Further Innovation From VCs: FF Class Stock

December 20th, 2006

Further innovation occurring with early-stage VCs, this time from the Founders Fund who have introduced the FF class of stock that enables founders to cash out early, enjoying initial returns from their work and aligning interests with VCs.

[FF] is convertible to any future class of stock, when certain conditions are true. For example, the holder of FF can convert it into say, a Series B class of stock and sell it to investors, at which point it takes on all the rights and preferences of Series B stock. But it can only be done during the new issuance of that Series B, and only when that Series B is sold to investors; you can’t convert randomly.

Partial Founder Buyout has been an idea that I’ve liked for some time, and it’s nice to see a venture firm making it a practical reality.

As Andrew Parker states, FF aligns interests and motivates the entrepreneur to work together with the VCs towards a bigger payday by allowing them, in a sense, to hedge their bet. [Fred has particular views on partial founder buyouts, I wonder if Andrew can make the sale when Fred returns from Italy :)]

Of course there are risks for exercising the clause, humerously shared through anecdote in the VentureBeat post:

The founder of Viaweb, a Paul Graham company, cashed out in order to buy his wife a Saturn car. It became known later as the “million-dollar-Saturn,” because of the worth that stock would have been had he kept it.

[Paul Graham helped catalyze my thinking on founder buyout along with my friend Eric Olson. It's interesting to note that Paul's essay was written before the "million-dollar-Saturn" exit event occurred - I wonder what his views on FF are.]

It will be interesting to see if FF is adopted by more entrepreneurs and VCs in their term sheets. Regardless, it’s great to see further innovation occurring by early-stage investors.

Viewing 16 Comments

    • ^
    • v
    By the by, checked back with a few investors - seems they say NO DEAL too - but they still threaten the framed share certificate. ;-)
    • ^
    • v
    By the by, checked back with a few investors - seems they say NO DEAL too - but they still threaten the framed share certificate. ;-)
    • ^
    • v
    I had not read that post by Fred. Very illuminating. Thanks!
    • ^
    • v
    I had not read that post by Fred. Very illuminating. Thanks!
    • ^
    • v
    At least it will make for a great story at dinner... as in, "remember when you funded my web service company? Mmmmm... this brocolli raab is delicious".
    • ^
    • v
    Nah, never tired of asking for money. Just trying to pre-empt the myriad of investor threats including the old "if I don’t make my money, we are going to have the share certificate framed and every time you come over for dinner we are going to hang it on the wall right where you can see it during the meal" – can you spell indigestion?
    • ^
    • v
    What if you took the partial buyout and then treated them all to a warm meal? (McDonald's $4.27 deal of the day?)

    You could go so far as to pick them up in your million-dollar Saturn (and $100k snow tires - sadly, with the state of rims... I suspect some people do have $100k tires on their cars). I mean, who has ever taken a ride in a million dollar car? Not moi.

    I can see your point though. You believe in the vision, the company, the product, the team, the ability to achieve the practically impossible. Your friends and family? They simply believe in you (or, are tired of you asking for funding during every holiday meal).
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    • v
    I get where you are coming from Fraser but more than a partial buy-out for me, I would prefer one for early investors and in particular, my friends and family. Most of them would never have invested in a high-risk start-up if they didn't believe in me and the other co-founders as much as the idea. For a founder to take the buy-out and then leave them in the dust (unless I am not understanding something here) so that the entrepreneur can feel less stress about their personal risk seems wrong to me.

    Net net, I still say no deal but if my friends and family get their return smaller and earlier (as I am sure many would prefer) I would be much more willing to go long(er) alongside the VCs.

    For me because ‘halleluiah I believe’ and the VC because it’s likely a risk they can afford.
    • ^
    • v
    Leigh, nice use of the deal or no deal analogy (I have yet to see the show, but how can you not enjoy someone who has such insane OCD as Howie?).

    The issue you raise w/ the founder not believing in their company is the standard one against partial founder buyout, and I can understand and appreciate the reasoning. However, there are lots of items in play as a company tries to scale from the $20M size to the $100 M size, and a partial buyout of the founder would sure help the entrepreneur stay motivated to pursue the larger 'win' rather than exiting early to a secured amount of millions.

    It's not so much the Car/Snow tires amount that helps, but consider the following:

    You're an entrepreneur reviewing a term-sheet from a VC that will give you a round of funding to enable the company to fight the scaling battle towards the $100M mark (and, in the process, become large enough that the exit satisfies the VCs necessary return). Lots of risk, but huge reward.

    At the same time you receive an offer from Yahoo to sell the company for $10M. No risk, but you sacrifice the potential of huge rewards (however, a few million in your bank account doesn't seem too bad).

    I imagine, when faced with the possibility of some level of guaranteed 'wealth', that the decision becomes slightly more difficult.

