Gowalla Founders v. Gowalla Investors

Location based service Gowalla is going to shut down at the end of January. The two founders, Josh Williams and Scott Raymond, will be heading off to Facebook. Loyal Gowalla users will be stranded as the service shuts down. And some of the investors have told me that they’re pretty angry over the whole thing.

Is it an acquisition? Or rather a shutdown with the founders taking new jobs?

There’s no clear answer to that. Williams’ blog post is intentionally vague on that point. An email sent to investors, though, suggests that some kind of deal between the companies is happening.

Some investors seem to know the terms of the deal – they’ll be getting twenty or thirty cents back for every dollar invested (the company has raised a little more than $10 million). But most of the investors I spoke with had no idea what was going on, and what if anything they’d be receiving back for their dollars in.

This is a tricky topic for me to write about, since I’m now an investor. But in 2010 I dove into the topic, noting a trend of startups being acquired for not much money, but founders and key employees were being given rich stock deals on the side.

This goes way back to Parakey, acquired by Facebook in 2007. Parakey investors got their money back and a little more, but stock grants were given to the founders that are probably worth hundreds of millions of dollars today.

I was more blunt in 2010 when Facebook acquired Hot Potato – and noted that there’s a real issue of breach of fiduciary duty when a founder takes a side deal but doesn’t cut investors in.

Two Ways To Look At This

When a startup gets acquired in this way – where investors get very little compensation and founders get a whole lot of compensation – it can be seen in two ways.

The first way is this: Investors see themselves as being taken advantage of, providing capital for founders to essentially buff up their resume to get their dream job. When a company is acquired, they say, the value of stock grants should be considered acquisition value and divided up among all stockholders. 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.

But there’s another way to look at this, too. Some investors, particularly Ron Conway and David Lee at SV Angel, have told me for years that they aren’t bothered by these types of deals. The argument is that the company (whatever company was being acquired at the time) was clearly not going anywhere and would eventually shut down, so who cares if the founders cut themselves a nice deal going forward. The investment was already a write-off. Investors in this group tend to focus their attention on the winners in their portfolio, the companies that will eventually provide a 10x – 1000x return. There’s little chance the founders will bail out in those companies to take middle management positions at Facebook, they say.

In this case, Gowalla was a goner anyway, so there’s no real harm done with the pennies-on-the-dollar acquisition. Clearly the founders could have communicated a little more effectively to investors, rather than just thank them in the blog post for “playing a special role in seeing us to this day.” That feels like gloating and condescension, said one investor.

Also, Facebook and other companies doing these deals aren’t to blame. They want the employees and not the other assets, and they’re doing deals that make sense to them. It’s not their job to protect the shareholder rights of the companies they’re acquiring.

These deals will continue to happen, and investors will continue to be frustrated. But there’s very little they can really do to fight it without looking anti-entrepreneur. And I mostly agree that there isn’t anything to really fix, anyway, given that these startups were all on life support.

Focus on the winners, and don’t lose sleep over the losers. Seems like a good investment philosophy to me. And yes, I’d probably want to invest in Josh Williams and Scott Raymond the next time they start a company. They fought long and hard for a win. Next time they may get there.

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80 thoughts on “Gowalla Founders v. Gowalla Investors

  1. I agree with Ron and David. If the company is a goner, and the founders take a side deal, what difference should it make to the investors? They’re going to lose out one way or another so why not let the founders move on?

    The only time I feel it would become an unethical issue is if the company is actually doing well and some side deal is made to cut out investors – now this would be screwed up.

    In any case, it doesn’t appear Gowalla was doing well so good for Josh and Scott.

    • I think it all matters what stage of the company the investors went on board and the type of investors they are. i.e. Angel vs. VC. The VC maybe investing later and more money for a larger return, so of course they’re going to care if you bail out half way through the journey!

      I think everyone should be considered in the decision making process. Speaks a lot to the founder’s character..

