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VC's Behavior Related to Payouts at Time of Business Sale

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Wanted to ask a question around how VC's behave around liquidations of startups when options aren't useful/are under water, investors are getting worn out from investing and want an exit. The question is "what is a reasonable standard that VCs will consider providing, for employees and management team if anything, when co sold below the investor's preferences?" Example 1- assume that the sale is happening now and there is not a big need for employee retention. How much, in what situations, do you see VCs willing to share the sale with employees when sold underwater/below preferences? Example 2 - assume that the close and the determination of sale price is delayed out/determined 2 years out while technology and revenues develop, but will still be underwater with investors, what do you see as a normal carve out for CEO, CFO, VP, employee base for the 2 year's retention? Thanks John for creating this forum too! /jeff

Answers

Topic Expert
John Kogan
Title: CEO/CFO
Company: Proformative, Inc.
(CEO/CFO, Proformative, Inc.) |

Example 1: I would expect zero for the employees. When investors are not getting their money back and there is no need for retention, I would say the odds are very low that an investor is going to take money out of their own pocket.

Example 2: now you have a negotiation. It's all about ROI for the investors at this point. If giving away part of their upside gets them that upside in the first place (and they believe that) then I would not be at all surprised to see some new options granted at a lower strike price or a repricing of options. Whichever, the new grants or repriced options will likely come with new vesting or direct performance triggers to help "motivate" the recipients. If there is no increased return for investors they will not want those new/repriced shares to pay out if converted to common b/c then they would be taking money out of their own pockets.

Topic Expert
Jeff Chase
Title: Advisory CFO
Company: Hazelcast, Juicebox Energy, and Social I..
(Advisory CFO, Hazelcast, Juicebox Energy, and Social Inertia ) |

Agreed - in scenario 2, I suspect instead of options, the VCs should have to agree to some sort of carve out. Is there a norm for carve outs that parallel say options strategies, like saying some % of the deal price - I wonder if VCs would agree to carve out say 10% of the exit deal price, then the CEO gets say 5%, CFO 1%, and remaining employees 4% or something varying by how many employees there are and such...I guess the option method would work as well, but it would be cliff vested and the number would somehow have to be derived off all types of share classes...

I suppose if they want to limit the upside, and given the fact of still being "under water", i.e, they're still losing money, and that the scenario was shorter term (2 years or less) maybe the reality is they cap the carve out at say 6 months or 12 months salary, so that the employees wouldn't take out too much, or the lower of the % method or 6 months salary...

Topic Expert
John Kogan
Title: CEO/CFO
Company: Proformative, Inc.
(CEO/CFO, Proformative, Inc.) |

Yes, a carve out is similar to where I was going and could be handled using stock or a straight % of the deal agmt. Two years would be an unusually long time, however, for any sort of carve-out deal unless it was an LBO or something similar where a mgmt team was brought in specifically for a turnaround. The % for a carve-out is a negotiation and certainly heavily favors the exec team. I have repeatedly seen boards but it off at the exec team and would expect similar behavior now when the supply-demand of talent is so out of balance. That is, they would take the "those employees are lucky to even have a job now" approach.

Mark Stokes
Title: CFO
Company: Private
(CFO, Private) |

In my experience it's every man (or VC) for himself. They would have to have some very direct motivation to keep anything aside for management. And I have never seen them give upside to anyone other than senior management although I could imagine it if there were some key technical folks who absolutely had to stay on board in order to complete product/code.

Topic Expert
Jeff Chase
Title: Advisory CFO
Company: Hazelcast, Juicebox Energy, and Social I..
(Advisory CFO, Hazelcast, Juicebox Energy, and Social Inertia ) |

Thanks Mark - I had lunch this week with a CEO, that had run into something similar to this question on the second part of it where retention is wanted - he thought that the "average" proposal where you have something more like an "earn out", and thus you need to retain some of the employees to the point the contingent consideration event is complete would look like:

10-15% carve out of the deal, whatever it ends up -
Of that, 30-50% of it for the CEO, 10-20% to the CFO, and balance say 30 to 50% for the remaining employees during this contingency/retention period. This is higher than the 1/5 to 1/7 of the CEO's carve out for the CFO, that i had heard from a CFO friend. For what its worth, that was his benchmarking that he had done. Thanks./jeff

Rajeev Seshadri
Title: CFO
Company:
(CFO, ) |

Concur with Mark. One experience I had with VC investors, is that they were only interested in maximizing their recovery. The info regarding carve-outs is illuminating - I suppose it requires hard negotiations at this point.

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