    And, if the VC believes in the vision and path towards an exit at some significant valuation... why not ensure that the entrepreneur stays motivated to stay the course? On his blog, Fred has hinted at all of the potential del.icio.us had to grow into a social search engine etc... would he have been happier if Joshua Schachter had stayed the course rather than exiting to Yahoo? I'm sure he's happy to have an exit, happy that Joshua generated some wealth, but what about the vision that they're no longer building towards?
    • ^
    • v
    At least it will make for a great story at dinner... as in, "remember when you funded my web service company? Mmmmm... this brocolli raab is delicious".
    • ^
    • v
    Nah, never tired of asking for money. Just trying to pre-empt the myriad of investor threats including the old "if I don’t make my money, we are going to have the share certificate framed and every time you come over for dinner we are going to hang it on the wall right where you can see it during the meal" – can you spell indigestion?
    • ^
    • v
    What if you took the partial buyout and then treated them all to a warm meal? (McDonald's $4.27 deal of the day?) You could go so far as to pick them up in your million-dollar Saturn (and $100k snow tires - sadly, with the state of rims... I suspect some people do have $100k tires on their cars). I mean, who has ever taken a ride in a million dollar car? Not moi. I can see your point though. You believe in the vision, the company, the product, the team, the ability to achieve the practically impossible. Your friends and family? They simply believe in you (or, are tired of you asking for funding during every holiday meal).
    • ^
    • v
    Here’s what I imagine for the partial buyout scenario: Entrepreneur who has been making just barely enough to live off of needs to buy a car for his wife. In comes the VC. He is in a booth. You can’t see his face only a silhouette of it. He makes a call. In comes Howie Mandel who answers it. He nods, gently looks at the start-up founder and pauses before he speaks softly and gently to him. He is willing to give you 100K for part of your founding stock. You can buy your wife a car and even some new winter tires so she can drive safely on the road in snow. He leans in further - "Deal or no deal". The entrepreneur starts to sweat. He wants his wife to have the car. She screams, NO DEAL from the sidelines….but he knows, she might regret that the next day when she is driving in her old ford pick-up. What should he do? His kids join in. NO DEAL….but they might regret that when they get squished in-between their parents because they don’t have an extended cab Howie interjects. It comes down to this, if you think you have million dollars in your suitcase, you should say NO DEAL. But if you aren’t sure, and think maybe it’s the dollar then you should say deal. Your changes are 1 out of a bazillion start-ups. It’s up to you.

    Now, if the entrepreneur takes the partial buy out- does this not mean they aren’t sure they have the million? And if they aren’t sure, well, that’s not good right? I mean, if the founder doesn’t believe, than who will?

    I say, NO DEAL…but that’s just me ;-)
    • ^
    • v
    I get where you are coming from Fraser but more than a partial buy-out for me, I would prefer one for early investors and in particular, my friends and family. Most of them would never have invested in a high-risk start-up if they didn't believe in me and the other co-founders as much as the idea. For a founder to take the buy-out and then leave them in the dust (unless I am not understanding something here) so that the entrepreneur can feel less stress about their personal risk seems wrong to me. Net net, I still say no deal but if my friends and family get their return smaller and earlier (as I am sure many would prefer) I would be much more willing to go long(er) alongside the VCs. For me because ‘halleluiah I believe’ and the VC because it’s likely a risk they can afford.
    • ^
    • v
    Leigh, nice use of the deal or no deal analogy (I have yet to see the show, but how can you not enjoy someone who has such insane OCD as Howie?). The issue you raise w/ the founder not believing in their company is the standard one against partial founder buyout, and I can understand and appreciate the reasoning. However, there are lots of items in play as a company tries to scale from the $20M size to the $100 M size, and a partial buyout of the founder would sure help the entrepreneur stay motivated to pursue the larger 'win' rather than exiting early to a secured amount of millions. It's not so much the Car/Snow tires amount that helps, but consider the following: You're an entrepreneur reviewing a term-sheet from a VC that will give you a round of funding to enable the company to fight the scaling battle towards the $100M mark (and, in the process, become large enough that the exit satisfies the VCs necessary return). Lots of risk, but huge reward. At the same time you receive an offer from Yahoo to sell the company for $10M. No risk, but you sacrifice the potential of huge rewards (however, a few million in your bank account doesn't seem too bad). I imagine, when faced with the possibility of some level of guaranteed 'wealth', that the decision becomes slightly more difficult. And, if the VC believes in the vision and path towards an exit at some significant valuation... why not ensure that the entrepreneur stays motivated to stay the course? On his blog, Fred has hinted at all of the potential del.icio.us had to grow into a social search engine etc... would he have been happier if Joshua Schachter had stayed the course rather than exiting to Yahoo? I'm sure he's happy to have an exit, happy that Joshua generated some wealth, but what about the vision that they're no longer building towards?
    • ^
    • v
    Here’s what I imagine for the partial buyout scenario: Entrepreneur who has been making just barely enough to live off of needs to buy a car for his wife. In comes the VC. He is in a booth. You can’t see his face only a silhouette of it. He makes a call. In comes Howie Mandel who answers it. He nods, gently looks at the start-up founder and pauses before he speaks softly and gently to him. He is willing to give you 100K for part of your founding stock. You can buy your wife a car and even some new winter tires so she can drive safely on the road in snow. He leans in further - "Deal or no deal". The entrepreneur starts to sweat. He wants his wife to have the car. She screams, NO DEAL from the sidelines….but he knows, she might regret that the next day when she is driving in her old ford pick-up. What should he do? His kids join in. NO DEAL….but they might regret that when they get squished in-between their parents because they don’t have an extended cab Howie interjects. It comes down to this, if you think you have million dollars in your suitcase, you should say NO DEAL. But if you aren’t sure, and think maybe it’s the dollar then you should say deal. Your changes are 1 out of a bazillion start-ups. It’s up to you. Now, if the entrepreneur takes the partial buy out- does this not mean they aren’t sure they have the million? And if they aren’t sure, well, that’s not good right? I mean, if the founder doesn’t believe, than who will? I say, NO DEAL…but that’s just me ;-)
 
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