Partial buyouts give founders room to take the long view
For hard-working entrepreneurs trying to build big businesses, should there be a pot of gold waiting at the middle of the rainbow?
That’s what happens on rare occasions when a company’s founders bank anywhere from a few hundred thousand to a few million dollars from private investors, before they’ve sold their company, taken it public, or even started turning a reliable profit. Some call it a “partial founder buyout.’’ Some view it as a symptom of a new tech investing mania. I think of it as a fiscal antianxiety infusion, which may help entrepreneurs relax and take the long view.
Starting a company sometimes involves maxing out credit cards or taking a second mortgage, and founders can have most of their net worth tied up in their company. “You may want to take a few eggs out of that basket,’’ says John Landry, a Wayland entrepreneur and investor who was involved in a partial founder buyout in the 1980s. “Stock in a private company is an illiquid asset. It can’t buy you a new house or pay college tuition.’’
The goal of these midstream payouts, entrepreneurs and investors say, is to reduce the founding team’s inclination to sell the business when the first mildly appealing offer appears, and give them the financial security to build something more ambitious. Try explaining to a spouse that you’ve passed up $20 million in favor of spending a few more years working like a dog to try do better.
The two founders of HubSpot, a Cambridge Internet marketing firm, took a few million dollars off the table in March, when the company brought in $32 million in venture funding. Four founders and key employees of Carbonite, an online data backup company in Boston, collectively pocketed about $10 million this past January. Carbonite has subsequently filed paperwork to go public, and HubSpot is considered among the top local prospects to follow suit.
To some, the idea of the partial founder buyout clashes with old-school business values. Shouldn’t money raised from investors go toward growing the business, rather than buying the founder a Ferrari? Doesn’t a six- or seven-figure bank deposit make an entrepreneur less hungry? At the very least, doesn’t an increase in these deals suggest we’re seeing “bubblicious’’ behavior, with investors willing to do anything — including line the pockets of founders — to get their money into promising start-ups?
“I think it’s a little bit of a scary trend,’’ says Woody Benson of Prism VentureWorks, a Needham venture capital firm. “In principle and philosophy, if we’re investing money from our limited partners’’ pension funds, university endowments, and wealthy individuals, “the money ought to go into the company.’’
But Benson says occasionally, founders get cash because there simply isn’t enough company stock for new investors without buying some from the founders. He says that’s what happened at LogMeIn, a Woburn company that markets a service that enables computer users to remotely access PCs. When Intel led a $10 million funding round for LogMeIn in 2007, Benson says, “We cashed out a couple of guys there for a couple million bucks, only because we wanted to buy more equity in the company.’’ The company went public two years later, and its stock is now trading at twice the initial offering price.
That’s the best argument for partial founder buyouts: They can build significant, enduring businesses that produce hundreds or thousands of jobs.
“It used to be that founders were in a rush to sell their company or take it public,’’ says HubSpot chief executive Brian Halligan. “This is a way to take the pressure off, and not be hot to sell your company the first time someone offers you $100 million for it.’’
The strategy doesn’t always work. In 2005, BzzAgent, which manages a community of consumers willing to try new products and then spread “word of mouth’’ messages about them, raised almost $14 million, some of which went to founder Dave Balter. “It made us feel like we had more runway to build the company,’’ Balter says. “Otherwise, there might’ve been the incentive to duck out when things got bad in 2009, with the recession.’’
But the extra time didn’t lead to a big payday for investors. BzzAgent, with 60 employees, was acquired last week by British retailer Tesco, for a sum that could reach $60 million only if BzzAgent hits certain growth targets. “While it will be in the ‘gain/win’ column,’’ says BzzAgent investor John Simon, of the Cambridge firm General Catalyst, “it won’t be among the highest-returning investment gains we’ll have, or anywhere close to that.’’
The outcome could be different at companies like Carbonite, HubSpot, and Bullhorn, a Boston company that sells software to recruiting firms. Bullhorn’s founders had boot-strapped the company without much outside investment for eight years, before accepting $26 million from General Catalyst and Highland Capital Partners of Lexington in 2008, some of which went to Bullhorn’s founders.
“It’s a much more common thing now,’’ says Bullhorn chief executive Art Papas. “Some of it is a result of the frothiness of the market today, with people getting paid just because they can, but some of it makes sense.’’ Papas’s company was generating about $13 million in annual revenues in 2008. He says the goal is to get to $100 million.
It’s unusual to find an entrepreneur who doesn’t like the idea of getting paid before the ultimate payday. But Steve Papa, cofounder of software company Endeca, is more of a traditionalist. Though his Cambridge company has raised about $75 million in funding, he says he hasn’t been tempted to direct any of it to his own bank account. “I wouldn’t want to sell my stake in Endeca early,’’ Papa says.
It’s odd, he says, when investors are plunking down money to bet on the future of a fledgling company, and founders are selling. “You might be able to do it,’’ he says, “but should you do it?’’
Scott Kirsner can be reached at email@example.com.