William Carleton, Counselor @ Law

Going Private

In a space of 24 hours last week I heard two different people - a smart young technologist and a seasoned growth company executive - make the same, non-intuitive observation: ostensibly private companies that have institutional or fund investors are not really private.

Both think "private" should denote companies owned by founders, management teams and/or individual investors. People in position to make the kinds of decisions that are best made by owners who feel proprietary about the business. People who don't carry incompatible agendas.

What about liquidity? Life happens, and from time to time shareholders, be they employees or angels, will need to sell.

The Northwest needs a secondary market for the equities of growing companies with organic agendas.

It may be just that simple.

Photo: "Holkham Hall - sign - Private," by ell brown.

Second Thoughts About Secondary Trading

Twitter CEO Dick Costolo has been widely referenced this week (e.g., this piece in Bits) as being downbeat about the impact of secondary trading in private company shares. "A distraction" he says in this video from FORAtv. (See the full question and answer beginning at minute 21:30.)

Then Kara Swisher on ATD (I just realized Joe's and my app has the same initials as the big tech blog!) writes that Twitter's new financing will be structured to accommodate (or will parallel) a significant repurchase of employee and early investor shares in Twitter. The reasoning is I guess to do this in an ordered way.

I like the comment thread on the ATD post which surfaces a difference in values informing why one might be pro or con on secondary trading. Is it unfair for insiders to cash out (or dump) shares on media frenzy about hot startups when the companies have no reporting obligations? On the other hand, who is hurt if the investors are accredited and can fend for themselves?

These are good questions to sort out and values to surface and make express.

Another way to frame the debate is: what is the value of labor? How appropriate is it to extend the potential financial upside of a startup down below the C-level management team? For those who throw their talent and time and opportunity costs -- as an engineer or developer or salesperson or startuper-of-other-stripe -- is it appropriate to access some of the same career and life options that might otherwise be reserved for founders?

So it would seem that antennae are up, that secondary trading is now suspect for raising the cost of hiring talent.

This issue is also directly related to PE style repurchase rights that came to light recently (the Skype equity incentive plan).

Capital, which can make room for founders, may be a bit more conflicted when it comes to employees. The message is often, "we need you, here's some upside," while behind closed doors plans are consciously drawn or indifferently allowed that make the dangled upside scenario illusory.

Secondary markets may well be giving more power to non-founder tech talent. That might not be a bad thing. How a given company limits the ability of employees to sell vested equity will say a lot about how much it really means the happy talk during hiring.

Poster: "'Free Labor Will Win,' 1942 - 1945."

Counterintuitive Wisdom

Dan Shapiro, the entrepreneur who recently sold his angel backed startup, Sparkbuy, to Google, doesn't blog that often (maybe once a month or so).

But his stuff always covers a well-chosen topic with broad perspective and peppers it with detail. He has a talent for arresting phrasing, too, all the more effective when he's countering conventional startuper wisdom.

His post this week about why he sold Sparkbuy, so quickly (just six months) after launching it, is a must read.

I wanted to call out six blog bites from his post that illustrate what's said above about Dan's thought and style. Each is out of context but then again each is a story unto itself.

• "It’s just hard to find reliable, accurate, unbiased, quantitative information about products. Search engines favor old prose over fresh data."
• "(Soapbox sidebar: health insurance reform is key to promoting entrepreneurialism and small businesses in this country!)"
• "It was becoming increasingly clear to me that the best strategic decision for the company was to raise a large financing round at a lofty valuation and grow like crazy – but I wasn’t particularly excited about doing that."
• "I had a list a mile long of initiatives to drive profitable growth, but in the end all you can do is experiment and iterate, and it can take a long time to find the magic."
• "This was not the hardest decision I’ve ever made. It wasn’t even in the top 10."
• "Since my investors were angels, they would look at the exit on a time-adjusted return basis."

Zynga & Pre-IPO Liquidity

The emergence of secondary markets is one of the most fascinating developments in the world of startups and emerging tech companies in recent years.

Access to a private, secondary market can give founders and early investors some liquidity, taking the pressure off companies who may may need more time to manage an exit -- or giving CEOs who don't want to manage to short term Wall Street expectations a way to avoid having an IPO.

