Here's the right way to behave, in two simple steps:
Step 1
Company management (in this case, the founders) have a fiduciary obligation to get as much money for the company as possible. In the sale negotiation, they should discuss the price of the company first. If the buyer tries to talk about their compensation, they simply decline to engage in the conversation, saying that their obligation is first and foremost to the shareholders, so the company price is the first order of business. They should negotiate as hard as they can to maximize the value returned to the shareholders.
Step 2
Once the company price is set, the management/founders should negotiate the best deal possible for the team - both themselves AND the other employees (don't forget the latter). The company's already locked and loaded. There is no reason for the team to hold the screws to the acquirer at this point for maximum value.
There are two classic mistakes that get made. The founder mistake is easy to make, because the company will encourage it: "How about if we lower the price of the company by $X, and add $X to your retention package?" This is wrong and possibly illegal (but it's hard to get caught). Taking this sells out your shareholders and violates your duties as an officer of the company.
The second classic mistake is an investor one: thinking the employee compensation belongs to the company. Employee comp is for future services rendered, not past. There's no reason the shareholders should get a percentage of the founder-cum-employee's stock grant unless they plan to do part of their work for them.
tl;dr: get the best price for your company, then get the best price for yourself and your team.
>""How about if we lower the price of the company by $X, and add $X to your retention package?" This is wrong and possibly illegal"
It would be good to clarify if this in fact illegal. If it is not illegal, than saying that it is wrong is subjective. In the case of talent acquisitions, the acquiring company has an incentive to focus more compensation to the 'founder-cum-employee' for retention and incentive purposes. I feel that it would be very reasonable for an acquiring company to use this as a negotiation tool (unless it is illegal, of course) as they are merely looking out for their own, longer-term interests.
> It would be good to clarify if this in fact illegal.
Well, as Dan mentioned - and I believe (IANAL, etc.) that this is enshrined is US law - the directors of a company have a fiduciary duty to the shareholders.
The excuse here seems to be that the company was going nowhere but my gut feeling is that opening negotiations with a potential acq/hirer is only acceptable if you've had discussions with your investors and, ideally reached some kind of agreement/consensus to recognise that the company isn't going anywhere and the founders should explore whatever options are available.
(Afterthought: Given that negotiations with a view to being acq/hired involve a clear conflict of interest for the founders, they should involve at least one non-exec director or investor to ensure that the shareholders' interests are protected.)
Otherwise, founders run the risk of being perceived as having spent millions of other people's dollars to build up their own reputation in order to get hired on a sweet compensation deal by Google or Facebook.
Definitely illegal in both Australia and the UK, and as far as my legal knowledge extends to the US (directors' fiduciary duties are pretty similar across these countries), illegal there as well.
In the situation described, founders are essentially sacrificing the valuation of the company (an 'asset' of the company and its shareholders) for their own personal gain - a clear violation of their duty to the company.
pyoung - whether the acquiring company is doing anything illegal is probably more open to question (though whether it's unethical is pretty clear in my opinion). It probably comes down to whether their behaviour gets to the point where it could be held liable for inducement to breach a contract, or inducement to breach fiduciary duty.
However, the focus of Dan's comment focuses the question (rightly, I believe) on the obligations and behaviour of the founders, which is where most of the responsibility lies.
On the most recent TechStars/Bloomberg startup reality show, a couple of investors tongue in cheek talked about investing in the career earnings of one of the entrepreneurs whom they thought had a lot of promise. Although the investors probably weren't too serious about this point, I don't think its a bad idea. If Gowalla investors had struck such a deal with the founders of Gowalla then of course they'd be entitled to some of the stock grants that Facebook offered. But they didn't. They invested in the company which failed, so they get nada.
And I give absolutely no credence to the argument that the investors funds boosted the profile of Gowalla founders so they wouldn't have gotten great deals from Facebook if it weren't for their investment. If that's the case, then limited partners should be entitled to a share of the profits from a VC's second fund if the first one goes bust. Because, you know, it was the limited partners' money that gave you a name in the VC community in the first place. Of course, no one takes such an argument seriously in the finance community, and neither should you entrepreneurs.
See also: taxes. The government subsidizes school (in some form) from kindergarten to your PhD, and in return, you pay them back in the form of taxes as soon as you use that knowledge to make money.
