Yesterday’s post on Most Founders that Raise Venture Capital Don’t Make Any Money prompted a number of comments and questions. One of the popular questions was “why?” If a startup raises millions of dollars of institutional capital, why would a founder not make any money? Here are three reasons:
- Stacked Preferences – Most venture investments are either participating or non-participating preferred equity such that investors get their money back first in the event of a sale. For example, if the startup raises $25 million in capital and ends up exiting for $20 million, the $20 million would go to the investors and the founders wouldn’t make anything (unless there was a carve out or incentive plan to join the new company). The more money the startup raises, the higher the bar to sell where everyone is happy.
- Down Round – If a startup raises a round at a valuation lower than the previous round, a variety of anti-dilution clauses kick in that “true up” the previous investors’ quantity of shares to reflect their previous investment in the context of the new, lower valuation. Depending on how much lower the valuation, these anti-dilution measures can completely wipe out the common shareholders including the founders.
- Bankruptcy – Not all venture-backed startups succeed, and a small percentage go bankrupt even after raising institutional capital. With a bankruptcy, shareholders are wiped out, including the founders.
A general rule is that if the startup sells for 3x the amount of money raised, things are usually OK for the founders. If the startup sells for 10x the amount of money raised, things are great for the founders.
Most founders don’t make any money after raising a venture round and these are a few reasons why.
What else? What are some more reasons founders might not make any money after raising venture capital?