  2. Sumit Datta says:

    Just a small typo I noticed:
    Parakey investors got they’re money back and a little more… should be:
    Parakey investors got their money back and a little more

  3. What if the company is fine, but the founder bails because his deal outside is sweeter than what he would have made if he stayed with the company? This can happen if the investors have been too aggressive initially and failed to keep their interests aligned with the founders.

    • To me that would essentially mean that the company is not fine. Because if it were, not anyone on the side could offer a deal better than staying with the company you had founded.

    • Andrew de Andrade says:

      I think this is a really important point to consider.

      Even if the company were going somewhere, we don’t know the specifics of how the deals with Gowalla founders were done up until today.

      It’s entirely possible that between dilution ($10.4 million since Feb 08) and terms that may not have been founder friendly, that the founders realized that the pot of gold at the end of the rainbow was already empty.

      It would be great if more of the details were available, because I’m sure that there is a lot that can be learned from deals like this.

  4. You can’t win them all. Important thing is recognizing it sooner than later so you don’t waste time. Swimming in the ocean is better than drowning in dead pool.

  5. Deboprio says:

    Spot on Mike. Gowalla is indeed a talent acquisition according to me. With regards to gowalla investors i am sure mike knows them personally :-P

  6. Carmine says:

    That’s the way the game is, sometimes the investors win and the founders lose out and other times its vice versa.
    You couldn’t have said it better “Focus on the winners, and don’t lose sleep over the losers”

    • michael says:

      “sometimes the investors win and the founders lose out”

      Feel free to point out any example where this has been the case. Thanks in advance.

  7. @MartyCrampton says:

    Good article, Mike. It is an interesting topic for you now as an official VC (despite being an investor for a while :) Glad you drew the conclusion you did. If VC’s can’t look after themselves with a dead co. …..

  8. Tomas Finnøy says:

    Well…

    Let’s say there are 2 competing companies. 1 large (like fb) and 1 small (like gowalla). The founders of the small company have created a real nice niche product which competes with a small, but important part, of the large company’s portfolio.

    The large company decides to headhunt these 2 geniuses, cutting them a nice deal, to boost this part of their portfolio.

    In the gowalla case, I agree that they weren’t going nowhere. But in many cases this simply isn’t true. Large companies can “kill” small ones by headhunting their key-people cutting them large deals which the small company can not compete with, leaving the investors (and the rest of the employees!) with nothing.

    I don’t understand how you can, in a general way, say that you don’t have a problem with this.

    It doesn’t exactly create competition and drive innovation.

    • All companies, both large and small, headhunt and poach key employees from competitors. Nothing wrong with it.

      Startups live or die by grabbing the best talent and holding onto it. From day one, each of their hires could get a better $$ offer from one of the biggies, but you want the people who would choose the startup instead.

      In fact, most startups are primarily made up people who left or were poached from other opportunities.

      Innovation happens because the best people are pulled into the best opportunities. The system works beautifully.

      • Doug Thompson says:

        However it’s different when the founders are the ones ditching the company/investors, rather than just employees leaving. While I basically agree with Mike, another factor is whether the founders will be working on basically the exact same product at the new company that they had built up for several years at the startup, using investor capital.

  9. Tomas Finnøy says:

    *sigh*

    In the gowalla case, I agree that they weren’t going nowhere.

    should be

    In the gowalla case, I agree that they were going nowhere.

    of course.

  10. I don’t know the ratio, but plenty of cases where the investors will get something back on a small acquisition and the founders get nothing after liquidation preferences.

    It would seem to me though it should have been a board level conversation with the ability to replace the founders if they really felt there was a business there. In this case there wasn’t, but I have to imagine there were conversations with at least the larger shareholders, otherwise my initial reaction would be angry as well.

