[ytx]

Very enlightening thanks! I wonder if there is or could be some notion of "vesting" over time of the investment such that (1) could not happen. So if the founder tried to sell tomorrow, the investor would get back 1x, but that 1x decays to 0.2x over 5 years or something.

But I guess VCs generally have the leverage and wouldn't want such terms.

[lpolovets]

I've thought about that kind of system before, and it's an interesting approach but it doesn't fully protect against bad actors. E.g. what if the founder raises $5m, puts it into a bank account, moves to Hawaii, and then sells it for $4.9m in 5 years?

[seandougfan]

There are some ways to make this work, I think (but I agree that time based vesting wouldn't work for the reasons you suggest). I've most commonly seen structures that contemplate something like this referred to as either a "bleed off" or a "kick out".

Bleed Off: set up a participating preferred with 1x liq pref and bleed off between investors A-Zx MOIC. In practice the preferred investors would participate by taking their 1x off the top, then sharing pro rata in proceeds. As the investors implied MOIC reaches the bleed off MOIC range, their participating preference would bleed off or be reduced ratably in the bleed off range until the participating portion approaches 0 (and eventually investor converts to common).

Kick Out: set up as a participating preferred with a 1x liq pref and a Ax kick out. In practice, investors would take their 1x then participate pro rata up until they Ax their capital. After Ax, the investor would collect no additional proceeds unless they convert to common.

I've seen both used, but the latter probably more appropriately works for instances in which there is a bid ask spread and founders want to solve for valuation (with the belief that they'll blow through the preference anyway and it won't matter) and investors want to shift the returns curves to higher probability (lower) equity values.