Very odd example, no? While pooled revenue from taxes does pay for collective benefits, any single individual's taxes are only tenuously related to the benefits they receive.
If it worked like you described, I'd expect a break from the IRS since my education mostly took place elsewhere, and I'd still be writing checks to the Canadian government for the education and healthcare I got as a child. (That wouldn't necessarily be a bad thing, but it's not how it works.)
Just like amount invested in a company is tenuously related to the returns you'll make.
From the government's perspective, they make a blanket investment in everybody in the form of providing education and services. Some people end up paying huge amounts back in taxes, others pay nothing back.
Maybe it is me but my 'moral antenna' says it wrong to leave users suddenly stranded.
Yes it was a 'free service', but the free users made it possible to get millions in investments. Users investest time and effort into making your service valuable.
Here is how I would do things differently.
Depending on the cost, I will have a shut down period of 3-6 months. Longer if possible.
I will make it easy for users to export AND import their data into a similar service. In this case 4sq. That is the very least they should do. The data from a users Gowalla account is ppractically useless if it is not put in context of a similar app/service. Telling millions of users "take your shit out by next month, thanks for your time" is not cool at all.
FriendFeed did it much better. Etacts is the worst I have come accross.
It is not cool for Gowalla, it will also not be cool for gmail.
If you're a user in the modern internet, it is not cool for you to keep yourself so much at the mercy of companies whom you don't pay.
I always keep a Thunderbird client running in the background of my laptop, which sucks out all emails from gmail and keeps a local copy. Yes, it would not be cool for gmail to one day suddenly cut me off, and yes, I feel Google, with its "Do no Evil" policy will not do that to me. But still, I prefer to make my copy of important data right now, thank you very much, instead of whining later that this is not cool.
Same with my Flickr pics and Delicious links (downloaded using a script). And my Facebook data I really don't care about.
>> And my Facebook data I really don't care about.
If you are based in the EU, them the european data-protection laws give you the right to get a copy of all the data Facebook has on you, not just the data you uploaded but everything.
They have up to 40 days to deliver a CD-ROM with all your data.
The operators of free services do not owe their users anything --- apart from safeguarding any data they took from users --- when their companies fail. This "somebody think about the users" meme needs to die. A company offering free service has an overriding first obligation to its own employees.
This "users using free services are of no value" meme needs to die.
Twitter is nothing without their users so are many of these web services. Getting traction depends on people using your service. If it becomes the norm that companies built will not exist in 2 years, why then should I invest my time in the service especially the free ones.
I have run a startup that was not financially viable so I know it is not the fault of founders if things do not go according to plan. However, my co founder and I have left the site up since it does not cost much to do. However, if it did, we will be sure to make the transition as easy as possible.
I am not saying users should be paid or compensated but should be thought of.
The management team of a failing company owes its first and most important responsibility to its employees, to make sure they're as well taken care of as possible.
Following that, it owes its investors the maximal return on their investment.
The users got their service for free. That was the deal: they use the site for free, in return for using the site. Any other obligation is a fiction. I might just as productively argue that it's the user's fault Gowalla failed --- punish the users for going to Foursquare! Except that's stupid, because Gowalla and its free users don't have any obligation to each other.
Future "free" services depend on users willing to rely on free services. One of those may be born every minute, but it's still bad for the typical startup if too many people get burned too badly and begin demanding control over their data. Some "group pressure" to take care of the users makes sense.
(This seems to be the most cynical HN comment I've ever written.)
That's why I think we have the odd reversed PR situation, where instead of companies trying to deny responsibility to their users, and critics arguing that they should be held responsible, we have the opposite. Companies running free services themselves do try to build a perception that they feel a sense of moral responsibility towards their users, cultivating a sort of "we're good stewards of our lovely users and their data, and wouldn't sell you out" perception. And their critics (like, say, Jason Scott or Richard Stallman) are the ones who emphasize the idea that free cloud services don't owe you anything (and therefore you shouldn't trust them to have your interests in mind).
Keep in mind that with most of these free services the users are the pawns. If you're not paying, or getting paid, then you are the thing being traded.
Companies exist to make their investors and owners money. Gowalla did not exist so you could check-in to places. It made a check-in service because they thought that was their most exploitable money-making opportunity.
Don't fight this. You won't win and will only frustrate yourself.