    • Jack says:

      It’s not even a matter of large vs. small shareholders. The earliest investors were punished here, presumably. And the ones who got a 20-30% return (which is bad but better than 0%) were the investors who came in later with more money. What would have been so bad about the founders saying to FB, “No, give all our investors a return or we won’t sell to you.” FB would then say no, and then Gowalla could kill itself (sell out of bankruptcy, whatever). Then Josh and the rest of the team goes and gets middle management positions at FB anyway. That would have been one way to handle this situation w/out punishing the angel investors. But of course, the later stage investors wouldn’t like it. Why should they get 0% instead of 25%. So, who was doing the punishing here? The Gowalla team or the later stage investors?

  11. kprasanna says:

    So when investors take complete control, kick out the founders and install their own management team, and then proceed to dilute the founders, that’s par for the course.

    But when the company is going nowhere and some other company essentially offers jobs to the founders & employees, then investors expect to be cut in on that?

    • Michael Arrington says:

      I don’t think venture investing should ever devolve into who can fuck who over first.

      • @MartyCrampton says:

        However, Mike, the thing to learn is that this perception does exist in start-up World. (Cliches may not be grammatically acceptable but usually have a valid vasis somewhere). It would be a good question to ask how it might be effectively redressed.

      • Jebb Dykstra says:

        100% agreed. BTW the Menlo Ventures already has (sold to Facebook) regarding Gowalla on their website. Enjoyed listening to your story in SoCal last week. I also think you truly undervalue your success. Selling a company for $30+ mm without financing (no Seed, no Series A or Series B) is equal to $100+ mm exit in terms of value to you. But you know that.

  12. cliveboulton says:

    A torrent of simlar exits and Term Sheets start to include golden handcuffs on goners employee sign-on bonuses? (non compete agreements)

  13. Steve Evans says:

    Seems the issue here isn’t with founders bailing on investors but rather with investors who lack a risk management plan to offset the risk of this happening in a number of their investments. For a new angel investor who put all their money into something they thought would be huge, this could be a big problem. For those who spray and pray, this is less of an issue due to diversification of portfolio.

    Basically, this is reality, founders will bail and some investments will tank. Investors need a strategy and plan to account for a deal with these occurrences.

    • The only “strategy” is just to write off the majority of investments, which investors always have and always will.

      Angel investors should not invest unless they also are willing to lose their money on most or even all of their investments.

      • Steve Evans says:

        Indeed, that’s the main strategy, but there are others for those willing to think outside the norm. However there are risk management and risk transfer strategies which could be successfully applied to investing in tech, both for VC’s and angels. These would involve passing on the risk to others and would obviously have a cost attached but could provide a level of protection for failed investments.

        You’re dead right on angels though, their investments are too small to warrant (or afford) a hedge of some description, so they do need to be prepared to lose money.

  14. It’s definitely a case by case type of thing.
    When facebook launched check-ins everyone assumed foursquare was a goner too. right about the same time they refused a real acquisition deal from yahoo and people didn’t get it. fast forward a year and facebook took a step back from location and foursquare is still the go-to location platform (API-wise).
    Being an entrepreneur is a lot about being in it for the long run. Not talking about Gowalla here, but I often get the impression that many entrepreneurs just lack the perseverance it takes to keep running and make their companies big and that’s why they sell out, regardless of what the price to their investors is.

  15. This is great article. I would love to know how this end :)

  16. consultski says:

    Agreed

  17. Third way of looking at this: Poor sap customers invested their time and effort in a free service, built a community of users for Founders, get nada in return.

    Beluga, Snaptu, Digital Staircase, I could go on.

    This model sucks for customers. One day they might even get sick of it.

    • Disagree:

      Innovation means risk. Risk means some products succeed, most fail.

      If you aren’t willing to use services that may fail, then you wouldn’t be able to use anything new on the web.

      And most are free anyway.

      • Great riposte Michael. On the face of it you’re absolutely right: no risk = no innovation. I agree wholeheartedly with that.

        However, I would argue that Gowalla was not ‘free’ for the most loyal customers who invested _time and effort_ in using the service and promoting it within their own social networks. You know, the evangelists.

        In fact, connotations may be negative for more rampant Gowalla fans (‘look at that derp – wasted all his time and energy on an LBS that got bought up and shut down’).

