NYT: The Wisest Entrepreneurs Know How to Preserve Equity

There’s an excellent piece on the NYT today called The Wisest Entrepreneurs Know How to Preserve Equity by Steven M. Davidoff. You have heard me talk about this many times, including in this video, where I reinforced: Ownership Matters.

Here are a few case studies from Davidoff’s article.

Groupon

Success can spell the difference in billions. Andrew Mason, the chief executive and founder of Groupon, is worth $2 billion less than Eric Lefkofsky, the man who financed Groupon’s start.

The multibillion-dollar difference is a result of a start-up’s need for capital at the embryonic stage. If an entrepreneur obtains venture capital financing early in the business’s life, it is typically at a huge cost. In exchange for this financing, the start-up’s founders will have to sell part of their company.

But the business is merely an idea at this stage and usually not a proven success. The venture capitalist has all the cards and can buy a substantial portion of the business at a low price. When the time comes for the company’s initial public offering, a large part of the money will go not to the entrepreneur but to the venture capitalist.

Decisions that entrepreneurs make early in terms of financing can affect how much money they will reap later. We need only to compare the I.P.O.’s of Groupon, Zynga and Angie’s List.

In Groupon’s case, Mr. Mason received about $1 million in start-up financing from Mr. Lefkofsky. In other words, before Mr. Mason even opened Groupon’s doors for business, he had sold a large part of it.

Groupon’s initial business plan was to finance charities through social media, but the daily deal soon caught fire. The company then experienced extraordinary growth.

At this point Groupon again sought financing, but it was in the driver’s seat. In December 2010, Groupon set a valuation of $3.87 billion for itself in a financing round, according to Capital IQ, thereby preserving the equity of Mr. Mason and Mr. Lefkofsky. Still, Mr. Mason’s need for early financing meant that he owned 7.5 percent of Groupon, worth about $1.2 billion, but Mr. Lefkofsky owned more than 21.5 percent, worth $3.2 billion.

That millions if not billions are at stake in these decision is illustrated by Angie’s List, which is set to go public this week. Angie’s List was co-founded in 1995 by Angie Hicks, the chief marketing officer, and William S. Oesterle, the chief executive. The financing, which carried it over 15 years, appears to have reduced the founders’ stakes. Ms. Hicks owns only 1.8 percent of her namesake company; Mr. Oesterle, 7.5 percent. Almost 63 percent of the company is now held by three venture capital companies and T. Rowe Price.

This segment is a part in the series : NYT