FORTUNE -- One of the most notable changes in VC financings over the past five years has been the widespread adoption of founder liquidity.
For the uninitiated, these are deals in which some of the new capital is used to buy shares from company founders, rather than to help grow the company. Oftentimes these transactions make pragmatic sense – particularly for older companies where founders have taken below-market salaries for years and literally are having trouble paying the mortgage. A bit of reward for past hard work/company success, and the idea that a founder can be more focused if not having to fret over personal finances.
But sometimes such deals also are excessive, and not in the best interest of the VC fund limited partners who actually are footing the bill.
All of this brings us back to Snapchat, which recently raised $60 million in VC funding led by Institutional Venture Partners. TechCrunch and others now are reporting that the total round actually was $80 million, including a pair of $10 million checks made out directly to the company's two, twenty-something founders. Sorry, but this is desperate lunacy.
Before continuing, let me be clear that I don't necessarily blame Snapchat's founders for taking the money. After all, that's the kind of money that can set them up for life, even if Snapchat were to disappear tomorrow.
And that's really the problem, isn't it? This isn't about paying the mortgage. It's about getting crazy rich today, off of a company that has yet to generate a dime in revenue (rather than putting that money directly into the company's coffers).
The LP-VC-founder alignment has now been skewed, because only the last part of that triangle is now in the money. Let's assume, for a moment, that IVP contributed $70 million and now holds an 8% stake in Snapchat. And let's further assume that it only has a 20% carry. By my calculations, Snapchat would have to sell for nearly $1.2 billion in order for LPs, in aggregate, to earn $20 million in profit from the deal (i.e., what the founders already got). And remember that Tumblr – another pre-revenue company whose main selling point also was explosive user growth – just went to Yahoo (YHOO) for $100 million less.
[Note: It is likely that the VCs have liquidation preferences on their investment, or at least on the first $60 million (since the other $20 million is likely common stock). At industry-standard 1x, my math still holds. Anything above that gets a bit trickier].
I know there are some who say, "Well, it's the price IVP had to pay in order to get into the deal." And others who argue "Well, if you don't give it to them now they'll just want to sell quickly."
Those notions should scare the hell out of venture capitalists. Why do your founders feel so strongly about banking huge checks today, if they believe in their company's future? And don't I want entrepreneurs building for the long-term, rather than ones just waiting for the first decent exit opportunity? Entrepreneurs who care as much about their vision for its own sake, as they do for the dollars that vision can represent?
Again, I have not discussed this particular situation with either IVP or Snapchat's founders. So my comments are more general than specific, with Snapchat serving mostly as an anecdotal placeholder. But I think VCs in general have gotten a bit too comfortable handing out millions of LP dollars to individuals who don't really need it. Maybe that's because certain VCs no longer view $10 million as the fortune it really is…
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Venture capitalists have valued Snapchat at more than $800 million. Why?
FORTUNE -- Snapchat is one of the world's fastest-growing mobile apps, with users sharing more than 200 million "snaps" per day. For the uninitiated (or those over 30), "snaps" are instant messages/photos that self-destruct ten seconds or less after being viewed.
It also has one of the mobile world's fastest-growing valuations, with multiple reports out today that the company has raised MOREDan Primack - Jun 24, 2013 1:25 PM ET
Applied Medical Corp. is going public against its will, and isn't shy about saying so.
FORTUNE -- We hear a lot about entrepreneurs who don't want to take their companies public, but who ultimately give in to arm-twisting by their venture capital investors. Never, however, does that reluctance make itself known in the actual offering prospectus. Well, almost never.
Take a look at the following item from an S-1 filed by medical device MOREDan Primack - Jan 7, 2013 11:02 AM ET
Twitter backer raises largest fund to date.
FORTUNE -- Institutional Venture Partners, a later-stage VC firm focused on the tech market, today announced that it has raised $1 billion for its fourteenth fund. This comes on the heels of a $750 million vehicle IVP raised just two years ago.
No real surprise here, as the $1 billion target had been widely reported. And I guess the size increase is to help IVP MOREDan Primack - Jun 28, 2012 11:07 AM ET
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