Startups and Funding (A Cautionary Tale)

I am thinking about the Microsoft/Facebook deal and the absurd valuation it places on Facebook. Then I started thinking about my experience with start-ups. The previous start-ups I worked for I am not familiar with how the financing worked exactly, but my current employer I have been with since before the beginning so I am intimately familiar with all of the details.

What strikes me the most is how an unscrupulous investor totally screwed us over by formulating a deal which would allow him to pocket millions while screwing us. He had obviously been planning this since the beginning since the terms of the deal contained many bizarre terms that, to me, screamed out "I am going to screw you over!" But I guess the "founders" were too blinded by the site of a couple million dollars to really think about the future. This guy's plan was to "financially engineer" an artificial valuation for our company, and everyone thought he was the bee's knees until he screwed us over, except for me - I never really trusted him at all.

Once the plan put in place by this investor (who has a reputation for doing this with companies) and the company and stock structure was in place the "founders" went out and started finding other investors. They did the whole dog and pony roadshow thing, at a ridiculous valuation for our company of $600 million. But they raised a good amount of money - most of which went right back into their pockets. It seems that the "founders" were not quite as stupid as one might have thought, and had arranged for themselves to be owed money by the company, payable either in monthly installments or once $x million had been raised. Some of the founders went even further and did their own private placement, the proceeds of which were ostensibly to pay off debt from their old company, but which actually went directly into their pockets.

So the "founders" made millions of dollars, in addition to their high salaries and ridiculous severance packages, right off the bat. I should have gotten 5% of those millions but they kind of screwed me out of that. Nevermind though, because they ended up giving me .5% of the company instead of the 5% I had originally been promised, which under the initial ridiculously high valuation of the company was worth several million dollars.

The plan put in place by this devious investor involved bypassing an IPO and becoming public through a reverse merger which allowed us to bypass FCC regulations and become public way before we were ready. We became public well before our stock was even registered to be able to be traded, which kept the valuation artificially high. Once the registration statement went through the price immediately dropped as 99% of the shares became tradeable.

Since then the price has dropped to 0.0167% of it's original price, the price which had been used for the first round of financing. A bunch of people lost a lot of money, including me, because I foolishly held on to 95% of my stock hoping it would go back up after the initial dive. I wish to god now I had sold more of it, even 10% would have made for a nice cushion and savings that would come in really handy now, but no, I just sold the bare minimum I needed to pay off my credit cards and other loans. The only people who made money were the initial investors and the founders, who had to defer their fat salaries as the company started to run out of money and the creditors came knocking. The problem was that since we were public, and so thinly traded that anyone can move the stock price around with a few hundred shares to trade, and the stock price was so low, they couldn't raise money anymore. If we were private I am sure we would have a high valuation and VCs lined up out the door as we have a great idea and a great product. But being public, and having this first investor holding the share price down, we would have to sell 1/2 of the company to raise even a couple million dollars.

The next chapters in this book are yet to be written. The company recently got its main new backer to extend the terms of the deal which we used to borrow money from them. Other people have been interested in the company but the terms of the deal with this new backer make it ridiculously stupid for anyone to invest in us. As far as I know the "founders" salaries are still deferred, though they may have paid themselves once the new deal was put into place.

This makes me think that they way to get rich is to start a company and make sure you have deals in place that ensure you get paid no matter what happens with the company. It might scare off some investors (I nearly peed my pants when I read the first 8k and finally learned about all of these backroom deals) but as long as you can get someone to invest you can still make money without having to do anything. Of course the people who lose are the people who invest in your company, but they presumably have enough money that it's not going to hurt them too badly.

As soon as I come up with a salable idea this is exactly what I am going to do.