        We’re not talking about buying a Cherry Coke.

        • Andrew de Andrade says:

          Ben Dodson, a Gowalla API developer, posted this relevant piece “Goodbye Gowalla”

          http://bendodson.com/weblog/2011/12/03/goodbye-gowalla/

        • True, but nothing you can do about it. You may as well complain that your favorite football team got knocked out of the playoffs despite your paying to go to their games.

          Everyone says they understand that startups are about failure. But folks outside of the industry don’t always understand that, no, they *really* are about failure. Yes, most really do fail.

          That has certain implications…investors usually lose their money, services are shut down, boards fight with founders, acqui-hires happen.

          And yeah, we really are OK with all of that.

          • Oh I have a much greater emotional investment in my favourite sports team than any consumer web service. I would forgive the sports team anything – even when they lose again and again and again.

            No, I fully understand failure in startup and have lived through it as a principal. Pertinent to the case in point I believe the investors are lucky to get anything back at all, even if it’s only a few cents on the dollar. As for the founders going on to something new: good luck to them. I’m sure they’ve learned many valuable lessons.

            My concern is for the consumers, many of whom are rapidly deleting their Gowalla profiles fearful that _their_ data is going to be sucked into Facebook. FUD? Maybe, but nobody has told them anything different.

    • Free services come with this risk. You get what you pay for i.e.. bupkis. When consumers are ready to pay for all free services they’ll get a lot more guarantees.

  18. A deal like this reflects the perceived allocation of value. The buyer is declaring, in effect, that the primary value lies in the know-how of the founders rather than the assets of the company. There are two possible interpretations of this:

    1. The founders have value because they have learned from the *failure* of the ongoing effort. The expectation is that they will apply this knowledge in the next effort. This interpretation defies the data; there is no evidence that second-time founders do any better than first-time founders.

    2. The founders have valuable knowledge derived from their current effort. In that case, the know-how is clearly the proprietary knowledge of the company being acquired and is owned (collectively) by the shareholders. In this case the founders should not receive preferred terms.

    If the company is failing, that’s life. Even so, it is a breach of fiduciary duty for the founders to seek terms that disadvantage the investors relative to the founders. Accepting money from investors incurs legal and moral obligations. While the investors may be willing to accept the view that something is better than nothing, the founders as officers of the company have obligations to investors that must be upheld.

  19. This article needs desperately to be grammar checked.

    “Parakey investors got they’re money back and a little more” does not sound intelligent.

    And I stopped reading right after I read that.

  20. Investors could do something to protect themselves. At the time of the investment in the startup, they could as clauses that give them a cut of any compensation deal if the founders leave for another tech job and the compensation is highly lucrative either with money or stock. Of course, the clause would have to be written in a way that it doesn’t violate state law restrictions on clauses that restrict rights to work. Also, some startups might balk at such clauses. On the other hand, if you are an investors in a startup and they really need the invested, why not add a term that gives you a cut if the founders leave like these Gowalla founders are leaving.

  21. DevX101 says:

    Arrington,

    You seem to be riding both sides of the fence on this one, so let me ask you one question to clarify your position.

    If Uncrunched Fund goes broke, should your limited partners be entitled to any share of profits in your next fund? (Keep in mind that your current LPs are raising your profile as a credible VC).

    I already know your answer to this one — “ABSOLUTELY NOT!”, and it should be the same answer given when asked if Gowalla’s investors deserve a piece of the founders’ compensation on their next job.

    • KungfuVC says:

      If Uncrunched goes broke, there won’t be a “next”.

    • Will says:

      That’s not a good analogy. A better analogy would be, “If the Crunchfund goes broke, should SOME of his limited partners (the ones who invested the most $$) be entitled to any share of profits in his next fund.” See, the issue here is that the earliest investors lost money, while the later investors with board seats are getting a return (though small, still a return).

