Apparently Even VCs Get Confused Over Ratio Ownership Compared To Total Value

from the and-those-are-the-VCs-you-don't-want dept

Mon, Oct 19th 2009 8:40pm — Mike Masnick

Venture capitalist Fred Wilson recently had a great post where he calls out a bunch of his colleagues in the venture capital business (not by name) for insisting on owning a certain percentage of a company in order to invest. Fred notes, correctly, that it's not the percentage that matters, but the actual value (and the appreciation of it) of the equity that one holds. In simplest terms: owning 10% of a $1 billion company is always going to be a hell of a lot better than owning 40% of a $1 million company.

But, what I find amusing -- and what Wilson doesn't mention -- is that this very argument is quite commonly presented to entrepreneurs from VCs. That is, when an entrepreneur frets about giving up a portion of his or her company, a VC will often make the point that "with our investment, we can take your company's valuation way up -- so even if you own a smaller percentage, your absolute value will increase." And it's a true argument (if the value increase happens). And, in many cases, it's the very same VCs who will use a line like this that then insist on owning a certain percentage. It makes you wonder if they believe what they're saying themselves, or if they're just using all of it as a negotiating tactic to take a larger cut of the deal.

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Filed Under: control, ownership, value, venture capital

6 Comments

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CAS, 19 Oct 2009 @ 10:17pm

ownership
Percentages come into play when it comes to the boardroom. For VC's who are investing plenty of money in a company, being a key decision maker is important. These guys often (rightfully) believe they can run the company better than the current leadership and need a large percentage ownership in order to push their own agenda in the boardroom.

Yes, the bottom line is return on investment, but proper leadership in an organization can often mean the difference between success and failure. I'd rather own 40% in a 1 Million dollar company than 10% of a 1 Billion dollar company if the 1 Billion dollar company is a backwards newspaper company that won't listen to my advice.
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- Fracture, 20 Oct 2009 @ 6:29am
  
  Re: ownership
  Ownership is correct, but Ben misses the point. Venture capitalists buy a controlling share of the company then leverage everything to maximize growth. They take their pay and hang on if things work out and global prices rise lock-step with their expansion, otherwise they bail out and sell once their balloon-company is at its largest. 10% of a $1 billion company cost them $100 million to buy into and they can't even control it the way they want. $400k for a $1 million company can let them leverage it out to a $5 million company (with lots of debt), sell or go public and bail, taking a few million with them. Now repeat en mass.
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- ddbb (profile), 20 Oct 2009 @ 9:36am
  
  Re: ownership
  I'm not sure "run the company better" is necessarily the consideration. Part of the appeal of VC money versus other types of funding is that the VCs have experience and networks from which the company can draw to expand.
  
  Rather than taking over, the VCs want some influence over the management of the company or at least a veto right with respect to fundamental decisions (sell, merge, liquidate, etc...). While protective provisions in the investment documents can provide some of this, buying a large stake on a percentage basis is helpful as well.
  
  That said, "because that's the way its done" is not always strong argument, but when you have the money you usually have the bargaining power. In addition, some investors are simply not interested in a small percentage, passive investments and only engage in transactions where they have a significant stake in the company and influence through ownership or board membership.
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- Chris Maresca (profile), 20 Oct 2009 @ 11:42am
  
  Re: ownership
  Maybe. But VCs rarely ever bring good leadership, it's much more common for them to fund great teams.
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Ben, 20 Oct 2009 @ 12:18am

As CAS pointed out percentages do matter.

Owning 10% of a Billion dollar company with a CEO that is gonna bankrupt it is not better than owning 40% of a Million dollar company with a CEO that knows his stuff with the market to back it.Owning a controlling share is the important bit. Pure take home for the moment, your right 10% of a Billion is more than 40% of a Million. 10% doesn't give you the sway to tell the CEO not to do something and have it happen though.

VC's don't have anything but percentage. They have to be able to ensure that the percentages they have are managed properly and "If you want something done right, its best to do it yourself."
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Chris Maresca (profile), 20 Oct 2009 @ 11:39am

Except that in my experience...
... entrepreneurs are almost always better off never taking VC money. That's because, whatever the exit valuation, cramdown will occur everytime you miss a milestone or there is another funding event.

The net result is that a founder that took two rounds of VC funding over 5 years would have been better off not taking any funding and just bootstrapping it. Yes, the overall valuation of the company will be far lower, but the actual value to the founder will be higher, with a LOT less grief.

That said, there are a few exceptions to this if VC money can enable truly explosive growth (cf. YouTube), but that not generally the case.
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