Putting Founders First

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The Founders Fund shares were created just months ago, so the firm does not yet have a track record. But the program is a radical departure from the way venture investments typically are structured, says Josh Lerner, a professor of investment banking at Harvard Business School who focuses on venture capital. In the rare instances in which a CEO does cash out early, it's usually because the relationship with investors has gone awry and the investors have chosen to buy the CEO out ahead of schedule. The issue for investors, Lerner says, is whether diluting an entrepreneur's financial risk also dilutes his drive to succeed: "It's a really interesting question, and it's not one with an easy answer."

But the principals at the Founders Fund believe the arrangement will give them an edge in securing the best deals. And that's no small thing. The investment world has grown increasingly competitive, with private equity players, venture capitalists, and individual angel investors often chasing after the same companies. At the same time, particularly with the Web 2.0 companies in which Founders Fund specializes, there's been a boomlet of new companies with relatively low capital needs without a correspondingly booming market for initial public offerings. As a result, says Howery, PayPal's former chief financial officer, "the top entrepreneurs can take money from whomever they want and they don't want second-class treatment."

Howery and his partners also believe that their fund is different because it is run by former entrepreneurs--people who truly understand the difficulties of running a start-up. Indeed, PayPal's is a classic entrepreneurial success story. Thiel and Max Levchin (now CEO of Slide, a start-up backed by Founders Fund) came up with the idea in 1998 and assembled a team of recent college grads. They gained customers by paying $10 bonuses for new accounts and quickly burned through a lot of cash. By early 2000, PayPal was losing $10 million a month and on the verge of going out of business. Still, it raised $100 million in venture capital--just days before the Nasdaq stock market began its plunge. The following year, PayPal filed for an initial public offering, and when it did go public in February 2002, its shares soared 55 percent. Several months later, eBay agreed to buy the company for $1.5 billion, and Thiel and his co-founders became gazillionaires before the age of 35.

That experience resonates, says Darren Rush, chief executive of Koders, a Santa Monica-based search engine for software developers. Rush received an investment from a group led by Founders Fund last April (before the development of the FF shares). "There is cultural compatibility," he says. Suneet Wadhwa, co-founder and CEO of Engage, an Internet dating site, feels similarly. At 39, he already has had one success as co-founder of Snapfish, which was snapped up by Hewlett-Packard (NYSE:HPQ) in 2005. So when he began trying to raise $1.1 million in seed-round financing for Engage in June 2005, he had a lot of options. Why Founders Fund? Simple, says Wadhwa. "They've been there before."

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