‘You cut, I choose’: A startup protocol for breaking up with your business partners
It was the winter of 2007 around Christmas time. I was about to receive one of the most beautiful presents I’d ever gotten.
Many founders dream to build a company and make an exit. I was negotiating with Sanoma Hearst on an acquisition of the company I started seven years prior. The exit was a well-deserved gift after many years of hard work. Sanoma offered ~$4M for one of my websites which valuated the entire company at $9M.
Four years before, I got an investment from a real estate fund that was interested in starting its tech operations, and gave them 60 percent of the company shares and control for an investment in the company. This was the first stupid move I made — giving up control to someone that has no clue about running a technology company.
When Sanoma had shown his interest for the first time, I went to the fund and asked if I am allowed to negotiate in order to get an acquisition offer. They said yes, but somehow, I knew from that moment that the yes they gave was inauthentic. This was the second mistake I did, to not address this issue, and started the negotiation.
Sitting on my favorite chair, my Blackberry’s red light started flashing, a sign that I had a new email. It turns out, I’d just received a new offer: $13.5M for the entire company.
I was about to explode with happiness. When you have an offer like this, you start making plans on what you’ll do with the money. First, I wanted to start a small angel fund to invest in startups. Second, I was looking to take a sabbatical year followed by building a new startup.
But suddenly, the dream ended
My VC partner told me that they were not going to sell, neither allow me to sell my shares. Then I realized that I had been just a simple puppet in their hands.
Why wouldn’t they sell? I still don’t know the reason, even until today. The only supposition I have is that, probably, they thought that things will go like in real estate, you have to wait 10 years for a good exit.
We exchanged tons of email on this topic, but with no results. So, after three weeks, I found myself in my VC’s office to meet their CEO. I was sitting alone in his large meeting room, waiting for him to show up and feeling empty looking at all those symbols of wealth and power: paintings, statues.
When the CEO arrived, he was very well-dressed and with a stiff attitude. I remember trying to convince him to sell because this is probably the best offer we can get, things are going to change, publishing will not be the same easy ride without strong expertise because the competition will increase.
But his face showed me how stubborn he was, and no matter the reasons I presented, we finished up the meeting with one conclusion: they are not going to sell.
I tried to convince them for a few more days, but the more I tried the more aggressive they became. After a couple of weeks of negotiations, they decided to show me where the power is by increasing the capital and diluting me as a shareholder in both companies I had with them, at the lowest valuation possible, and far away from the offers we got.
I obsessively reread the email that notified me about the dilution. To continue, I had to accept that they can do this any time they want, and maybe work for a few more years and get nothing from the company I started.
So began the legal actions
I asked a friend to recommend me a lawyer in NYC, and we scheduled a meeting. I sent him the terms and waited for his advice on what legal actions I could take to make things right.
A day later, he called me. Hearing his voice, I realized that he is not going to give me good news. The terms we signed were crap, with absolutely zero protection for me as a shareholder, and all this because I didn’t pay attention in the beginning.
This was another lesson learned: One should pay attention to the term sheets and hire the best possible lawyer right from the start, not when problems appeared.
So, my only option was to sue them, but it required $250k and the chances of success were pretty low.
Realizing that I didn’t have any chance to get what I deserved was like an extremely cold shower. But I still had hope and kept looking for a solution.
‘You Cut, I Choose’
One day, I was in the park and saw two kids fighting for an apple, and… bang! The idea flashed before me. I remembered one protocol the VC taught me a few months before, the “You cut, I choose” protocol. It’s simple:
If you want to split an apple between two kids, ask one kid to cut it in half, and let the other one to choose his part. A totally envy-free solution.
In Game theory, envy-free is a property of certain fair division algorithms over which different partners may have different preferences.
For example, the You Cut, I Choose protocol is envy-free in the following sense: each of the two partners can act according to her own subjective taste, her allocated piece is at least as valuable as the other piece, regardless of what the other partner does. Here is how each partner can act:
- The cutter can cut the cake to two pieces that he considers equal. Then, regardless of what the chooser does, he is left with a piece that is as valuable as the other piece.
- The chooser can select the piece which he considers more valuable. Then, even if the cutter divided the cake to pieces that are very unequal (in other people’s eyes), the chooser still has no reason to complain because he chose the piece that is more valuable in his own eyes.
To an external viewer, the division might seem unfair, but to the two involved partners, the division is fair — no partner envies the other.
For me, it was a revelation, and on that same day I went back to my investors. I told them, ‘Guys, you taught me this protocol, let’s use it. It’s obvious that we no longer feel good in this partnership. Let me buy your shares at the price you’re willing to buy mine, or vice-versa.’
I was beating them at their own game, and apparently it worked. It’s hard for someone to be unreasonable and inconsistent with something you believe.
This protocol is so brilliant that it will make any person reveal his true intentions. If you are fair and ethical, then you won’t have a problem accepting this protocol. But if you are unfair, and ethics is not your strong point, then the only way is to not accept it.
It was the end of January, while driving back home from the office, when I got a phone call from their CEO telling me that they don’t want to sell, nor to accept the protocol. He also told me that I was no longer the CEO of my company, although I could remain their partner if I wanted to.
But I’m not the kind of person who makes compromises on my own life. So, I told them that I didn’t want to be their partner if they didn’t accept the protocol.
I left the company I had built for more than seven years with all my dreams broken, and with the vivid pain of leaving the team I built there with a totally uncertain future.
It was extremely hard and painful, but I learned a few big lessons for the rest of my life, lessons that I want to share with other fellow entrepreneurs. I hope you won’t make the critical mistakes I did.
Applying the protocol
One of the most important lessons was to understand how to apply the “You cut, I choose” protocol. I tried it a few more times in other companies I started, and it’s fantastic how easily this can reveal the personality of your co-founder, and how fast this can solve problems.
Let’s take an example and see how this rule might work in a startup: Let’s say you own 48 percent of the company and your co-founder 46 percent. Lately, you two are fighting a lot, so you decide to part ways.
Applying the “You cut, I choose” protocol, your co-founder will decide on the valuation of the company, and you will decide if you’re going to buy his shares at that valuation, or sell yours. So, if he decides on a $1M valuation, you will either buy his part for $460k, or sell yours for $480k.
In case you and your partner don’t want to continue anymore, instead of selling the company at the wrong price or to shut it down, use this principle to find out the best valuation. And, probably the best way to elegantly end your partnership.
Originally published at thenextweb.com on November 3, 2014.