      • Will says:

        Correct, I just looked at the company on Crunchbase. Probably not correct to say the earliest lost money–probably the investors who lost money were the ones who didn’t put in “enough” to get the 20-30 cents on their dollar–the individual investors in the series B. I wouldn’t be able to stomach having to tell some investors that you get $0 but Firm X is getting some cash…but it seems that Gowalla and its board didn’t have a problem with this.

  22. EJ Campbell says:

    Here’s a good scanario to think about:
    1) Facebook is willing to pay X + stock options for founders
    2) Another company is willing to pay X*1.5

    Are the founders obligated to take #2?

    In the oriiginal parakey post you mention there was a bidding war, but Facebook won since they offered the founders options. That seems a tad unethical since it wasn’t in the best ineterests of the investors:

    http://m.techcrunch.com/2007/07/19/breaking-facebook-has-acquired-parakey/?icid=tc_parakey_art&tag=parakey

  23. Look in the end it boils down to this:
    Investors put their money into ownership of a company, not the people. This isn’t a slave/owner relationship. The acquiring company has zero obligation to the original investors. Paying off the investors to acquire the employees is a courtesy really. Facebook should be focusing on the forward-retention-incentives for the newly acquired team.

  24. Caveat investor, no? I think Ron and David’s approach is the correct one in most cases. Why punish the founders further? Don’t you think they’re bummed about the outcome, too? If the employment package is too rich (e.g. seven figures), then maybe there’s a valid cause for concern. Otherwise, it’s just a better ending to a sad story.

    One thing to learn from Gowalla, however, is that features and clones can never carry the day – there’s a transition point that is necessary, whether it is in depth of offering, # of users, or commercial success that must be achieved early to differentiate from seemingly identical competitors. The jury is still very much out on Foursquare’s long term prospects, but they’ve clearly emerged as the survivor in the space. Whether the “space” has a long term future remains to be seen.

  25. ethan says:

    To hear Mike talk lately, you’d think investors basically just hire entrepreneurs to do their grunt work, like part-time fry cooks.

    Pretty clear that his attitude is firmly anti-entrepreneur. At the end of the day, he seems to live in a world in which VCs make things happen, and VCs do all the hard work – not entrepreneurs.

  26. Investors deserve a share of the spoils, even if they’re losing spoils. There is no legitimate justification for cutting them out of the part of their loss they could recoup.

    This is disgusting, and so is the apologism.

  27. Let’s say the founders didn’t get offered jobs (yet) but Gowalla closed down anyway. Does this entitle the investors to demand compensation whenever the founders do anything else? Say if the founders were offered a job in 12 months time on the basis of the skills and experience they gained at Gowalla, would they still owe something to the Gowalla investors? What about in 5 years time? Or 20?

    Sure, it’s not entirely fair that the investors lose their money but that’s the risk they took when investing. Any monies made by the founders subsequently, to me at least (though IANAL) are separate issues. If the investors were due a cut, how would the cut be divided? Did the investors invest in the founders? The team? The IP? The market traction? Clearly all but the investment in the founders isn’t a lifelong investment; and I can foresee serious problems in trying to split up the contributions of the founders’ skills against all other assets of Gowalla.

  28. While it may OK w/SV Angel that Gowalla founders leave for greener pastures at FB, ethically, it’s not OK. Without the $10M of investor, Gowalla would not have gained traction or come to the attention of FB. The investors need to see more than $.30/dollar return. Several years ago I tapped friends and family for a start-up that never got lift-off due to under capitalization, I am not forgetting them, because without their investment I would not be where I am today, with the opportunity before me, and as a result, when Mobile2Metrics is successful, I will provide them with a return on their investment in me. while not legally req’d to do so, it is the right thing to do. Founders need to do the right thing for their investors, employees and customers. Always.

  29. Ryan says:

    Don’t worry angry VCs, just think of this as the founders setting a liquidation preference for themselves.

  30. Emil says:

    “Parakey investors got they’re money back”

    Ekhm, don’t want to be that guy, but I think its their.