There's no actual confirmation that Facebook is acquiring Gowalla as a company. In fact, Facebook's statement (as quoted on various news sites) seems to suggest the opposite:
”While Facebook isn’t acquiring the Gowalla service or technology, we’re sure that the inspiration behind Gowalla will make its way into Facebook over time."
It wouldn't surprise me if it turns out that what's actually happening is that the core Gowalla team is quitting Gowalla to work for Facebook, and Gowalla will be shut down, with the remaining funds being returned to the investors (i.e. the "twenty or thirty cents ... for every dollar invested" that Arrington refers to).
Gowalla lost. This is what happens to investments when companies lose. The "side deals" the team makes after their company fails are irrelevant. Nobody is better off going down with the ship; not the founders, not the employees, and not the investors.
I tend to agree. If the founders shutdown the company and started a new one, there wouldn't be much fuss. So if they shutdown the company and get a nice signing bonus to join Facebook, that seems the same to me.
If I were an investor in Gowalla, I certainly wouldn't be thrilled with it, but I would at least try to own the fact that my investment failed. An investor should be most pissed at Facebook. This is the equivalent of recruiting away Gowalla's employees one at a time with big piles of cash. As the last employee is recruited away, Gowalla effectively becomes an empty shell. How much can investors get for the shell?
Gowalla lost. This is what happens to investments when companies lose.
Not necessarily. Sometimes they pivot from a failed product to a successful one, in which case the investors are rewarded for sticking with the team (which often requires follow-on investment in such cases). VCs often say that they invest primarily in teams, not ideas. It's not clear that the team really lost here, but the investors obviously did.
First, when you "pivot" after losing a fight for a market and take an A round of funding, you failed. Not all failures are fatal, but the word "pivot" isn't a magic startup 1-up mushroom.
Second, whatever you want to call it, nobody is better off not selling if Gowalla 2012 was destined to fail anyways. It is among other things (very) hard to retain talent at a company facing (at best) a heavily dilutive future round just to keep the lights on for a (very) uncertain new product.
Ultimately though, I'm just repelled by the idea that people think operators owe it to financiers to go down with the ship. I think the real issue cuts in rather the other direction: founder-operators who kowtow to VC partners to preserve their reputations and future fundability, come what may to the employees they recruited to their doomed company.
First, when you "pivot" after losing a fight for a market and take an A round of funding, you failed.
The product failed. You (and your investors) might take the lessons of that failure forward and enjoy wild success with a different product. The question is whether the team has a new idea to pivot to, and whether the investor has confidence that the team will do better the second time around. I don't know the facts of the Gowalla situation, but suppose the 'new idea' here was that while the Gowalla product didn't make sense on its own, it could be combined with Facebook to create a profitable feature for them. If so, the investors who helped create that value should not be cut out of the deal.
Second, whatever you want to call it, nobody is better off not selling if Gowalla 2012 was destined to fail anyways.
Just because Gowalla had no value as an independent company doesn't mean the company had no value. Obviously Facebook valued something about it, and like anything else, a company is worth what someone is willing to pay for it. Now maybe Facebook just really valued the founders' skills and work ethic, in which case I'd agree with you. But maybe they want the founders to reproduce Gowalla as a Facebook feature, in which case the total price they pay to acquire that expertise should in fairness be distributed to the shareholders and not just to the founders. In the software business there is a fuzzy line between a talent acquisition and a straight-up acquisition.
Who cares how well the second go-round is going to go? The company burned $N MM on the first product; it is $N MM in the hole on the next product. What rational top-tier engineer stays on to do a next product with extra dilution overhead, when there's hundreds of excellent next products to do without that dilution?
You're pretending like the company and the product are just abstractions. That's one of the perils of thinking about startups in the airless vacuum of Hacker News. In reality, you run out of money, you have to get more, and the more times you hit the money dispenser, the lower your upside.
Here you run off the end of the moralizing cliff, because whatever it is you think the founders should do, top engineers aren't idiots, and financiers have no moral claim on them --- the opposite is true, in fact, since most startup engineers are morally investors in the company as well having sacrificed market salaries in exchange for options.
Which places the founding team in a bit of a pickle, since not only do they have the prospect of a reduced upside, but they are also on a path towards losing the engineering talent they'll need to differentiate their product.
This is one of the problems with the VC model of product development. It shoots your company out of a cannon. It's awfully hard to course-correct. It's a good reason to bootstrap (I recommend consulting): consulting gigs actually are magic 1-up mushrooms for product startups.
