Sometimes we come across a start-up, which in the past did, is doing, or is planning to do an ICO, or Initial Coin Offering. Simply put, an ICO means the company prints it’s own (digital) money and offers it to potential investors.
Most ICOs are in the form of utility tokens, which is a means of payment for services or products sold by the issuing company. I’ve seen special tokens for payment for ads or tutoring, for example.
Picture it as if you are going into an amusement park, which uses tokens for payment. You can buy these tokens at the entrance cash desk, in exchange for dollars. One token for one dollar. Some rides cost one token, some three and the roller-coaster costs ten tokens. It’s a little inconvenient for the visitors, but simpler for the management, as they don’t need to handle cash at all rides. Unspent tokens can be exchanged back for money, when you leave the park. We’ve all experienced something like that.
And now, picture the management doing something completely different. At the start of the season the park announces that it will offer 1 million tokens for sale, $1 a piece. The one mil it hopes to raise will be spent on improving the park and to cover operational cost. Thanks to the improvements, more people are supposed to visit the park. The demand for tokens will rise and based on economic theory, the price should increase. Close to the park, just three tram stops from the entrance, is an exchange, where you can exchange money for the tokens. Our park tokens can also be exchanged for other park tokens, everything for market rates, based on supply and demand. Decentralization galore! And if that’s not enough, one convenience store in town announced, it will accept the tokens for purchase of groceries.
Doesn’t make much sense, does it? Not just for potential token investors, park visitors, but even for the park itself. So when we see the ICO in the pitch deck, it mostly also means an IKO. Immediate K.O.
A few months after I founded my first business (there were eight of us), one American said, “Eight? Then you are President and the other seven are Senior Vice-Presidents.” It took me a long time to realize that it was not a joke, and it took me even longer to understand what he actually meant.
In corporations, the business card title is one of success symbols and a source of respect. In the end, it is understandable, because thousands or tens of thousands of employees have to find out who and how important one is. And fair to mention, when someone in a multinational corporation makes it from bottom to a Vice President, he probably needs to prove some abilities. That’s why even in startups, the founders somehow distribute the well-known functions, but the problem is, they often stick to them later on. However, in the startup world it’s different. The CFO can be the Shylock-in-Chief, and the CTO can put a Blessed Bitpushing Guru on the business card, and it does not matter. To a certain size, people just respect personality and professional qualities, charisma, the ability to do their job well, and lead the company so that it grows and thrives. Scientifically it is called leadership skills. Outside of the company it is a bit different. Successful people want to deal with successful people and nobody wants to deal with someone who is the car’s fifth wheel. And the business card title allows the company to visually “enlarge”. If the company has a senior vice president, it sounds like he is presiding some vice-presidents, each of whom leads several senior managers, and so on. The maid can be a Chief Sanitary Officer and, if the company has two drivers, one of them may be VP, Transportation and the other Car Fleet Manager.
And that was what the aforementioned American meant … the “who’s bigger” game. But it’s just a game and otherwise the titles are useless. Sometimes it even hurts. Often, it turns out that the business overcomes the skills of one of the founders and there is the need to hire someone better. Or that the founder at the start of the company took a role that did not fit him completely. But oops, when we’re hiring someone and the title is already taken, what to do? He’s got an ego, too? Then there is only one good solution. Just scratch that title off him without mercy. Nepotism destroys morale and eventually everyone’s just laughing at it. Company’s success is somewhat more important than an individual’s ego. The ego can not buy a house, a car or a yacht in the Pacific, and the kids of a startup founder will not be proud of their father was the senior vice president of a company that went bust. On the other hand, if someone builds a big and successful business from scratch, no one will be interested in what sort of a title he had on his business card. These people often do not have any… it’s enough to put just name and surname.
Been there, done it. I took investors into my company and awarded them with extensive rights without much thinking about it. I trusted their talk about how they had the same interest with me, how they would never block anything, and how it all was a pure formality. Bullshit. Quid pro quo. High valuations mean high risks and more extensive veto rights.
I’ll tell you a couple of stories.
Story 1. Mall.cz. A major global financial crisis occurred in 2008, and moreover, we screwed SAP implementation. The investors said, “Do not expect any more funding from us. You’re on your own.” Well, we would have expected our partners to stay with us in good and bad … but at least, they would not torpedo our efforts to save the business. Us, founders, had to once again bet everything on the company, we pledged our houses … and saved the company. It grew again, yet we still needed more cash. One of our investors was willing to support us again. The second investor, however, said that not only he would not invest any more money (he lost his biggest LP due to the crisis), but that his stake shall not be diluted should anyone else invest! “We have a veto right to any funding, so unless you guys keep our stake at where it is now, we will not give you our consent.” That was obviously unacceptable for our lead investor who said they would rather let us go bankrupt than succumb to such a blackmail.
Story 2. A global startup success story, a company most of you know. At the beginning, they took money from an investor who got a blocking right to everything. Moreover, he always had ill manners. In the board discussions, he would attack the founder with open vulgarisms. There were several exit talks of the company to big multi-billion players. And now imagine a stakeholder who says to the prospective buyers: “Boys, I have the rights to block it all, so you shall give me more money than to the founders, otherwise go home.” No kidding. As a result, no exit discussions ever progressed.
Veto rights are a standard part of most investment contracts. The investor gets the right to veto any important decisions, for example any other funding, M&A, but often also ordinary business decisions such as senior hires and their compensation packages. On the one hand, no problem with that, he has more experience, so can help avoid fatal errors. But there is also the flip-side. To understand the risks, it helps to know, how an ordinary investment manager job actually looks like. In the vast majority of cases such a wealthy-looking guy is not an entrepreneur like you. He often is just a corporate soldier. A person who works for his salary, and, similarly as in a corporation, his main interest is not to make bold decisions, but not to make mistakes. He fears to be fired. And what is the best strategy to not make mistakes? To assume no responsibility, to decide nothing. So, it is quite common for an entrepreneur to send a so-called “consent letter” to hire a super-employee with whom he felt in love. (By the way, just the constant stress to exactly fulfill all your obligations of the hundred-page investment contract … but that’s elaborated on elsewhere). And after a few iterations, a month went by and although the investor (or his legal department) finally releases the written consent, the love is lost and the guy is already employed somewhere else. Or, you arrange to acquire your competitor, agree on everything, pay due diligence process, prepare contracts, etc., the investor will “support you” all the time (“Great idea, we shall formally approve it after everything is ready”), yet when there’s the time, he doesn’t have the balls and you will not get the approval. True story.
One does not read these things in the PR texts about successful investments and it’s easy to listen to the Sirens. They always sing beautifully, wearing golden robes and waving big valuations. However, it is extremely important for you to have investors on your side, your blood, your values, same motivations. They shall be with you in good and bad and have the balls to make courageous decisions. Veto rights in the contract and their potential unscrupulous enforcement are far more important for the future of your company than if the investor has 12% or 18% stake in your company.
Disclaimer: Of course, not all investors are alike. Many are not corporate soldiers, many can assume risks and have genuine interest to help you. And also it would be naive to think someone would bet on you big bucks without any veto rights. The point of this article is, that founders tend to be blindfolded with the valuation… whilst there are much more important things to look for.