Many people in the tech industry dream of building a startup, making it grow, taking it public, and growing rich along the way.
All of that is perfectly possible, but one thing these dreamers don’t always realise is that these days, by the time a tech company goes public, the founders tend to own very little of it.
Often they own less than 10% of their own companies. For instance, among the tech industry’s most recent S1 forms, Aaron Levie, founder of Box, will own about 6% after the IPO. Zendesk co-founder and CEO Mikkel Svane will own about 8% after the IPO.
We asked two founders of two hot startups, “What gives?”: Krish Ramakrishnan, founder and CEO of Blue Jeans Network, (his third successful startup), which has raised $US98.5 million so far; and Ross Mason, founder and vice president of product strategy at MuleSoft, which has raised $US130.5 million so far.
Why are founders willing to give up so much of their companies?
Ramakrishnan tells us that CEO founders are simply not worried about the size of their stake affecting control in the board room. Their investors know that founders are integral to the company, and they want the founders to succeed.
The only time there’s an issue of control is a “downside scenario” where the business is in trouble, and if that’s the case, there’s more going on than just a power struggle.
Ramakrishnan says a CEO founder is much more likely to be ousted if things go wrong after the company goes public. “Public markets have little patience for change. A CEO founder is not as revered because, the public markets are only looking for financial results.” A founder, on the other hand, maybe focused on a long-term vision at the expense of short-term financial gains, he said.
Founders also tend to grant significant stakes to their engineers. The engineers, particularly in early stage companies, are the company’s lifeblood.
“If they leave, it’s a piece of your company walking out the door. You need to make them invested like founders not just employees,” he says.
He says that the decision to to share ownership is made from the first venture investment. At the seed round, an investor may take a big chunk. (We’ve heard up to 50%, though that varies from deal to deal.)
As founders raise more funds, their share gets diluted — meaning the percentage of the company they own gets smaller and smaller. But the dollar value of the stake should be worth more: a smaller piece of a growing pie.
“As a rule of thumb, a successful company will dilute itself by raising more money but the key is that the valuation goes will go up and that is far more important than ownership,” he says.
Mason says, “Companies are waiting longer to IPO these days. No longer is it three years from launch to IPO. They are proving their business models first. This requires more cash and so dilution is just part of the process,” he says.
Mason, who also does some angel investing, has observed that startups these days often raise smaller amounts, “but raise more rounds (C, D, E, F) as the company hits milestones like delivering a product, early break-throughs in a market, scaling the sales team, expanding into new geographies, etc.,” he says.
Each time they raise a round, they are selling off more of their companies, and diluting their shares.
Ultimately “the goal is to build a really big business, so even though the stake gets smaller, even down to single digits, it’s worth more as the company grows,” Mason says.
For instance, Marc Benioff, CEO co-founder of 15-year-old Salesforce.com, owns about 7% of his company, according to forms filed with the SEC. It’s worth $US2.2 billion.
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