Tell HN: Our VC turned the process of getting acquired into a nightmare
This is the situation: My startup is profitable with a team of 10 or so people and with a very happy and loyal customer base. But after five years in business I have come to accept that it has failed to yield any really high growth. This has forced us to take a step back and look at how we can reframe our business. We need to find a new product/market fit to kick in the next gear and get back on track to higher growth.
Three months ago, a favorable acquisition offer comes along. Part cash part equity, favorable terms. Because of our dwindling growth it is lousy timing valuation-wise. But right in this situation an acquisition might not be so bad because we know that we have a couple of years of very hard work ahead of us if we are going to turn the company around. Our VC has been supportive and great all along the way, although a huge red flag is that he has declined to be part of any new round of financing if that would happen. Discussing the offer with him, we agreed to go for a very rapid negotiation process and see the results.
But now when money is on the table, the VC turns very aggressively on us demanding much more of the deal value than stipulated by his share in the company. During the process he behaves very strangely, travels overseas and does not answer emails or calls for days and weeks on end which drags the negotiations out into months. The shareholder agreement allows him to block the deal if he's not happy with the terms, but so can us founders so the negotiations turn into a battle of wills.
In the teleconferences we do manage to set up, our VC uses whatever means he can to lean hard on us, including very verbal attacks on us personally. Sometimes he turns awkwardly friendly, doling out legal advice that on fact-checking turns out to be erroneous bordering on dangerous.
What happened in the end was that the acquisition offer was rescinded. The reasons cited for the offer to be withdrawn was that the timing was no longer there and that the buyer would not be happy to have our VC as shareholder because of his attitude.
So here we are. At this stage our relationship with our VC completely lies in ruins. I'm very ambivalent, the only thing really keeping me from quitting my company is the strong loyalty I feel towards my awesome team of founders and employees. If I'm going to develop a new product and perhaps bring in new funding, why do it in a company where I'm already diluted and the VC has proven to be a huge liability during financing and potential exits? On the other hand, if I start anew I will have to bootstrap completely from scratch instead of leveraging the great team and cashflow I already have.
If I do leave, the company will probably saunter along just fine without me. Maybe new management is just what it takes for it to skyrocket.
I would love to get an outside view on the above. Bash my head in if you think it is needed, that would be very refreshing. I have a really great lawyer at hand, so whatever legal advice you give me can do little harm because I run everything by him. What do you think?
49 comments
[ 2.6 ms ] story [ 115 ms ] threadBefore quitting and losing control over so many years of hard work, I would recommend putting your recent frustration with the VC aside and sitting down with him to understand what he wants from any future liquidity events. You say he has been a good investor so far, and may be he is under pressure from LPs or has something that would explain his strange behavior.
I can imagine it would be hard to work on a startup where your final outcome seemingly depends on a person who seems to be fickle and unreliable. Any clarity you can get on this may help align your interests with them.
Reminds me of something a very wise venture capitalist once told me in a cynical moment: "At exit, everyones' interests are misaligned". The only thing you can do to avoid this is try to 'hire' VCs who are also good people.
Sorry it has come to this. Hope it works out for you.
Niels Bohr said that "An expert is a person that have made all the possible mistakes in a narrow field". Sometimes I feel like I'm getting there...
The only leverage you have over him is the damage his behavior, if public, could do to his reputation - since VCs live and die by their dealflow. If the deal was still on the table, I would've politely discussed his future exposure - 'if this behavior keeps up and the deal doesn't happen, you are not going to look good in the post-mortem I'll be posting to Hacker News'. Quality VCs know that their reputation depends on keeping entrepreneurs happy.
Now that the deal's dead, you might as well leave - but you'd be doing a disservice to the rest of us to not reveal who this guy is. If you can't do it in public (perhaps you're worried about raising money again from someone else - which, sadly, is probably valid), at a minimum you should be describing the whole story over at The Funded.
That seems to be the only option that explains his behavior unless I am missing something.
So what are the chances that you can line up another buyer? Even at a valuation less than before would be worth considering because it looks like he is out screw you over. You might at least get something out of it even if it was not what you imagined.