  31. I think there would have to be a reasonable cause to believe that the founders at some point knowingly made decisions that were not in the best interests of the company and share holders before they can be called out on this. Otherwise it is them taking what skills they’ve picked up and applying them elsewhere (much like any other employee).

    Easier said than done though because its hard to know (and even harder to get consensus) about when its time to call it a day and go do something else.

  32. Mark Sigal says:

    Great post. There is a lot of ego in this topic, as let’s face it, you are backing the individuals so the idea that they cash out, and you don’t feels asymmetric.

    Then again, we pretend that entrepreneurs and investors are on the same side of the table. They aren’t, especially in these instances.

    There are far more cases where investors boot founders, cram a down round (usually because no one else will invest) or pass on further investment, than one’s where the founders make coin and the investors don’t.

    I will say that the smartest investors that I’ve worked with don’t invest their egos in worrying about such asymmetries because: A) they’re focused on counting dollars and not nickels; and B) they’re just as self-serving when they need to be.

    • Henry O. Henry says:

      “There are far more cases where investors 1.) boot founders, 2.) cram a down round (usually because no one else will invest) or 3.) pass on further investment, than one’s where the founders make coin and the investors don’t.”

      Let’s go over each of these.
      1. They boot founders ONLY when the founders aren’t doing a job and deserve to be booted (eg. Eduardo Saverin. He wasn’t doing a good job and deserved to have his Facebook shares taken away)
      2. It’s the founders’ fault if no one else will invest.
      3. If the VCs pass on further investment (and their fund is 200 million or more), then the founders must really be fucking up. And again, this is the fault of the founders. If you do a seed round with VCs you’re taking a huge risk.

  33. Chiatt Price says:

    Show your Meh pride. Officially licensed Meh tees – designed by Ken Murphy – http://www.mehtees.com

  34. InsiderOutsider says:

    Ooops, there it is. Sorry but the VCs lost.
    If Gowalla was worth $10 Billion and the founders had given 99% to hard bargaining VCs we’d be like: it is how it is.

  35. Rantling says:

    Ok I disagree with this.

    I signed up as an investor for the battle to be fought to the bloody end, or to clearly be in the know that it was time to close the doors and take what I could get and move on.

    Goner or not, the officers of the company have a DUTY to the investors to get them the BEST deal possible. That can’t happen when there is a conflict of interest. Ie; that the officers have a sweet deal to close the doors and come work for what used to be a competitor.

    Close the doors, move on and then take the job. Might be the same end result but you won’t look like the slimeball that you actually are.

    And Mike what about deals like Plaxo where the company was worth more than what was gotten by the officers (not the original founders, they had moved on), yet the officers of the company were given a very nice “bonus” to make sure the deal happened. The had less stock than folks I knew yet ended up walking with more cash. That’s not kosher, honest or ethical in my book.

    So you can gloss over deals like this. And investors like Ron can as well, they are investing in the shotgun method of investing and have the money to do so. But the other investors in companies like Gowalla were brought in by the vision and the energy of the founders, and probably aren’t investing in 100’s of companies, in fact this could be the only startup they have invested in ever, and now it will be the last one.

    Founders like this make it harder for the rest of the founders in the world to hold their heads high. How can anyone raise money and then essentially F*&k the investor who paid their salaries and bills while they made the effort. Not saying the founders didn’t work hard, just saying the bailed on their investors.

    Where is the honor or honesty there. And they have left poison in the well for the next founder that comes along to Joe Investor and says Believe Me….

    THIS ISN’T RIGHT, no matter how you cut it, or coat it or whatever. If it looks like a snake, moves like a snake, it’s not a rabbit.

    Wake up and Smell the Coffee….

  36. Jeff says:

    who would have ever thunk? entrepreneurs, not VC’s, are now seen as the vultures

  37. Kevin Solomon says:

    I do not see how you can trust the Gowalla founders to not bail on their next project or just take a better deal. I think there is a TRUST issue here.

