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How do co-founders benefit personally from a funding round?

This might be a silly question but here in South Africa, funding is not as existent as it is in Silicon Valley. I read an article here PandoDaily about how the Secret guys made about $6 million dollars each personally after their funding round. How does that happen?

  • Most investments work by the investor purchasing new shares in the company at a share premium. The company takes this share premium and now has that capital to spend however it wants. The investor now owns a % of the company – and those shares are issued as new shares (diluting the % ownership of everyone else).

    However, in very rare circumstances the investor may also use a small portion of their money to buy some shares from early investors or founders to also gain more % ownership of the company. For this, none of that money goes into the company and instead goes directly to the original share owner. So these shares were sold from one party to another.

    This can benefit early stage investors who may want to get out early with a 2-5x multiple on their money (especially friends and family round).

    And can benefit fast growing companies who need to ‘clean up’ a cap table, and having 8 ‘mom and pop’ shareholders makes executive leadership messy at times.

    I believe when founders invested personal money (thus being an ‘early investor’) this is the most common situation for seeing founders get a cash out on a round.

    Or, when an institutional investor has no faith n the founders, but thinks the company/product is great, and they want to remove the founders from majority (or any significant) ownership. “Buy me out bro”

    However, it’s not beneficial to the company because:

    That cash is money that could have been inside the company as share premium
    The founders wont be as ‘hungry’ for a big exit or major growth
    It can lower morale of employees in the company as their leaders are creating a ‘Plan B’ for themselves
    It can lower morale of employees because they have to wait years to make anything on their options, so it seems unfair

    Reply

  • The whole point of founders taking money off the table is to encourage them to go big, rather than sell the company early. It can be a good thing in the case of a quickly growing company like Snapchat.

    Reply

    • +1

      Some additional color. Typically, this is done in conjunction with a fundraise and is done at a slight discount to the round (investors buy preferred shares typically whereas founders own common). The discount is negotiable.

      Unless you cash out a ton, the hunger argument really doesn’t come into play. Founders work their tail off and frequently do so for below-market pay in exchange for the upside. Taking a small amount off the table as the business starts to shape up can give founders some financial insulation that can buy the basics (contributions to a child’s college fund, a starter home, etc) but not so much that you’d be able to retire or never have to really worry about money again.

      I suspect that when you read about large secondary transactions, they are more of an anomaly than anything else. Generally these are the hottest companies in which VCs are in bidding wars. At that stage, VCs will appeal to the personal interests of founders to get deals done.

      All I know is that it’s probably a good thing that I didn’t get a $6M offer to take cash off the table in my early 20s, as I probably would have never made it to my early 30s.

      Reply

      • I’m the guy whose post you’re replying to. The Snapchat founders took $20 million off the table, so between two guys that’s $10 million each. Like you were saying, that’s not enough money that they would feel like quitting, but now it means that all their eggs aren’t in one basket, so even if the company implodes they will be financially secure.

        This will give them an incentive to try to go as big as possible and possibly get an IPO or an acquisition similar to WhatsApp which sold for $18 billion to Facebook, whereas Snapchat was only offered $3 billion by Facebook.

        So, the investors think and I agree with them, that Snapchat can go for much more than $3 billion, so of course they will go out of their way to make sure that the founders have some cash so that they don’t get desperate for a sale and sell for less than what they could possibly get.

        The Snapchat founders received just enough money to buy a house, one or two fancy cars, and some money just in case they want to buy any other fancy toys, plus their childrens’ future are secured. Now they can rest easy and go for that $20 billion plus outcome.

        Reply
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