Since the first day, Pillar VC has offered to buy common shares in new companies.
Instead of the standard 10-page venture capital terms sheet riddled with terms and conditions, our team believed that a much simpler structure in which we had the same security as the founders would align interests, increase trust, and hopefully , would improve the return on our investments. .
There are many terms and conditions in a preferred terms sheet that can misalign investors and founders.
Five years from the launch of Pillar, when we finished investing our second fund and start implementing our thirdWe thought it was a good time to reflect on whether buying common shares instead of preferred shares has delivered the benefits we expected.
Preferred shares can misalign incentives between parties
There are many terms and conditions in a preferred terms sheet that can misalign investors and founders; For brevity, I will highlight two below. (For more information, see the term sheet qualifier).
Preference: Preferred stocks have a “preference” that gives the investor the right to choose whether to get their money back or take their percentage of the total earnings. In downside scenarios, getting an investor back may mean that they are taking a much higher percentage of the profits than the founders “thought” they sold.
For example, if an investor buys 25% of a company for $ 2 million in preferred stock, their breaking point in this decision will be $ 8 million, which turns out to be the post-round money valuation. If the company sells for less than $ 8 million, the investor would prefer to recoup his $ 2 million. If the company sells for more than that, the investor would choose to keep 25% of the total.
The founder believes that they sold 25% of their company, but that percentage is actually determined by the sales price of the company. Yes, if the company sells for $ 8 million or more, they sold 25%, but if the company sells for, say, $ 4 million, investors will choose to get their $ 2 million back, which is 50% of the Profits. Worse still, if the company sells for just $ 2 million, investors will get it all.
Anti-dilution: This clause means that if an investor buys shares for $ 10 and the startup raises money in the future at a price below $ 10, the investor’s share price will be recalculated retroactively at a lower price. How do you do this? Issuing investors more shares, which dilutes the rest of the ownership pie, especially founders and employees. The company is not doing well and investors are recovering at the expense of the founders. Aligned? Hardly.