If you line this offer up you and the team can give the investor an ultimatum. I think that sometimes directly calling out people's bad behavior can help.
If you can't line up an offer and then working out the math it might be best to quit.
Also I might recommend 'Getting to Yes' as a great book for negotiating. Might be too late this time, but there is always a next time!
At this point, I would anonymously blog about the entire situation regarding the VC's behavior while never revealing your own name nor the name of the company - only the name of the VC.
Sure, the internet will find out the company name in due coarse, but you will have several days or so of the VCs behavior out there all on its own for the rest of the community to evaluate.
The threat of doing so is really the only thing that would have any benefit, perhaps encouraging the VC to move faster with future deals, actually posting may damage the OP's standing with potential VCs in the future. There is likely another side to this story and I lean towards keeping dirty laundry private.
2. Outing the VC could provoke him to retaliate by filing a lawsuit for defamation, and/or for tortious interference with prospective economic advantage. The OP doesn't need that kind of grief right now.
3. It might be worth spending a few bucks to talk to a savvy business litigator -- this sort of thing comes up fairly often in closely-held corporations. Maybe Grellas will put in an appearance on this thread?
As for taking the conflict public, I don't have it in me. It is not something that aligns with my world view because I know that I too can be wrong sometimes and not see the whole story. I prefer that people know they can trust me rather than applying that kind of leverage.
When seeking revenge, bring two shovels and all that.
Before the crash and down round, your interest is worth $(y * x/100). After the crash, your interest is worth $z * (x + d)/100%, but you have to pay an additional d%/100% * $z. Therefore, the crash and down round changes your wealth by $z * (x% + d%)/100% - $(y * x%/100%) - d%/100% * $z = $(z-y)*(x%/100%). Since z << y, and x > 0, the VC will always lose wealth by destroying value to force a down round. If they could get a z value higher than the true value, the situation might, change, but that would be difficult.
What I think is actually happening here is the VC is playing what is called a game of chicken in game theory (http://en.wikipedia.org/wiki/Game_of_Chicken) to try to get more than their rightful share of the deal. A game of chicken is where if one player gives up first, the player who gives up loses a small amount, and the other player gains a small amount. If neither player gives up, they both lose a large amount. The VC wants you to give them more, by forcing you to choose between doing what they want, or hurting both yourself and them by completely destroying value in the company.
Strategically, you now need to either capitulate to what they want, convince them that you won't back down (if they are convinced you won't back down no matter what, it is in their interests to back down and let the next acquisition opportunity go ahead), or find a way to stop them blocking acquisition.
You've got a good team. You have successfully served a niche. Now what? Spin off the existing product and start from scratch? Take the technology and launch a new product, while managing the cash flow of the existing customer base? Much of this depends on what you want: a good lifestyle (where you should bootstrap) or to get rich (where you should take on a VC).
Since the relationship with the investor is important, try hard to repair it or find a new investor somehow, even by starting over.
I know the advice is very generic, but I hope that helped.
If there's some team solidarity on the matter, you could try renegotiating the terms or buying him out.
i.e. you could say: "We feel like that deal broke down because of you, which was contrary to the interests of the founders and other shareholders of the company. It's hard to be motivated to grow this company when we know that you could submarine any exit or additional financing at a whim. We talked it over and 6 of the 10 people on the team are going to walk, though of course we'll give you a month to find new management if you'd like to. As an alternative, we'd stick around if you'd be willing to legally adjust your rights so that you can only block a sale of less than $1M dollars. As an additional alternative, the company will buy back your shares for $X over Y months."
If there's no solidarity and everyone but you wants to soldier on (either for the lifestyle job or trusting that the VC will act sensibly next time), then you should probably announce your intention to step away and see what your co-founders want to do.
- Throw good money after bad by pouring more money into a loser, and
- Give up on a company, only to have it succeed without you, either through a cram-down or an acquisition on unfavorable terms
So in that situation, the VC's interest is that your company either succeed without further investment or go out of business.
