I’m struck by a lot of the chatter around the shutdown of Secret and the question posed by the founder secondary that had previously been done during the company’s large raise last year.
For those unfamiliar with the facts, they’re pretty straightforward: Secret was a hot-sh!t company with buzz and early momentum. They raised a big round, intensely competitive, and as part of the deal the two founders arranged to each take a pretty good chunk of money ($3M each) as a secondary stock sale to the new investors. Apparently one of them bought a Ferrari with a portion of the proceeds.
The outrage about this is illustrative of the tension that pervades our ecosystem right now, tension that I think is part and parcel of the feeling that money is coming quickly and easily and … maybe a little randomly. And so when one of these rocket ships flames out like Secret did and along the way the founders made money, everyone gets upset. Calls are made for them to return the money to their VC’s, which strikes me as bizarre on its face.
At a basic emotional level I suppose I understand why it’s viscerally unappealing that a couple of founders whose company didn’t work got paid anyway but … so what? This is in no way a distinctive feature of the startup world. In fact the opposite is true — big company executives, bankers, investment fund managers are all FAR more likely to get a multi-million dollar payday without having end-state success. Startup founders, amongst the group of people for whom a large payday is a possibility, are among the least likely to get paid without generating success for all stakeholders.
As an investor, I look at this episode and see a fact pattern that is getting more and more common — founders who have strong negotiating leverage are given the right to sell shares. Sometimes this is driven by their desire for liquidity but just as often it’s driven by investors’ desire to own more of the company and the valuation and round dynamics are such that the ownership target can only be achieved by buying shares from an existing shareholder, usually one or more founders.
And there are good reasons to do this. Liquidity at a middle stage of success can much better align founders’ risk profile (whose assets are typically entirely concentrated in their company) with investors’ need to go long and generate outsized returns when a path to a massive win is visible. This is especially true for first-time founders. The tension that develops between founders looking for a life-changing liquidity event and the business model of venture capital comes into play when an early, mid-sized acquisition offer appears (and for great companies, it almost always does at some point). Allowing the founders to get partially liquid is the best solution I’ve seen to resolving this tension.
Perhaps even more fundamental — this is a negotiated, market transaction between sophisticated investors and selling shareholders of sought-after private company shares. If the investors turn out to be wrong and the founders are “unjustly enriched”, who’s to say that’s objectionable? Lots of trades have a winner and a loser. If the company is wildly successful, both sides win — founders diversify their holdings, investors buy shares at an attractive price. But even in situations where the founders “win” over their investors, I see no cause for the kind of outrage that David Byttow endures right now, and I think the suggestion that these founders should give the money back is dramatic at best and immoral at worst. Red Ferrari or no.