But look at this disclosure from the Zynga S-1 filed last week:

It discloses that Zynga has recently purchased its own stock from members of the company's management and certain of its investors. According to the chart in the S-1, Zynga has paid $233,159,670 - that's right, nearly a quarter of a billion dollars - to redeem stock in the first quarter of this year.

These aren't transactions among shareholders, or private resales between insiders and third parties on a secondary market. These are transactions in which the company itself is the buyer.

This kind of strategy is probably going to work best for companies backed primarily by venture firms. For instance, it would appear that Zynga isn't concerned about preserving QSB status for the sake of founders or indvidual investors. But it's a neat trick: use the cash you have -- and/or cash you raise in a private, late-stage round, presumably anticipating an IPO -- to give early investors significant pre-IPO liquidity.

Founders & Risk Temperature

One thing I'm noticing among founders who eschew financing past the point when it would actually be available to them: some of them are stressing out.

Some are taking risks they wouldn't take if they had a venture capitalist or an experienced angel investor on their boards.

I don't mean the risk of failure. That's an acceptable risk. I don't mean the risk of leaving vendors unpaid. That's the ordinary course of startup business.

I mean persevering past the point that any investor, willing to write off her own investment, would urge you to pay final wages, lock down member data or other sensitive information, call it a night.

I used to say that I'd never seen anyone cross over from the corporate world to startupland and ever go back (except brief tours as part of the price of a liquidity event). But this stress of pushing past the point of the capacity of the system to wipe the slate clean . . . that may ruin entrepreneurship for some talented folks who would do better to take the money, make it big, and self-fund next time.

Photo: Vienna graffiti, by southtyrolean.

Go Big

Check out John Cook's and Rebecca Lovell's GeekWire "red carpet" interviews of two of the "best startup CEO" nominees from the Seattle 2.0 Awards Thursday night: Dan Shapiro of Sparkbuy; and winner Sunny Gupta of Apptio.

Shapiro emphasized the consumer product strengths of Seattle, whereas Gupta analyzed the unique opportunity to build a next-generation, substantial enterprise business in the Northwest.

Here's something that Gupta said about "going big" that I found particularly interesting (starting at 4 mins., 11 secs.):

"The problem with the small companies are they get acquired by much bigger companies and then they disappear and not much happens out of that. And then from a personal motivation, I just feel that I've been a victim to taking a couple of these small companies and selling them too early. I just feel like life is too short. We have to build something of substantial value, now is the time. All the big guys are asleep at the wheel, they are not really innovating from within. So that gives us incredible opportunity to build something of substantial scale."

Valuation and Supervoting

Been thinking further about Brian Rogers' comment on the post about supervoting shares:

"Why aren't these companies taking a valuation hit? Can a share of a company with permanently entrenched management really be worth as much as a share in the same company where management can be removed if their performance takes a nose-dive? Maybe this says something about the lack of shareholder power generally."

In the case of Zillow, the supervoting shares are (according to its filed S-1) to be held by Rich Barton and Lloyd Frink. In the case of LinkedIn, the supervoting shares are (according to its filed S-1) to be held by Reid Hoffman, as well as by VC funds managed by Sequoia, Benchmark and Bessemer.

When the effect of the supervoting shares is to extend the influence and control of the visionary founders who lead the company, maybe the fact of them preserves, or actually enhances, the perceived future value of the company. Because it's plausible, or probable, or conventional wisdom, that the very greatest of CEOs are founders who grow into the role. (You can turn the owner of the product into a CEO but you can't turn a professional CEO into a product person, etc.)

Zillow might be following this rationale - or a permutation of it.

Zillow's CEO is Spencer Rascoff, and, if the filed S-1 is to be relied upon, Rascoff doesn't have supervoting shares. So the theory needs a permutation: the market must want a better-known power behind the throne. Or, to use a sports management metaphor, the market must want a general manager in the front office that can be trusted to put in the right head coach. Barton has a good record as a "GM" (I don't know as much about Frink).

The visionary leader rationale doesn't work at all to explain what LinkedIn is proposing.

Sure, Reid Hoffman is a co-founder and a former CEO, but he is not the current CEO and was made chair of the board only four months ago. Even if he is LinkedIn's answer to Barton in the role of "GM," that doesn't really wash as Hoffman's supervotes are to be overwhelmed by the supervotes of the VC managed funds, post-IPO.

Image: Michael Maggs. Licensed under the Creative Commons Attribution-Share Alike 2.5 Generic license.