Venture Capitalists used to invest in startups so founders could build businesses. And if those businesses became successful, then the founders would make fortunes.
In frothy times however, that order of events occasionally gets jumbled. A few founders are raising millions and pocketing some of the cash before their businesses are proven.
As Business Insider reported in July, the founders of Secret took $US6 million off the table during a $US25 million funding round just six months after the company launched. Now Secret has lost traction and it’s pivoting its business.
Another app, Robinhood, reportedly took a few million dollars from venture capitalists and spread it around to its executive team. The easy stock-trading app only launched in November.
The founder of profitable startup Buffer has also pocketed a few million dollars, according to WSJ’s Evelyn Rusli. He claims the money will simply be used to invest in other startups and “grocery shop and not think about things too much.”
Why would investors de-motivate founders they back and allow them to get rich quickly?
There’s too much money floating around and there are not enough great startups to invest in. So the best startup deals are extremely competitive, and founders are allowed to make brow-raising demands of investors, and the investors sometimes comply.
One investor who spoke with Rusli says venture capitalists are fighting over startups like “drunken sailors.” Other investors justify giving founders one million or two because that’s how much top engineers at companies like Google, Twitter and Facebook make.
Jeremy Liew is an investor in startups like Snapchat and Whisper, a Secret competitor. Snapchat’s founders Evan Spiegel and Bobby Murphy were allowed to take millions off the table during a round of financing despite the fact that the app hasn’t generated meaningful revenue.
Spiegel actually blew a Snapchat investment when he asked Tencent for $US40 million for he and Murphy to split. When his board member Mitch Lasky asked Spiegel why he did that Spiegel responded, “Well I just turned down a billion from [Facebook CEO] Zuck.”
Whisper’s founder, Michael Heyward, has raised $US60 million. He, unlike the Secret and Snapchat founders, hasn’t kept a penny for himself. Heyward says he has no need for millions of dollars right now. He doesn’t have a family to support or loans to pay. He also says he believes in his product so he doesn’t want to swap equity for cash. It wouldn’t be smart since he believes his company will be worth much more in the future.
Liew thinks taking money off the table isn’t wise. A leaked email about Snapchat from the Sony cyberattack shows Liew discouraging Spiegel from pocketing millions.
“[Jeremy] said that he’s a seller if you are a seller — if you do any secondary he wants to sell pro rata. He denied that he’s a seller into a 100% primary deal,” Lasky wrote to Spiegel. In other words, if Snapchat’s executives traded stock for cash, Liew wanted to sell shares too. If Snapchat opted to keep stock — a sign that the founders were committed to their business — Liew wanted to keep his too.
Allowing founders to pocket millions can be smart. In Snapchat’s case, giving Spiegel and Murphy a few million dollars may have made it easier to turn down Facebook’s multi-billion-dollar acquisition offer. The company is reportedly close to raising money at a $US10 billion valuation.
Despite the recent drunken sailor fighting among investors, Liew says it’s still rare for founders to take money off the table. If an established entrepreneur is asking to pocket millions of dollars, it can be a warning sign to investors that the founder isn’t serious enough about building a big business.
Another investor who spoke with Rusli, Gil Penchina, also admitted that pocketing millions of dollars early is rare, and founders rarely ask for it. But he noted that he feels fine giving founders a few hundred thousand dollars — just not millions.