There is a perspective from which the venture model that dominates a large subset of the tech industry is a little baffling. The infrastructure necessary to operate web/software products has never been cheaper. To an extent, the manpower has also never been cheaper (in the respect that it is increasingly practical to hire from a global talent pool spanning regions with very modest salaries). Still, the model that dominates Silicon Valley and other leading innovation hubs is one of selling off huge chunks of equity and pursuing liquidity for shareholders (via acquisition or IPO) over autonomy and sustainability (i.e. indefinite operation with profit distributions).
I say this is “baffling”, but there are reasons why the model persists. Having worked in several companies that pursued and (at least transiently) thrived under the model, the justifications I have observed are:
- It often *is* good for founders, in that if founders are able to do secondary sales in later financing rounds, they can get paid up front (by investors directly purchasing their shares) sums of money that it might take many years of slogging to pay themselves through distributions/bonuses if operating a non-VC backed company.
- If the company has a major liquidity event (big acquisition or IPO) founders and (occasionally and with caveats) early employees see significantly more money than they would have had they operated under a more traditional model. This is another way of saying that with the VC model (and with many caveats) you will “win bigger” if you win.
- Even though infrastructure/manpower costs might not justify selling a ton of equity for capital, there are certain domains where you really do need massive financial resources to win dominance or bust through bureaucracy (things like Uber are a good example of this, using VC both to subsidize rides sold at a loss and also to shoulder the legal expense of fighting regulation).
- You can pay yourself a salary (and even sometimes a very generous one) while being unprofitable.
- Salaries (at what I have seen in engineering) can be very high in VC backed companies. Employees aren’t subject to a natural accounting for their value since there is not an expectation of ongoing profitability.
- You get resources, guidance and a sheen of legitimacy/prestige by having the backing of established VC firms.
- You have someone in your court (your VC backers) with a financial interest in seeing you win very big (this is a double-edged sword).
The very unhealthy aspects of the model that I’ve observed are:
- VC backers actually have a financial disincentive for seeing you become sustainable and cease pursuing an exit. It might take 5-10+ years or longer for them to just break even on their investment through traditional profit distributions (or liquidation of their shareholding) if you cease to pursue IPO/acquisition. Breaking even on a company over 5-10 years is actually an outcome of objective failure for their limited partners (LPs) and in the scope of the fund.
- Founders end up owning less and less of their company through dilution over many rounds of financing. This can be justified as having a “smaller piece of a bigger pie” and coming out net ahead but it does do something to the soul of a company and does cause them to leave sooner in my experience (i.e. either being pushed out by the board or leaving after an earn-out/golden handcuffs at an acquiring company).
- Employees typically get shafted as far as the class and treatment of their shareholding (common stock with fewer entitlements and longer lockup than the preferred stock that VCs and founders will hold).
- Often the company’s objectives become misaligned with those of its customers/users. Think of the countless product shutdowns that have happened after acquisition and consolidation or the many user/community-hostile decisions companies have made because of the independence they have surrendered after extensive VC financing.
This line of thinking led me to consider what a more symbiotic model might look like. I have been thinking through a product that is a sort of marketplace. It has no value for customers without an actively engaged seller community. Providing a well-functioning, well-designed platform and ongoing support are obviously important, but similarly essential is the community. It seems to me reasonable to offer the community equity.
One startup that I know of that granted equity to its users (in the form of restricted stock) is the New York-based car-sharing service Juno. Their particular case has actually been a bit of a disaster, but an instructive one.
Juno is a competitor to Uber/Lyft that was founded in New York in 2016 by Talmon Marco, the founder of the once very popular mobile VoIP company Viber. Juno granted restricted stock to its drivers in proportion to the work they did on the platform. Juno stated that 50% of the entire cap table should belong to their drivers by 2026. In 2017, Juno was acquired by competing ride-share company Gett in a merger that eliminated the driver equity program and that drivers claim substantially undervalued what shares they had earned. Drivers are now suing Juno in a class-action over the handling of their equity in the acquisition.
The accusation leveled against Juno is that the restricted stock program was a disingenuous ploy to lure drivers away from entrenched competitors (Uber, Lyft, etc.). I don’t disagree, but I do think that there are valuable lessons that can be taken away from the disappointing episode. One is that this concept of incentivizing user engagement with stock works. If you are in a relatively commoditized space with many competitors, it appears that it may be an effective way to distinguish your product among users. The other is that the model is possible from an implementation perspective, within existing legal frameworks (which I don’t think had previously been clear).
I hope that in the coming years more companies experiment with this model (and in a less dubious way than Juno appears to have). There are many domains where developing/delivering a product demands very modest (if any) startup capital, so I would love to see more companies give some of the equity that they would have sold to VC to their users instead. If a company will live or die by its users, it might be good business to make them owners.