Short Note on Liquidation Preferences
There's an interesting TechCrunch post a while back on the amount of money different people made on the Google acquisition of Slide. Slide was the maker of different Facebook applications, perhaps best known for its Funwall before Facebook took over those features and made the service redundant. The reason the post is interesting is the fact that it shows how different investors get their returns in a case where the valuation is only 36% of what it was 2 years ago.
Max Levichin, the founder and initial investor into the company, profited some $32 million from the total sale price of about $228 million, which include employee retention bonuses. He initially invested about $7 million into the company, profiting $25 million in preferred stock and about $14 million with his common stock.
Later stage investors, such as BlueRun Ventures who invested $8 million in series B made $28 million with the sale. A figure dramatically lower to Levichin's. The Founders Fund and Mayfield Fund who both invested in series C as well as Fidelity Investments, part of the series D only made their money back - without a profit.
In 2008 Slide was valued at $500 million and now Google acquired the company for about 36% of that price. Does it make sense to ramp up your valuation no matter what? According to this story, if you're an early investor - it does. With this, Levichin was able to keep a large part of the company to himself while raising a whopping $85 million in four rounds of funding.
However, there's always a catch - what if the later stage investors aren't happy with the acquisition price and refuse to sell? Then you better hope your term sheets state that you don't need a unanimous vote on the sale. Nevertheless, this is a good story to remind all the entrepreneurs out there of the technicalities in selling your company.
Agreed! You should always have a plan when entering negotiations for a shareholders' agreement. List out issues that are deal breakers for you and issues that you can be flexible with to a certain degree - those in the second group should then be the ones that you will use as tools in the negotiations. Remember that legal terms and valuation are part of the same package, not separate issues. High valuation with a loss of decision making power in the board, veto rights or weak drag-along terms might be way worse than lower valuation with more control of the company and of the possible exit. Not to mention liquidation preference, which should really be looked at carefully.