I wish I had good advice for you--perhaps, as some others have suggested, threats may help. My guess is that you don't have much to lose.
At this point, you should explain to your VC (hopefully he is your only one) that you intend to: (1) wind down the business, layoff all staff, pay off all debtors and cease all company operations. And (2), without soliciting any employees or infringing on any IP, you intend to reconstitute a new company in the X space where X is your current business.
Explain how it was a pleasure to work with him, and you're sorry you were unable to return his equity in this endeavor. You can ask if he is interested in finding a buyer for his remaining equity, despite it's precipitous loss in value pending the imminent loss of all employees, and if so, you may be able to arrange a buyer.
You are on the east coast so be sure you do not have any sort of non-compete agreement with your company that is enforceable. You most certainly have a non-solicit agreement in place, so be cautious, and email none of these communications or plans around. This is a decent time to be paranoid.
You need to work through with your lawyer and ask him or her in great detail what options you have in terms of forcing the VC to cooperate. Can you wind up the company without his/her agreement? What non-compete clauses apply? Can they be worked around?
Do you have the right to make a share issue in a way that would dilute the VC below a control threshold (while satisfying all legal and fiduciary obligations)?
Others in this thread have suggested you 'out' the VC - do not do this without legal advice, and I would recommend you not do it at all. You need to be 100% in compliance with the law of libel etc. Even if a staff member leaks information without your consent that places you in a weaker position not a stronger position.
If you have strong options, then pursue them. This may lead to the VC showing willingness to compromise. In which case, do genuinely consider compromise.
In fact, the partner even resigned from our board during acquisition negotiations, because the squeeze he was attempting, enriching his firm at the expense of other shareholders, wouldn't mesh well with the fiduciary responsibilities of a board member.
Some people think using every lever at their disposal to eke out a few extra percent at the last minute proves their business mettle. I suppose they expect – or prefer to guarantee – that this be their last transaction with the others affected.
We wound up acquiescing to his demands to avoid ruining the acquisition. And most of us resolved to never do business with him or his firm again.
If another acquisition materializes, you may just have to acquiesce and/or play chicken/hardball with this VC – all the while hiding any internal dissent from the acquirer, so that ultimately it's up to you and your investors whether you walk away from a deal.
If he's a bit player at a larger VC firm, you might privately share your concerns with other more senior partners there – which almost always would be a relationship-destroying maneuver, but if the relationship is already kaput, why not?
Hardball might involve having your own lawyer find the maximum you can do under the investment agreement without the VC's agreement – asset sales, de facto liquidation, etc. – or find grounds to (credibly threaten to) sue the VC for breaches of various duties.
It was already a good result for the investor – the last-minute extras demanded weren't a part of any prior negotiated preference, they were just new things extracted in return for not vetoing a deal everyone else wanted.
In the end, everybody is unpredictable. If you don't protect your rights from the start, you'll have problems. Even (especially?) if you're BFFs, everything should be spelled out in advance, including metrics for conceptual terms such as "success", etc.
You have 10 staff, and you're profitable. It sounds as though it might be best to try and sever ties with this investor if he's making things difficult for you.
One way of doing this would be to cut costs in order to offer to buy out this investor after some period of time, eg. you have 10 people, if you can redistribute the equity held by the current VC/Angel whatever to your employees as restricted stock with a vesting period of two years you may be able to save enough money to buy out the "toxic investor".
Taking this approach depends, of course, on your staff's ability/willingness to withstand a paycut for that, long, the ability to make that kind of decision independently of the existing VC and whether or not you could buy out this dude after some reasonable period of time (eg. 2 years).
The other thing I would point out is if you already have a profitable business and 10 employees, you really shouldn't need any new funding to build a new product. If you have half your team work Fridays on new product development you'll have something in 6 months or so that you can sell.
Best of luck!
Have you considered the possibility that he is having serious trouble in his personal life - perhaps financial or relationship trouble?
His recent behaviour does sound dodgy but in common with how people react when they are facing serious personal issues. It could also be that someone else is putting pressure on him in regards to this deal.
