Opinion

Felix Salmon

Snapchat’s early cash-out

By Felix Salmon
June 26, 2013

Dan Primack is awesome when he’s angry, and boy is he angry today, reacting to the news that Snapchat’s two co-founders have cashed out to the tune of $10 million apiece as part of its latest funding round. “This is desperate lunacy,” he writes, adding that these kind of deals “should scare the hell out of venture capitalists”:

The LP-VC-founder alignment has now been skewed, because only the last part of that triangle is now in the money…

Don’t I want entrepreneurs building for the long-term, rather than ones just waiting for the first decent exit opportunity? Entrepreneurs who care as much about their vision for its own sake, as they do for the dollars that vision can represent?…

VCs in general have gotten a bit too comfortable handing out millions of LP dollars to individuals who don’t really need it. Maybe that’s because certain VCs no longer view $10 million as the fortune it really is.

I agree that little good can come from these deals, from the VC point of view — but I’m less angry about it than Primack is.

For one thing, the LP-VC-founder alignment has always been skewed, with VCs getting by far the best deal. Most VC-backed companies fail; historically, that has meant the founders walking away with nothing. And LPs have not done very well either. Only the VCs seem to get paid no matter what. By allowing founders to sell equity outright in early rounds, VCs are allowing them to monetize crazy early valuations — just as they themselves monetize those crazy early valuations by using them to market their next multi-billion-dollar fund. Is it bad that the pendulum is swinging back a little bit from capital (VCs) to labor (founders)? No, it not.

Secondly, it is absolutely understood in the founder community that the deal you make, when you accept your first dollar of VC funding, is that you will be building for growth and exit, rather than trying to create something which you will bequeath to your children. If you want “entrepreneurs building for the long-term”, you want entrepreneurs who aren’t taking VC money in the first place.

Thirdly, especially in Silicon Valley, it’s downright silly to expect entrepreneurs to “care about their vision for its own sake”. This is the home of the pivot, of the serial entrepreneur, of the fail-fast culture, of A/B testing, of trying many different things until you find one which works. This isn’t about vision, it’s about the ruthlessness of the market. Indeed, founders who care too much about their vision, rather than about maximizing VC returns, are liable to get unceremoniously ejected.

Fourthly, if VCs have reached the point at which they no longer think of $10 million as being a particularly large amount of money, then it’s about time that a few founders could join those ranks as well.

Finally, we’re living in a world where VC-backed companies almost never IPO any more, and where private exchanges like SecondMarket and SharesPost are becoming an increasingly important source of liquidity. I had lunch with the CEO of Green Dot yesterday; it was funded by Sequoia Capital in 2003, and Sequoia is still the single largest shareholder in the company, ten years later, with no final exit in sight — despite the fact that Green Dot went public back in 2010. In that sense, IPOs have become just another funding round. If companies are privately raising sums of money which five or ten years ago could be found only in IPOs, then you have to expect founders to start getting liquid around those rounds, just as they used to do during IPOs.

From a personal-finance perspective, of course, it makes all the sense in the world that Snapchat’s founders should diversify their net worth away from being 100% invested in the highly volatile and illiquid equity of their company. VCs and LPs are all perfectly sophisticated when it comes to managing their personal wealth; founders should be allowed to be just as sophisticated. Otherwise, accepting VC money starts too look far too much like indentured servitude.

So good on Evan Spiegel and Bobby Murphy for cashing out: they created a great product, and now they’re rich. That’s how Silicon Valley is supposed to work. And if the current valuation doesn’t work for the latest tranche of investors, that’s more the LPs’ problem than it is the problem of Snapchat’s co-founders.

Comments
13 comments so far | RSS Comments RSS

Primack’s outrage is unwarranted. Yes, the founders got to cash in $10M of their shares, but that’s probably less than 10%, if that, of their remaining stakes in the company. After taxes, the two might see $5M from this sale, which is not massive wealth in the valley.

Further, they may have done other shareholders a favor by limiting the dilution of the stock. It’s possible the latest investors insisted on investing that $20M in the company, and that the founders didn’t feel it was necessary, so they sold some of their shares to keep other employees from getting more diluted than necessary. In any case, given the attention the company is receiving, and the chances for a huge exit, it’s very unlikely the motivation of either founder will be diminished.

