Viddy, the maker of a hot online video-sharing app, raised $30 million at an eye-popping $370 million valuation earlier this month after signing up celebrities like Britney Spears to be among its 30 million registered Viddyographers. But that’s not the only thing eye-popping about the deal.
To get that money, Viddy’s management agreed to terms that strike us as unusual in these founder-friendly times.
If Viddy sells between now and May 8, 2013, investors in its Series B—a group which includes NEA, Goldman Sachs, Khosla Ventures, and Battery Ventures—will get two dollars for every dollar founders and other common shareholders get. That’s known as 2X participation rights.
That’s on top of the usual liquidation rights venture-capital investors get—essentially, a guarantee that they’ll get their money back.
Those terms—especially since they expire in a year—create all kinds of crazy scenarios, according to VCExperts.com, which provided us with a detailed analysis of the terms and their implications:
- If Viddy sells for $370 million—its ostensible value after the financing round—by May 2013, Viddy’s Series B investors will get $60 million.
- If Viddy sells for twice that, the Series B investors will get the same amount: $60 million.
- Viddy’s Series B investors will break even if the company sells for as little as $38 million. At that price, Viddy’s founders and employees will get almost nothing.
Now, $38 million may seem like a fire-sale price, but it may be where Viddy is headed unless the company can reverse a dangerous slide in its daily active users. (See chart below.)
Viddy’s chief marketing officer, Evan White, said the company wouldn’t comment on the terms of its investment. Peter Sonsini, a partner at NEA who led the Viddy investment, didn’t respond to an email requesting comment.
So we just have appearances to go on.
By all appearances, the Series B investors really have little motivation for Viddy to be an Instagram-like success. But they do have 60 million reasons to sell the company within the year. Even at a low price, they’ll still make money—just not the 10X returns most venture capitalists say they’re looking for.
The company’s founders have different incentives: Their percentage take from a sale goes up sharply. At $100 million, they get 26 per cent of the profit from the deal. At an Instagram-like $1 billion, they get 38 per cent.
That sharp differential goes away in a year’s time—meaning the founders make more money, especially at lower sale prices, if they wait it out.
That’s one positive spin investors can put on the terms: Structuring the deal this way takes away founders’ usual incentives to sell the company fast for a quick profit and instead focuses them on the long term.
And of course, there is one way everyone’s incentives are aligned here: If Viddy ends up being worthless, everybody loses.
Viddy just rolled out an update to its iOS app, and they have $30 million to build out their service and figure out how to deal with the drop in their Facebook-connected user base that’s put them behind their archrival, Socialcam.
But the clock is ticking. It says so right on the term sheet.
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