changed, which is a red flag and even makes investors' confidence slip. In reality, Down Round situations abound. For example, Airbnb’s latest valuation fell from the previous round of 31 billion U.S. dollars to 26 billion U.S. dollars, and Wework’s valuation was even cut in half.
Down Round can cause fatal damage to the founding team. PE/VC investment often sets Anti-dilution clauses, ranging from weighted average to full ratcheting. Once the Down Round occurs, the anti-dilution clause will be triggered. Once the investor exercises the anti-dilution rights, the founder must make up money or make up the shares to ensure that the investor’s share price is not affected by the Down Round.
In addition, it was mentioned in the play that Javeed caused Reverse Vest because of Down Round, and was eventually expelled from the company and bankrupted. Reverse Vest is a concept in the employee equity incentive plan, that is, the equity incentives obtained by the founders can be realized without waiting, but it is still subject to some restrictive provisions (such as the founders not leaving the company). Once the restrictive clause is triggered, the shares owned by the founder will be repurchased. Of course, Javeed’s terms are too strict. Normally, it will only be triggered if the founder voluntarily leaves the company. However, after Javeed is fired by investors, it also triggers a repurchase, which is equivalent to Javeed completely losing the initiative and leaving the investor completely at his disposal. At the mercy.
This clause is not common in the PE/VC market in mainland China, but who knows? Maybe someday PE/VCs will introduce it on a whim.
2. Who is in charge of your board?
The Pied Piper team, as a representative of immature entrepreneurs, made a fatal mistake in the allocation of seats on the board of directors during the initial financing: because Russ Hanneman provided financing to Pied Piper as a white knight when Pied Piper was desperate. Richard signed an "unequal" treaty and agreed to many harsh investment terms, one of which was to give Russ two board seats.
In this case, the composition of the board of directors is very delicate: Russ has two board seats, Monica has one board seat on behalf of Series A investor Raviga, and Richard and Erlich each have one board seat. Regardless of Erlich's identity as a half-team and half-investor, in fact, Richard, as the founder, has only one board seat and is completely unable to control the board. This has led to many tragedies afterwards.
At the beginning, Richard, Erlich, and Monica said they would form a united front and move forward and retreat together. However, due to private interests, Erlich began to vote against, which led to the majority of Russ’s proposals being passed. The money was wasted to set up billboards to make the not wealthy. Pied Piper made the situation worse. What's more serious is that when Russ' equity was transferred to Laurie, Raviga occupied three board seats and completely controlled the board. In the end, it caused the tragedy of Richard being removed from office as the founder of Pied Piper in S3E1.
Therefore, the distribution of seats on the board of a startup company is a science. Whoever controls the board of directors controls the company. Once the founder loses the majority of seats on the board, he will lose potential control of the company and may face the fate of being slaughtered by others.
Generally speaking, every round of investors will ask for a seat on the board of directors. The practice in the Chinese PE/VC market is to grant a seat on the board of directors when the early financing exceeds 10%. In order to maintain the majority of the founder’s board of directors, for every additional investor’s board of directors seat, the founder’s board of directors’ seat will also be increased by one. However, an excessively large board size is likely to cause slow decision-making or factional struggles. In particular, the upper limit of the board of directors of a limited liability company under Chinese law cannot exceed 13 people. Therefore, in the later financing process, it is often necessary for investors to abandon their board seats, or several investors share a board seat.
3. The "serial killer move" in the equity acquisition
As mentioned earlier, the "unequal treaty" signed by Russ and Richard gave Russ too much investor rights. These rights are in the hands of Russ, an inexperienced investor, and at most they will cause trouble for the Pied Piper team. But when Russ transferred its equity and shareholder rights to Laurie, Laurie, as an experienced VC investor, frequently used "killing tricks" to firmly control the fate of Pied Piper.
(1) ROFR and ROFO
Although there is not much description in S3E8, from Laurie's words, it can also be seen that in the Erlich cash transaction, Laurie exercised the right of first refusal ("ROFR").