Remember, we're talking about founders here, officers of the company with a fiduciary duty to shareholders. It's one thing to hire a top employee away---he's bound by whatever IP clause is in his employment contract, but beyond that he has no duty to the company. It's another thing entirely to acquire a company's IP assets indirectly by hiring the founders via a big equity package, leaving the shareholders pennies on the dollar. I don't know that that's the case here at all, I'm just saying that it raises the issue. Obviously it matters how much they got. If it was a $500K incentive, no problem. But $50M would be a problem. Somewhere in between those numbers a line gets crossed, and it becomes an ethical (and perhaps legal) issue.
When the primary asset of the company is its team, the investors lose both their moral and practical claim on the value of those "assets".
Morally, it is wrong (and without foundation in contract law) to prevent an employee of a company from finding more gainful employment somewhere else simply to maximize the value of your investment. While it's true that every retention policy of every company is designed precisely to keep employees from finding better offers, those are carrot policies, never sticks (the sticks tend to get shot down in court).
Practically, there's no effective way to compensate investors for the value of the team, because every dollar you don't give the team decreases the likelihood of retaining team members, which is the whole point of making a talent acquisition.
All of this is a long way of making a simple point.
Gowalla lost. Its investors knew it might lose when they made their investment. Trying to claw ROI back from the value of the individual employees on the market is simply not a reasonable investor goal.
Your assertion that employees are never under a moral or contractual obligation to their employers is simply wrong. An employee in a sensitive position, under a non-compete, cannot take trade secrets from his employer and give them to another company. This is both immoral and illegal, and contrary to your statement, sometimes the 'stick' is enforced.
Even if you were right about employees, as I noted above, the situation is very different for founders. It is morally (and in extreme cases legally) wrong to accept a payoff in order to circumvent the investors to whom you have a legal and ethical duty as corporate officers.
If I invest $10M in Startup X to develop and market Cool Service, and a year later the founders accept a $50M stock package from Company Y so that it can offer Cool Service, and I'm left with nothing, then "trying to claw ROI back" is absolutely a reasonable goal. (I'm not saying this was the situation with Gowalla, only that your position that it's never justified seems extreme.)
> If a founder leaves stockholders behind to take a lucrative side deal, they’re not acting ethically. I’ve mostly taken this position in the past, before becoming a VC.
As if VCs are acting "ethically". I have seen many VC cases (and been involved with a few) and be assured, VCs are not "ethical" or think founders AT ALL. All they think about is their money. If they could exchange founders future for a fat pile of cash, they will do it.
If the VCs are minority owners (as it seems in case like this), they can just accept what is decided. This is also the case with founders when VCs have majority. They will always do what they want (what's best for their money) without thinking founders best interest or "ethics" of their actions.
Considering that the founders will be taking positions at facebook, these 'side deals' appear to be closer to salary/compensation negotiations than anything else. Just because you invested in a company, it doesn't mean you own the founders. While the company may not have succeeded, these guys are probably very valuable assets and should be compensated by FB accordingly.
Arrington mentions 2 ways to look at it (both from the investor perspective), but there's a third - entrepreneurs raising a stiff middle finger to investors who have fucked them over (or tried to).
I'm not saying it was the case with Gowalla, nor am I saying all VC's are assholes. Just saying that it it's another motive for deals like this.
I don't get the reason for this article's existence. Nothing is new or unusual here.
In any acquisition, the CEO and senior staff simultaneously negotiate their compensation packages with the acquiring company.
This always leads to major conflicts of interest, which is why the board gets to approve the acquisition, and why in larger transactions there's often some outside help brought in to negotiate.
If the board doesn't like the proportion of the proceeds going to the employees, they can always block the acquisition. They have that power precisely for situations like this. Since Gowalla's board approved the Facebook acquisition, they're presumably fine with it.
As for the minor investors who've been kept in the dark - I'm sure they agreed to drag-along provisions in their investor rights agreements, which meant they didn't have to be consulted. You have the rights you agree to.
It makes sense from the investor's perspective. They weren't going to get a better, more lucrative exit. Gowalla would probably just whither and die eventually. Instead, now the investors get to talk about how they had a "successful" exit, which might help them get future deals (most startups would prefer to raise money from someone with several exits). It seems like it was the best deal for all involved.