  38. andrew moss says:

    Seems to me we’d all need a lot more hard facts to have a proper and robust discussion about the specific parties involved with Gowalla here.

    And that isn’t going to occur over a blog.

    So it’s interesting to discuss here such topics like the apparent trend of acqui-hires and who benefits/who loses, or various ways to best align founders + angels + vcs + “professional management”, etc.

    But I’d caution folks to avoid posting definitive judgments about Gowalla’s founders being “vultures”, “snakes”, dishonest and likely to bail, etc

    • Katy Rose says:

      This makes more sense than most of these comments. Thank you for encouraging us to not jump to conclusions about the founders of Gowalla. It seems to me that the original post contains hypothetical scenarios of a general and negative nature, NOT specific in any real way to Gowalla’s situation. The reader may be mistakenly led to believe that Gowalla’s founders behaved in an unethical manner, when there is no evidence whatsoever to support this assumption. It’s important to notice that in the last paragraph of the post, the investor claims he would be happy to invest in a future business founded by these two men. Hmmmmm.

  39. Riz Virk says:

    This is a tricky one. Having been both a founder who’s gotten screwed by investors, and an investor who’s expected to get my money back first, I can actually see both sides of the coin and think that Mike’s done a good job in presenting them.

    Now usually an acqui-hire is a reasonable outcome when the company has not raised much money, the founders are eating ramen and not drawing much of a salary, and the company is out of money. I’ve known founders like this who decided to “call it quits” because they just couldn’t do it anymore on no salary. This is a totally understandable acquihire scenario.

    However, it doesn’t look like this was the case here … the gowalla founders took $10 million in financing which means they were paying themselves big fat salaries (by startup standards anyways) and agreed to pay the first $10m back to investors (i.e. in a liquidation preference, which i’m assuming the investors had).

    The real question is: is the value of the facebook stock the gowalla founders got more than the $10m they took from investors? I’m sure no one was holding a gun to their heads and saying “you better take $10m or else!” – if they took the money and agreed that the first $10m should go back to the investors, then they really should honor the agreement.

    In this case, if I was an investor I’d be a *little* pissed because they may have found a “creative” way to get around their agreement. Squirmy founders (they’re not the only ones – Silicon Valley is full of them and apparently Austin is too!).

    That said, founders do get screwed by investors (usually VC’s) pretty often, when they replace the founders with hired-gun management, and then issue tons of new stock/options to dilute the original founders while keeping the hired-gun management’s percentages steady. Happens all the time – and i’m sure by some of the same investors who put money into Gowalla. Squirmy VC’s.

    Generally, the other reasonable scenario for a fire-sale type of acqui-hire is when founders and investors basically decide they’d rather own the stock of the acquiring company than the stock of the startup. Zynga has done this pretty successfully with a number of their acquisitions – and I’m sure the investors in some of these companies were thrilled to end up with Zynga stock rather than “failing startup game company X” stock. Of course it’s not at all clear if investors here got Facebook stock ….

    In any case, these investors generally sound like they knew what they were getting into and are used to losing money in 8 out of 10 deals, so I’m inclined to not lose *any* sleep over them not getting their full investment back.

    The only really funny part of this for me is if the current investors are saying they’d back the entrepreneurs again if they had the chance! More power to them…i’m sure this will lead to some colorful language/scenarios in the future. Even as an investor who is also an entrepreneur and understands that some companies just don’t make it, I think the real issue is how the founders handled the situation. Based on what’s described in this article (and not knowing the full story), i’d probably lean towards “once bitten, twice shy”.

  40. richy says:

    As much as it feels a little weird standing up for vc’s I think this kind of deal is disrespectful, immoral and harmful to the industry.
    Investors take a gamble (albeit an educated one), they use their money, expertise and contacts to back an idea to fruition in return for a stake in the idea. Not every idea works out, which is why they expect large returns not libor + 2%. Go ask a credit union for 5m, unsecured, to fund a usb powered duck titilator. Show a vc a good enough business plan and you stand a chance to be pleasing mallards, albeit for 90% of the equity.
    Deals like this just smell wrong. The whole I’m alright screw you mentality is counterproductive and childish. Just because you can do something doesn’t mean you should. VC’s are not hedge fund managers, they are human and deserve to be treated fairly.