You may want to approach him sympathetically to see if that could be the case.
I think of VCs as managers, and I'm usually of the opinion that the most likely solution to a bad manager is a new job, so I'm inclined to favor any path away from this guy. What path would be best?
Having a profitable company with 10+ employees is a pretty good position to be in if you want to launch something new. I'm inclined to recommend making full use of that opportunity, whether new equity from this VC is a possibility or not. Another concern, though, is that you don't want to risk the health of the company by diverting too much of the available cashflow, or by hurting their market positioning. So it seems to me that any pivot is going to have to be a soft one, or else you'll have to find a growth or new opportunity that really does seem like a sure bet. So my recommendations are: 1) Swallow your well-justified bitterness. It just won't help you get through this. If you want to spread truth about this VCs character, do it after you have gotten out of the current stickiness, and even then I think some coded politeness can suffice. 2) Tell the VC that you're going to double-down on finding new growth opportunities. Lay it on thick, and check in more frequently to give him backing with his peers. 3) Assume that the VC will talk smack (widely) about you if ever challenged in any public context, and may be doing so anyway now that this deal exploded, so be proactive about working your relationships with his peers and your peer community. Consider this your ongoing side project as you... 4) Work on finding the right pivot for you and for the company. Consider this your top priority. If you find another startup that has a better opportunity that you can jump to, take it. But don't risk your current profitable status. Tipping into negative cashflow will endanger the whole situation but will also give the VC more ammunition in laying blame on you.
I can provide no advice based on experience but since the acquisition offer has been revoked, I would suggest for next time to do the following calculus:
In one year, if I agree to his terms, will I /really/ be that much worse off? Will I be so poor?
If not, agree with a stipulation that it is to be completed within X timeframe otherwise they get the old share.
If so, be prepared to lose it all.
9/10 times, you're usually better off capitulating and making sure all your friends know NOT to deal with this guy.
Anyway, good luck.
It's a nightmare scenario. If it was me I would play hardball back. Walk away from the whole thing and let the company melt down, better that all should lose than he should win and all you should lose. Alternatively maybe he comes to his senses, but you have to be willing to carry through with it. I hate playing hard ball, but once you find yourself with someone who is going to do that, you have to play hard ball back or you'll lose for sure.
If you do decide it is all for naught and you are probably going to bail, I recommend you open source your code base for some plausible business reason, and then wait a few months before leaving. This way you'll be able to recover your own work for use in future ventures should it come to that.
Obviously you picked the wrong VC but why on earth would you give him such veto power. That was your mistake and now you are paying the price. Oh well.
Even the YC 'Series AA' model document terms include protective provisions where a majority of the preferred shareholders have veto power over any merger/acquisition.
It's a customary provision, and this previously-supportive investor may have had the majority of an early round. So even if his shares, if converted, would only be a small percentage of the company, he may have effective veto power.
In the end you're counting on the decency and reputation of your investor(s) that they don't turn out to be the kind of people who think, "can I squeeze a few more bucks out of this deal if I'm willing to blow it up, and don't care what people think of me?" (Or even if, in the investor's real peer group, he can tell it as an impressive war story of his negotiating prowess.)
It'll be dressed up as something else – "I'm not receiving a proper premium for my preferred privileges!" – but is really just a bet that their toughness/ambivalence can force other shareholders to cave.
I suspect it's a more likely tactic with investors whose background is in other older, and more zero-sum industries. (The similar experience I mentioned in my other comment was with someone from the government-granted telecom franchise field.)
It is my strong opinion that him going dark with communication was a negotiating tactic. He was stretching you over a barrel and then fucking you. You telling him you will (and then doing it) to sign the legal documents is the way to unblock that situation. That is what happened to the other person who had a VC do this.
You need to absolutely document that this VC did this in TheFunded.com. There needs to be consequences to VCs. You would want your VCs in the future to be self-policed by TheFunded against doing something like this.
you're so close to exit it would be a shame to leave, its like stopping at mile 20 of a marathon, just stick it out and finish. gl.