Whatever, Do the Secondary Sale

Metadata §

• Author: Benn Stancil
• Full Title: Whatever, Do the Secondary Sale
• URL: https://benn.substack.com/p/whatever-do-the-secondary-sale

Highlights §

• Adam, and the story of WeWork, have been exhaustively chronicled, analyzed, and fictionalized – sometimes accurately. For all the energy put into covering the story, it’s often under appreciated that only one person has fundamentally redesigned the office experience and led a paradigm-changing global company in the process: Adam Neumann. We understand how difficult it is to build something like this and we love seeing repeat-founders build on past successes by growing from lessons learned. For Adam, the successes and lessons are plenty and we are excited to go on this journey with him and his colleagues building the future of living. (View Highlight)
• Investors don’t invest in nice people; they invest in monetizable people. (View Highlight)
• As a brief explainer, most secondary sales typically go something like this: Say one person starts a company, creates 80 shares in total, and grants them all to themselves.6 When they want to raise money, they might decide to sell 20 percent of the company for $20milliondollars,whichwouldvaluethestartupat$100 million. For a variety of reasons, rather than selling 20 percent of the existing shares, the company will create 20 shares out of thin air, and sell them to the investor for one million dollars each. Now, there are 100 shares, with the investor owning 20 percent and the founder owning 80 percent, with each share valued at one million dollars.  Next, suppose that the company gets hot. Lots of people want to invest, and the market—i.e., the price that most investors are willing to pay—values the company’s shares at roughly six times their previous valuation, or $6millionashare.Twodesirableinvestorsmightwanttoeachbuy15to20percentofthecompanyatthatprice,andthecompanywouldliketotakemoneyfrombothofthem.Thecompanycouldcreate50moreshares—foratotalof150—andsell25toeachinvestorat$6 million a share, raising $150 million from each one. The founder would still have 80 shares, or 53 percent; the first investor would have 20 shares, or 13 percent; both of the second investors would have 25 shares, or 17 percent each.  But there’s a problem with this: It dilutes the founder and the first investor by a third. Prior to the fundraise, the first investor owned 20 percent of the company; now, they only own 13 percent. Given how hot the company is, they probably want to raise less money and keep a larger share. And the prospective investors are unlikely to buy smaller amounts—say, eight percent each instead of 17 percent—because VCs typically don’t want to invest in companies if they can’t acquire a meaningful stake. (View Highlight)
• But a second solution is for existing shareholders to sell some of their shares directly to the second investor. In this case, the company still creates 25 shares, and sells them to the first investor for $150million.Andthenothershareholders—mostlikelythefounder—sell25oftheirsharestothesecondinvestorforanother$150 million. (View Highlight)
• In both cases, the company ends up in the exact same spot: It’s valued at $750milliondollars;thereare125outstandingsharesworth$6 million each; it has $150millioninthebank;thefirstinvestorowns20outof125totaloutstandingshares,or16percentofthecompany.Theonlymaterialdifferencebetweenthetwoscenariosisthat,inthesecondcase,thefounderhas$150 million. (View Highlight)
• And if you were suddenly $150millionricher,you’rechangingthetermsofthedeal?Whenyoutooktheirmoney,youwererelativelypoor.Thatpovertymadeyoudesperate;thatdesperationmadeyouhungry;thathungermadeyouausefulvehicleforhighly-speculativecapitaldeployment.Ifyoucashinyourlotteryticket,thefirstpartofthatwon’tbetrue—youwillberichandnotpoor—andthesecondpart\ast might\ast notbetrue—youcouldbecomeasatiatedfatcatwithahouseinCaboSanLucas,[wastingawayinMargaritaville](https://www.youtube.com/watch?v=mrF4nF8VUb4).Andbecauseyouraisedmoneyontheimplicitpromisethatyourstartupwasthethingthatcouldtakeyoufrombeingpoortobeingextraordinarilywealthy,andbecause,ifyouhavea$150 million dollars, your startup can only take them from being extraordinarily wealthy to dynastically wealthy, you have a moral duty to turn it down. (View Highlight)
• It is not enough for a founder to merely want their startup to succeed; they have to need it to succeed. (View Highlight)
• Moreover, we seem to selectively choose how to view rich founders. On one hand, if founders make a bunch of money through secondary sales, they risk becoming lazy and unfocused. But if founders have a bunch of money, we will eagerly write them checks. Former Salesforce CEO Bret Taylor, who probably isn’t poor, raised $110milliondollars](https://fortune.com/2024/02/13/bret-taylor-clay-bavor-ai-startup-sierra-110-million-funding-sequoia-benchmark/)inoneroundforhisnewstartup.ElonMusk—theliteralrichestmanintheworld—willhavenoproblemraisingmoneyforhis[$6 billion dollar AI startup. And while there’s lots to question about Sam Altman’s effort to raise $7 trillion dollars for his AI factories, nobody is saying they won’t invest because they’re afraid he’ll get distracted by the casual half-billion dollars he’s going to make from the Reddit IPO. Again, this isn’t to say that money isn’t a powerful incentive; it’s to say that “money is demotivating” is, at best, inconsistently and opportunistically applied. (View Highlight)
• Another argument people could make against secondary sales is that, as a founder, you owe it to your investors to not take the money. As Lemkin says, “they took a huge bet on you. That used to be a big deal.” They have your back and you should have theirs. “Founders that put themselves last like this, I put first. I’ll have their backs forever. No matter what the outcome or returns.” (View Highlight)
• But is that argument not self-impeaching? How can a VC simultaneously discourage a founder from cashing in a $150 million dollar lottery ticket—because it might, hypothetically, distract them from maximizing the value of the VC’s investment—say, in the same breath, that they will always have the founder’s back, no matter their own returns? (View Highlight)
• The good news is that this suggests a possible resolution to all of this: Secondary sales are fine, so long as everyone in the company is told about them. Give employees an implicit veto over selfish and undeserved sales, by subjecting them to the court of public opinion. (View Highlight)
• The most useful heuristic I ever found for making backroom decisions was this: Assume everyone will find out. Assume the decision is public, in Slack, on Twitter, and written up in The Verge. Assume that, partly because it may well be public one day,11 and mostly because it will compel you to do the right thing. “You can lie to yourself and your minions; you can claim that you haven’t a qualm; but you never can run from nor hide what you’ve done from the eyes” of your employees.12 (View Highlight)
• So if you’re a VC, let people sell. But let employees, who aren’t just betting one piece of their portfolio on their executives but their entire careers, decide if a sale will cause them to check out. Let employees, who are logging the hours, decide if it’s fair that leaders got to sell and they didn’t.13 And let employees, who have a better appreciation of a founder’s work—or lack thereof—than anyone, decide how much they’ve earned. (View Highlight)