  41. mpowers says:

    One form of early acquisition I have experienced as an angel investor is where the startup runs for 2+ years off angel money, builds up a team, launches a product that gets a moderate level of uptake (or fails to launch but iterates an internal product that has some cutting edge infrastructure to it) and then a competitor comes out that makes building out the company difficult. Now a fast growing company comes in, wanting the talented team that has cut its teeth on a new area that the acquirer needs and has some IP/infrastructure they want as well (although they downplay that value and say they just want the team). The acquirer then wants to pay as little to the investors as possible and weight the employee contracts for all team members to hold into them for another 4 years. This happened with one startup that sold to Zynga and another that recently sold to Groupon. Its okay to say that the big investors bet on the 1 in 10 that might make it to a large payout but for most angel investors you would like to see some base hits as well. If the acquiring company simply converted the payout to shares rather than simply paying principal and interest then the angels would have some potential upside. Otherwise they have simply given a high risk, 6% interest loan, for two years to founder who used that money to attract a unique team in a unique and valuable space, all for the benefit of the acquirer who got them for a song.

  42. What was the alternative? Put team Gowalla in purgatory?

    You saw the last release. It was a stinker. They had to do something. They lost the “LBS Wars” (which in my mind is akin to losing the Battle for Delaware). The money ran out and they weren’t getting more.

    It’s a great team and Josh Williams doesn’t have a dick bone in his body (except probably in his dick).

    • KungfuVC says:

      Maybe something in the likes of “if we ever get enough money out of the FB stocks, we will give back the money to our investors”?

  43. Danny says:

    Great Article Mike, I recently wrote on how these sort of issues are affecting innovation in the entire startup ecosystem. Please let mek now what you think: http://legendarymoves.com/?p=105

  44. Danny says:

    Mike just this morning I recently wrote how these sort of issues are killing innovation in America. Please tell me what you think of this article: http://legendarymoves.com/?p=105

  45. I wrote blog post about a deal that I was involved in where the CEO wrote his own deal and the investors got a choice of total stock conversion or 1/3 cash, “Preferred” investors had no option to recoup money. This is the new reality and it seems to be happening more frequently. http://www.mischievous.org/2011/10/questions-of-fairness-in-silic.html

  46. Nic says:

    Let’s just admit it. In situations when all is going gangbusters, people are more than happy to share the wealth and the praise. Investors, founders, CEOs, employees…all singing kumbaya.

    But the vast majority of startups that do make it out of infancy aren’t that way. They stub their toes, they hit potholes, they need a new transmission. When that happens, the alignment between the 4 groups goes out the door. The investors have their liquidation preferences, the CEO (especially if a new one is brought in) ensures he/she doesn’t get diluted with the rest of the common. And the rank-and-file employee, who doesn’t make much money off an acquisition in almost all cases, learns it the hard way.

    I recently chatted with a superstar employee who worked 4 years at a company that went public this year with a $300M market cap. That person’s take from 4 years of fully vested options, $46K pre-tax.

    In most cases of an exit, the rewards start at investors and then to CEO and then the pieces to the employees. In Gowalla’s case, I could make the case that the employees got a disproportionate value compared to the standard. I’m not shedding a tear for the investors.

    • John Eden says:

      Compelling perspective. Couldn’t agree more that interests are aligned best when all is going smoothly, and then fall off a cliff when the storms come (as they inevitably do for most start ups).

      Your example of the rock star employee w/meager rewards raises an interesting question: Why is it that such employees (key people, with deep skills) don’t realize more clearly their own value to the start up’s key mission and push for more equity? Is it that they don’t understand their value, don’t want to rock the boat (or seem greedy), or is something else at play?

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