The right of first refusal is very common in PE/VC investment transactions: when a company shareholder wants to sell equity to a third party, other shareholders of the company have the right to first purchase the equity to be sold under the same conditions. In a broad sense, the right of first refusal can be divided into Right of First Refusal ("ROFR") and Right of First Offer ("ROFO"). The difference between the two is: in the case of ROFR, the seller needs to obtain the quotation from the third-party buyer first, and then seek the opinions of existing shareholders, whether it is necessary to exercise ROFR, which is equivalent to "last look"; while ROFO needs to first seek the company’s current There are shareholders’ quotations, which is equivalent to "first look". Considering that third-party buyers usually need to conduct due diligence and negotiation before quotation, these costs will inevitably lower the quotation. Therefore, ROFO is more beneficial to the seller, and ROFR is more beneficial to the original shareholders.
If according to ROFR's regular terms, Laurie can buy Erlich's equity at the same price of 4.3 million US dollars at most, how can Erlich leave the market penniless? The reason is that Laurie’s shareholder rights also have a high probability of Veto (one-vote veto power), that is, Laurie has the right to veto a shareholder’s transfer of equity to a buyer who she does not agree with.
Therefore, the joint use of these two shareholder rights is the result: Laurie can veto all transfer transactions and only agree to sell Erlich to herself. In the case of her being the only buyer, of course, Laurie decides the transaction price at will, and Erlich only Able to leave without any money.
(2) Drag-along (drag-sale) and Liquidation Preference (preferential liquidation right)
In S3E10, Laurie exercised the right to sell, demanding that all of Pied Piper's equity be sold to the highest bidder. In the end, Erlich's Bachmanity narrowly defeated Hooli by $1 and acquired the equity of Pied Piper. However, since Laurie also has Liquidation Preference (priority liquidation rights), that is, the benefits obtained from the sale of all equity will be used to pay Raviga's priority income first. Therefore, although Bachmanity bought Pied Piper for $1 million, Laurie took all the price, and the Pied Piper team remained penniless.
Therefore, for founders, "dragging rights + liquidation priority" is a deadly killer, which will give investors the right to sell the founder’s equity together, and will also give priority to the distribution of income. PE/VC institutions It is very likely to rely on its profit-seeking nature to package and sell the company as a whole to competitors, regardless of the founder's ideas. That year, Zhang Lan of South Beauty was also out because CVC exercised the right to drag the sale.
4. The plight of professional managers and Fiduciary Duty
In the theory of corporate governance, the separation of company ownership and control will cause the interests of shareholders and professional managers to be inconsistent, resulting in a principal-agent conflict of interest: company shareholders want to maximize the return on investment, considering the company’s sustainable long-term development, but professional Managers often hope to maximize their personal benefits, that is, maximize their management performance during their tenure. Therefore, professional managers often devote themselves to seeing results in the short term, and abandon long-term projects, even if the benefits of long-term projects are higher. This is why in S3E4, Jack knows that the platform is a better choice in the long-term, but still hopes to produce the box, because the profit brought by the box is the performance that can be seen in the short term during his tenure.
At the same time, under the US company law, directors have Fiduciary Duty (fiduciary duty) to the company, that is, directors should comprehensively consider all substantive available information and make decisions that are most beneficial to the company in a cautious and diligent manner. Therefore, although Laurie knows that the production of boxes is a very short-sighted behavior, since the production of boxes has basically reached a contract, its profit can be quantified, and the profit that the platform can obtain is invisible and intangible. Therefore, based on Fiduciary Duty, Laurie can only choose Production box.
The Pied Piper team also used the fiduciary duty of the directors to solve this dilemma: As Pied Piper’s competitor Endframe was acquired by Hooli for $250 million, it was equivalent to providing a valuation basis for Pied Piper’s platform. Therefore, the value of Pied Piper's platform is much higher than Jack's box, which is why Laurie finally agreed to build the platform and fired Jack.
The Pied Piper team has overcome difficulties and stepped on the pits of venture capital financing in the past six years. Countless startups ups and downs can't escape the fate of the death of the C round, just as Pied Piper's financing also stopped abruptly in the B round. Ten years after saving the world, when Pied Piper returned to the incubator hut, a new generation of entrepreneurs had already started their new business, but they had never heard of Pied Piper's name. Aoyama is still there, How Many Suns.
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