How can one write for a living and spell like this? English is not my mother tongue and yet I now the difference between they're and their, it's vs. its.
Or is this the result of poor speech-recognition software?
It's an artifact of how native learners acquire language, compared to adult learners. Our native tongues are acquired rather ad hoc, and most people 'think' in speech. (As evidence, watch a slow reader. Often times they will sub-vocalize the text as they read. This is a side effect of their brain turning the text back into sound.)
So, to somebody who learned English as a child -- and is therefore aurally dominant -- the words "they're", "there", and "their" will all basically occupy an overlapping space in their mind. Somebody who learned English later will use textbooks to support the process; Things like contractions will be give special emphasis, etc.
You make an interesting point, and what makes it very interesting is that it's testable: are native speakers worse spellers than non-native speakers? And which words do each group have the most difficulty spelling?
It doesn't seem likely that non-native speakers are better general spellers than native speakers; but it's possible that some words are especially difficult for native speakers and not for non-native ones.
Are you aware of existing studies on that subject?
Aye, there have been numerous investigations into it. Among linguists, it seems to be basically taken as a given that homophones, particularly when compared to less skilled native readers, are going to be easier for the non-native, because of acquisition methods. I should've prefaced that with the disclaimer that I am not a linguist, but I have worked in the past with linguists on language-related work, both in L1 (native) and L2 (non-native) contexts. Here are a couple of references I was given on this specific subject:
1. Van Orden, Guy C. (1987). A ROWS is a ROSE: Spelling, sound and reading.
2. Binder, K. & Borecki, C. (2007). The use of phonological, orthographic, and contextual information during reading.
3. Ota, M., Hartsuiker, R. J., & Haywood, S. L. (2010). Is a FAN always FUN?
A couple thoughts here:
1) As the article states, Facebook has fiduciary duty to Facebook and nobody else.
2) Same with the VCs.
3) This isn't unique to high tech. Sometimes a CEO will accept a bad merger price to become the CEO of a larger firm. This is called the principal-agent problem and is why boards should be involved in all M and A.
4) Unless there are competing bids it is hard to prove a failure of fiduciary duty. In the end it's reputation. If the Angel and VC feel screwed then the execs won't get money again. If not it is ok. It is lie Prisoners Dilemna - you play nice in a repeated game.
I think a more interesting question is what sort of responsibility Gowalla founders had to its employees. I've noticed that a good number of employees aren't staying on with the Facebook transition (by my count, only a small minority are going on to Palo Alto). Maybe they had better offers elsewhere, but considering some people are opting for uncertainty / unemployment, my speculation is that they got the short end of the stick with this one.
Those complaining should look back to 2000 when a deadpooled startup left a gaping hole in the economy with lost jobs, bad investments with ordinary Americans, and a negative impact on every other startup in the space.
Given the alternative, I'll take founders selling out and moving on over what we went through 10 years ago.
Is Arrington essentially saying when he invests in a business he wants a cut of all future salaries and compensation of the founders should the company get liquidated?
Wake up buddy. A VC invests in the business, not the people. A shareholder is insulated from liability and for that privilege they are not entitled to anything outside the scope of the corporation.
Step 1
Company management (in this case, the founders) have a fiduciary obligation to get as much money for the company as possible. In the sale negotiation, they should discuss the price of the company first. If the buyer tries to talk about their compensation, they simply decline to engage in the conversation, saying that their obligation is first and foremost to the shareholders, so the company price is the first order of business. They should negotiate as hard as they can to maximize the value returned to the shareholders.
Step 2
Once the company price is set, the management/founders should negotiate the best deal possible for the team - both themselves AND the other employees (don't forget the latter). The company's already locked and loaded. There is no reason for the team to hold the screws to the acquirer at this point for maximum value.
There are two classic mistakes that get made. The founder mistake is easy to make, because the company will encourage it: "How about if we lower the price of the company by $X, and add $X to your retention package?" This is wrong and possibly illegal (but it's hard to get caught). Taking this sells out your shareholders and violates your duties as an officer of the company.
The second classic mistake is an investor one: thinking the employee compensation belongs to the company. Employee comp is for future services rendered, not past. There's no reason the shareholders should get a percentage of the founder-cum-employee's stock grant unless they plan to do part of their work for them.
tl;dr: get the best price for your company, then get the best price for yourself and your team.