Putting Founders First
How one VC Firm coddles its CEOs.
Published March 2007
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COMMENT ON THIS ARTICLEEntrepreneurs have long complained that investors don't understand them. Venture capitalists, they gripe, are impatient control freaks, more focused on their eventual cash-out than the steps necessary to get there. VCs, of course, have issues of their own, grousing that business owners lack the experience and fiscal discipline needed to build successful companies.
Like a peace negotiator stepping into the breach, Founders Fund, a venture capital firm in San Francisco, aims to build a bridge between these often hostile parties. Launched two years ago by three founders of PayPal--Peter Thiel, Ken Howery, and Luke Nosek--the $50 million fund holds stakes in 15 companies, many of them founded by PayPal alumni, including Facebook, the well-known social networking site; Geni, a social networking site for people researching their genealogies; and Ironport, a spam-filtering company that agreed to be acquired by Cisco (NASDAQ:CSCO) in January for $830 million. But while Founders Fund aims to make money, it also harbors larger ambitions: to transform the relationship between entrepreneurs and investors. "We hope we will be an example for the rest of the valley," says Nosek, 31, one of the firm's managing partners.
That's easy enough to say. But the Founders Fund is backing up its words with some action, altering some of the fundamental rules of venture investing. The firm's biggest innovation is the way it awards shares to the founders of companies in which it invests. In the typical venture capital deal, investors put money in and founders can't take any money out until the VC's investment is recouped with an IPO or a sale. Why? Venture capitalists believe that a hungry CEO is a more effective CEO. Let a founder take some cash out early, they argue, and you risk diminishing his commitment and drive.
This has long been a sore point among business owners, who often have their entire net worth tied up in their companies--not to mention loads of credit card debt they'd be delighted to settle--but not a lot of cash on hand. To address that concern, the Founders Fund has created a new type of preferred stock, called Series FF. It gives entrepreneurs far more flexibility by allowing owners to convert their FF shares into subsequent offerings of preferred stock. Say a company in which Founders Fund has invested is successful and ready for a second round of financing. When that happens, the FF stockholder can convert his shares and sell them to the investors. There are some restrictions--the conversion can be done only when the new shares are issued and there are caps on the amount that can be converted. Still, the arrangement lets owners sell a portion of their stakes without being forced to wait for an initial public offering or sale of the company.
Barney Pell, founder and chief executive of San Francisco-based Powerset, an Internet search firm that raised $12 million last year (the bulk of it from the Founders Fund and another venture firm), thinks that's a big deal. In fact, his company was the first test case for the FF shares. Pell maxed out his credit cards when founding Powerset; he says the knowledge that he can get some cash in a subsequent round of financing goes a long way toward reducing the anxiety that's part of founding a company. "They really think like founders and they really want to help the company," he says of his investors.
