[prostoalex]

Almost any significant round outside of seed would come with liquidation preference. CrunchBase says a total of $20.9 was raised, so if the final sale price was less then $20,900,001.00, there's likely no money left for common stock.

[tomglindmeier]

Interesting. I didn't know that. I understand that if expectations are not met there have to be consequences. But leaving the founders of a company with nothing while others earning money feels completely wrong.

[prostoalex]

I forgot about the debt holders. So if there was any debt (including un-converted convertible notes), the pecking order is:

1) Debt holders

2) Most senior shareholders and their liquidation preference

3) Less senior shareholders and their liquidation preference

...

99) Common stock holders

This is actually to align the founder incentives in shooting for a big exit. Insert any other order of preferences, and the founders have a stronger incentive to flip the company as quickly as possible in order to create a payday for themselves, screwing investors in the process (which also happens to be a very irrational proposal for investors, which is why you rarely see a round on those terms).

[adventured]

Investors don't inherently get screwed in the process of a quick flip if they have common shares. It means the investor is directly aligned with the founders, and makes it harder for the investor to get a return at the expense of the founders.

Investor puts in $1m for 20%.

Founders quick flip for $30m. The investor just made six times his money, and earned a payout fully aligned with the founders. Absolutely nobody got screwed.

The reason investors like liquidation preferences, is so they can improve their odds of getting their money back at least (and yielding the first dollars of return). They aren't aligning their interests with the founders in this case, they're putting their interests in front of the founders, just as debt does. Liquidation preferences are a way of saying: my equity is more important than your equity; you need my money, so I'm going to make sure my money is treated with more importance than your equity.

Liquidation preferences exist solely to protect investors from their own poor choices at the expense of the founders / earlier shareholders.

[leereeves]

Liquidation preferences exist to protect against a company raising $10 million for 20% and selling for $5 million, with the founders taking a nice payoff of $4 million and the investor losing all but $1 million.

In that scenario, without liquidation preferences, the interests of the founders and investors aren't aligned--the founders profit while the investors lose money.

[alain94040]

Try again with an exit at $2M and you'll see why the investors wouldn't be happy with common stock.

[daemin]

So does this mean employees could be owed something in terms of debt (i.e. if they haven't had their benefits paid out fully) or are they what I assume:

100) Employees

[troels]

Depends on the jurisdiction of course, but generally salaries would be first in line.

[KayEss]

Number one preference is the tax man isn't it? At least in the UK, he always gets paid first.

[RobAley]

That's not been true for a long time. The only "preferential creditor" in the UK now are employees, HMRC take their chances with all other debtors.

[KayEss]

My knowledge of this comes from the dot com crash 15 years ago. I'm pleased that the employees now come ahead of the tax man.

[prostoalex]

In the US you'd have to make a profit to have the tax liability, and if that's the case, the company is unlikely to be going through a fire sale. There's a host of payroll taxes associated with employees, but those get paid as employees get their paychecks, so qualifies under "debt".

[vidarh]

See item 1) debt holders. Within the class of debt holders, the tax man and/or employees with salary claims often have special preference amongst creditors in many countries.

[brc]

Put yourself in the shoes of an investor. Someone asks you for money after their company hasn't been doing that great. You think here is potential, but you think there's a chance you'll lose some/all your money. So you provide the cash with the stipulation that any sale means your cash comes back first.

The alternative is for the company to tank and the founders - who tanked the company - walk away with your money. That is completely wrong.

Founders don't accept deals for money which are bad for them if they don't need it. You need money, you get the terms.

Same goes if you lose a house by default and then go and ask for money for another house. The subsequent mortgage is going to be at terms significantly less desirable than you may have got on your first try.

Failing companies create no winners.

[jasonlotito]

But they did get something. What they got was more money to keep trying. They didn't have to take the deal, but most likely would have been still left with nothing.

They got something before. They are paying for that now.

[EpicEng]

>But leaving the founders of a company with nothing while others earning money feels completely wrong.

Why? They founded a company which tanked. They made poor decisions along the way which led to said taking. They did it on someone else's dime. No one made money here, so why shouldn't the investors get some of the investment back?

[Kliment]

Isn't the whole point of venture capital that you take on a large risk in return for a large potential payout. VC is called "risk capital" in a number of languages for a reason.

[vidarh]

But at some point the risk gets so large that the choice is for you to not get any investment at all, or get one with additional clauses to reduce the risk to levels acceptable to your potential investors.

It's a tradeoff. And sometimes it can work to your benefit. E.g. if you and your potential investor disagrees about the level of risk and/or about the potential size of an exit, you can try to negotiate a multiple liquidation preference in return for less shares.

[leereeves]

Depending on the terms and the sale price, the investors may have lost money too.

Without liquidation preferences, the founders could earn a profit even if the investors lost money.

(Plus the founders and employees earn salaries, often paid from the invested funds.)

[prostoalex]

Yep, you're right, the lesson out of this is "stick to the common stock for as long as possible". I'm aware of at least one company (5 years running, raised a B round with numbers in mid-eight digits), that still had only common stock floating around.

Unfortunately, the only way to afford that luxury is to not actually need the money, but be in high demand for investors to keep pinging you, and relent at some point with "alright, we don't need money, but if y'all agree to X valuation with common stock, we'll take your money".

[pbreit]

It's unlikely anyone earned any money. Some investors might have gotten some of their investment back.

[blumkvist]

What happened to this douche sounds completely right to me.