I don’t know exactly what happened, but it really isn’t a big deal, and if Primack is angry, he probably has a bad life, as there are far more important things to get angry about. Most likely, though, is that it’s just jealousy.

Posted by KenG_CA | Report as abusive
 

Dan’s wrong. This kind of deal is precisely the kind of deal that aligns LP, VC, and founder interests.

VCs and LPs want a massive exit — their whole business is built on hitting a few rare home runs rather than many (much) smaller singles. Founders, on the other hand, can be made financially well off by taking some money off the table, which pulls away their incentive to take an exit that would, for a VC, be a single. With a few million in the bank, founders are free to swing for the fences and try to hit that VC-scale home run with significantly lowered downside risk.

Posted by dmcdougall | Report as abusive
 

woohoo! The return of Felix updating us on his lunches.

@KenG_CA – If you read Primack’s piece, he states,

Before continuing, let me be clear that I don’t necessarily blame Snapchat’s founders for taking the money.

now, obviously he doesn’t say that the founders are blameless but the majority of the blame rightly falls on the shoulders of the VCs.

I myself vacillate between Primack’s greater than zero to Felix’s zero “blame” on the founders. After all, let’s not fool ourselves here, right alongside the “change the world” mantra is the “let’s get rich” chant. Most people, and certainly not people who take outside money, are in startups for altruistic reasons.

@dmcdougall – for 20 somethings, they are already trying to swing for the fences anyway because they know that this isn’t their only opportunity, they still have plenty of time. And the inverse of your argument can be made as well, with the founders having a nice cushion even if this company doesn’t work out, they can coast a little bit. Or god forbid they start buying houses or dabble in angel investments on the side which divert their attention from the main job. This is just as likely as your scenario.

Posted by GregHao | Report as abusive
 

@gregHao

Yeah, god forbid anyone buying a house – they should be sleeping in their offices….

As @dmcdougall points out, it’s not like $5m is a lot of money in SV. It would barely buy you a nice size house in most desirable SV neighborhoods. It does, however, take care of the one very large fear a lot of founders have, which is basically having to find a job of sh*t goes south…

Most startup people don’t give a damn about $$$. Sure people talk about what might happen, but the main motivator is doing something interesting, cool and that others find useful. The people who want to get rich are the LPs & VCs and they mostly fail miserably… That said, everyone would like to avoid long term poverty and is fully aware that on average, entrepreneurs make 30% less than if they’d followed a traditional career path…

Posted by ckm5 | Report as abusive
 

@ckm5 -

couple things, not everybody enjoys or believes in the benefits of owning a house. I know many people who don’t buy.

the median income for San Francisco is $72,947 (http://quickfacts.census.gov/qfd/states  /06/0667000.html), I daresay most CEO/Founders or even CTO/Founder are making more than that. Even if they are relatively slumming it.

you’re both right that compared to other “successful” entrepreneur CEOs, $5MM is not a lot of money. But this is like someone earning $400K a year complaining that after sending their kids to private school, put away money for retirement, new cars every two years, and a 5,000 sq ft house that they are poor. By any objective measures and standards, this $5MM liquidity event will represent the most money these founders will have made up to this point in their career and _is_ a significant amount of money.

I also agree that money is usually not the primary motivating factor, and don’t believe that is what I wrote, but it is certainly part of the consideration. Hell, we have startups in New York (and in the valley) who are competing on fringe benefits like what kind of yogurt they stock in the company pantry! (http://www.nytimes.com/2013/06/20/fashi on/the-calorie-packed-perk.html?pagewant ed=all&_r=0)

Again, if we are talking about guys who’re in their 30s, have a family, and have toiled at their startup for a few years then I certainly agree that a liquidity event for the founders isn’t out of order and is often warranted. That is in fact also Primack’s position. But that’s not what we’re talking about here.

Posted by GregHao | Report as abusive
 

GregHao, I didn’t say that Primack shouldn’t have been mad at the founders, I just said there was no justification for anger. There was ** absolutely nothing ** wrong with investors buying $20M worth of shares from the founders. The founders are also early stage investors in the company, and early stage investors often sell some or all of their stake in companies before there is an exit.

Posted by KenG_CA | Report as abusive
 

I think Dan has some good points but I wonder if the amount of money going to the founder’s in one lump sum is part of the issue. What if the founder’s were able to vest with say just $1mil to kick off the investment and large(r) valuation that they built giving them the ability to live comfortably and participate in the start up community in a much more validated way and then have an on-going vesting opportunity, say quarterly, to build their wealth as they go which would also entice them to continue to build the wealth and success of the company they created.

