From the first day, Pillar VC has actually used to purchase typical stock in start-ups.
Rather of the standard 10-page equity capital term sheet riddled with conditions and terms, our team believed that a far easier structure where we owned the very same security as the creators would align interests, increase trust, and ideally, boost the performance of our investments.
There are many terms and conditions in a favored term sheet that can misalign financiers and founders
Five years considering that introducing Pillar, as we end up investing our 2nd fund and begin releasing our third, we thought it was a great time to assess whether buying typical stock rather of favored stock has provided the benefits that we had expected.
Preferred stock can misalign incentives between parties
There are numerous conditions in a preferred term sheet that can misalign investors and founders– for brevity, I’ll highlight just two listed below. (For more, see the term-sheet grader).
Preference: Preferred stock has a “choice” that provides the financier the right to choose whether they want to get their money back or take their percentage of the overall proceeds. In downside scenarios, having an investor take their refund may suggest that they are taking a far greater portion of the proceeds than the creators “believed” they offered.
For instance, if a financier buys 25% of a business for $2 million in preferred stock, their break point on this choice will be $8 million, which takes place to be the post-money appraisal of the round. If the company is cost less than $8 million, the financier would rather take their $2 million back. If the company is sold for more than that, the investor would select to take 25% of the total.
The creator thinks that they offered 25% of their business, but that percentage is in fact figured out by what the company is cost. Yes, if the business is sold for $8 million or more, they offered 25%, however if the business is sold for, say $4 million, the financiers will choose to take their $2 million back, which is 50% of the earnings. Even worse still, if the business is cost just $2 million, financiers will take all of it.
Anti-dilution: This provision means that if an investor buys shares for $10 and the start-up raises money in the future at a price point that is lower than $10, the financier’s share cost will be recalculated retroactively to a lower rate. How is this done? By releasing the investors more shares, which waters down the rest of the ownership pie, especially the creators and workers. The business is not performing well and the financiers are made entire at the cost of the creators. Lined up? Hardly.
Article curated by RJ Shara from Source. RJ Shara is a Bay Area Radio Host (Radio Jockey) who talks about the startup ecosystem – entrepreneurs, investments, policies and more on her show The Silicon Dreams. The show streams on Radio Zindagi 1170AM on Mondays from 3.30 PM to 4 PM.