$10mil is a lot of dough by any standard and I can’t believe it’s not being acknowledged that way here!

Posted by Ballman | Report as abusive
 

Wow does this whole discussion reek of envy and smart people with too much time on their hands. Why not do something actually productive with your lives rather than dissecting the actions of people who are?

Primack and Salmon sound like the worst kind of busybody idiots. Pearl-clutchers tutt-tutting at the bedroom companions of their favorite TV actresses.

KenG’s first comment is the only thing here that is sensible.

Posted by QCIC | Report as abusive
 

@greghao

I live in SF and it’s insane expensive. The median income may be $72k/year, but the city considers you eligible for subsidies if you make less than $70k/year. Coupled with a 30% increase in rents in the last year (a 1-bedroom now averages around $2500/mo) and the median apt costing $750k, you need at least $150k just to live here if you are new. Even just a simple room costs $750-$1000/month. If you’ve been here for a while, it’s a different story as you have either a low cost rent-controlled apt or bought your house for cheap(er).

The reality is that to buy a place here, you need $1m – preferably in cash as you are competing with all the money fleeing China and the 58k Apple employees with options. And that’s for an average apt, never mind if you want something really nice or an actual house in a nice neighborhood.

If you count what you need to live for a few years after you leave your startup (and have spent $1m+ on a place to live) and are trying to figure out what to do next, then $5m doesn’t sound like much (BTDT). And let’s not even talk about retirement savings.

The other reality is that a lot founders never get big dollars at exit – they are often subject to cramdown & liquidation preferences that leave them with peanuts (see http://www.feld.com/wp/archives/2005/01/ term-sheet-liquidation-preference.html). Cashing out while you have leverage is not only smart, it’s really the only way you can assure a decent payout.

Most founders don’t know enough to follow this through and when they realize what they should have done, it’s often too late and someone else is getting the big dollars…

Posted by ckm5 | Report as abusive
 

ckm5-

No one has to live in San Francisco. There are plenty of less expensive communities all around the Bay Area. Despite that I know people of relatively modest means who have apartments right in town (film grad student and girlfriend who is a manager at a small theatre, or two graphic artists who share a studio apt.).

The idea that you need 5 or even 1 million dollars to be “comfortable” in SF, just shows how puffed up your conception of comfortable is.

Posted by QCIC | Report as abusive
 

we seem to have gone kind of off topic and I just want to point out that Snapchat is actually based in Venice Beach. That’s in Southern California where houses are expensive but nowhere near the levels we’re talking about. And I just want to reiterate my point above, which QCIC also touches on, by any objective standard, $5MM post tax is a lot of money.

Posted by GregHao | Report as abusive
 

@ckm5 – if I were an entrepreneur and my VC came to me and said, “hey, as a part of the latest round, we’re going to also make it a liquidity event for you at a stupid* valuation.” There is no way in hell I wouldn’t say yes. Of course I would and I don’t begrudge the founders of Snapchat for doing the same thing. And that’s why I am sympathetic to Felix’s view. But if I were an LP whose VC is throwing around cash like that, I would be worried. That, I believe is Dan Primack’s point and one that I agree with.

Posted by GregHao | Report as abusive
 

I’m surprised that Primack is so concerned about money for the founders because he also covers buyouts. It’s routine in buyout deals that executives are taking some dollars off the table while also maintaining a go-forward equity position. It’s not just top execs for large go-private deals who are pocketing meaningful amounts. That’s also very common in relatively small middle-market deals, because so many of those companies are family-owned businesses who are maintaining a minority ownership stake going forward. Overall, I’d say it’s common – perhaps even the norm – that the CEO of a private equity backed company has more wealth in outside investments than in company stock.

As an LP, what would scare me is to see a VC putting my money into (pre-revenue) Snapchat at an $800 million valuation. (In fairness to Primack, he also makes this point.) Maybe I’m too old to appreciate Snapchat, but it sounds more like one feature of a social network or mobile OS than a standalone platform, so I view the valuation upside as limited. Tough to see how Snapchat generates major advertising revenue because the whole point of it is to look at photos that quickly disappear. I’d also think some advertisers wouldn’t want their ads showing up next to sexts.

Posted by realist50 | Report as abusive
 

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