Private Equity 20 Lectures (11) The exit sequence of private equity funds? What? !The later investor

Private equity fund 20 lectures, Silicon Valley investors of the law must learn, I am the United States attorney Liu Xiaoxiao.

After the private equity fund puts money into the project company, the fund will exit when the project is mature, so what rules are followed when exiting? Let's start with a rumor: many people think that the earlier the investor comes in, the stronger the power, and some people even think that the founder's rights are stronger than the investor's rights, which are actually wrong. "LIFO is the iron law of private equity exit mechanisms. If we compare entrepreneurship to a giant ship, the Titanic.

First, the iron law of private equity fund exit "last in, first out".

1. Common Stockholder (common stockholder)

Then Founder (founder) is the captain of the ship, Co-Founder (co-founder) is the ship's first mate, they are the driver of the ship. They are the first to arrive on the ship, and then they have to keep an eye on the ship's direction of travel, manage the ship's employees to ensure that they are working steadily, and take care of the passengers on each cabin level. If the ship makes it to the other side and lands in NASDAQ port, everyone gets off the ship happy and the Founder Captain and Co-Founder First Mate are honored and become startup stars.

But if the ship sinks (i.e., the company goes out of business) or if the ship gets picked up by another, larger ship (i.e., a merger or acquisition of the company), the class of the people on the ship is especially important. Don't be surprised if I compare a Dissolution to an Acquisition because they are exactly the same in terms of the modeling of the exit of different classes of investors, except that in the case of a Dissolution only a very small number of people tend to get a share of the money or nobody gets a share of the money while in the case of an Acquisition only a very small number of people tend to get a share of the money or nobody gets a share of the money. In the case of an Acquisition, most of the people get a share of the money, but it's just a matter of how much.

2. Preferred Stockholders

Series Seed Preferred Stockholder, Series A Preferred Stockholder, Series B Preferred Stockholder, Series C Preferred Stockholder. Preferred Stockholder (Series C Preferred Stockholder) boarded the ship one by one. In the event of a shipwreck, Series C Preferred Stockholders on the evening boat are first class passengers and have priority in boarding the lifeboats. Next are the Series B Preferred Stockholders, Series A Preferred Stockholders, Series Seed Preferred Stockholders, and the ones who paid the most. The Founder Captain and the Co-Founder First Mate commanded everyone to leave, only to go down with the sinking ship.

3. ESOP (Employee Stock Incentive Plan)

In fact, in addition to the Founder (Founder) Captain and Co-Founder (Co-Founder) First Mate, there are a group of people who are even worse off, that is, the various employees on board, including the workers who burn the coal in the cabin, and the waiters who clean the rooms on all floors, and the waiters who run the kitchen and scrub the dishes. These people are the owners of the Stock Option under the ESOP (Employee Stock Incentive Plan) in the startup company. The Founder and Co-Founder are at least Common Stockholders, while Stock Option holders have to wait for the 4-year Vesting Schedule, and after maturity, they have to pay a sum of money to exercise their stock options before they can become like the Founder and Co-Founder. Founder (Founder) captain and Co-Founder (Co-Founder) first mate, if not before maturity it, the ship sank, sea water into the employees are directly dead, even thinking time is not.

"What? What kind of logic is this?"

The first time you hear about this, you will definitely think that it is very upside down. Venture capital is a game of capital, not a game of laborers, not who works more and who has the final say, but who pays more and who has the final say. You chose the path of entrepreneurship, we must follow this set of rules of the game, rather than naively thought that the capital will pity the poor people.

Second, why "last in first out" is the iron law of private equity cash?

1. Investors prioritize returns over founders

• The fundamental reason is the inequality between the founder and the investor's obligation in venture capital. Hu Weiwei, the founder of Mobike, said, "Capital is to boost you, but in the end, you actually have to return it." Since the obligation of investors in venture capital is not equal to their returns, you will see that all the capital of the company is invested by investors, but only 10-20% of the equity. In this scenario, it is very unfair to the investor if he can only receive a return equal to his equity share and cannot prioritize his return over the founders. Just like the Titanic, although the Founder (founder) captain, Co-Founder (co-founder) first mate every day to be responsible for the ship's voyage, ESOP (ship workers) need to work hard, but the ship's voyage in addition to the efforts of these people, but also a lot of financial support. The passengers' tickets are the financial support, which also supports the Founder Captain, the Co-Founder First Mate and the ship's staff. If the rule is that when the ship sinks the Founder, the Co-Founder, and the staff get off first, then no passengers will pay for tickets and the ship will not sail.

• Another reason is to avoid the entrepreneurs from the investors inappropriate profits, so that the interests of investors damaged. For example, an investor invests 10 million dollars and gets 20% equity. Then the company dissolves the company as soon as the investor's money arrives. If the rule is that the founder exits before the investor, then the investor loses all his money. This is also like on the Titanic, if the rule is that when the ship sinks, the Founder (Founder) captain, the Co-Founder (Co-Founder) first mate and the ship's employees get off the ship first, and they are familiar with all the structures on the ship, then they are very likely to take advantage of the passengers sleeping, secretly take all the passengers' finances, and then create a shipwreck right away, Founder (Founder) The captain, the Co-Founder's first mate and the ship's staff disembarked first and boarded the lifeboat without incident, leaving the passengers in the cabin empty-handed.

2. Later entrants will get their returns earlier than earlier entrants.

Risk compensation: The later investors enter the company the higher the valuation of the company becomes, the more they need to invest, and the more the company's growth may slow down after multiple rounds of funding, so the last round of investors usually take on more risk. It's like the first class passengers on the Titanic, who paid dozens or even hundreds of times more than the third class passengers' fares to get on the ship, and if the first class passengers were told that they would have to get off the ship after the third class passengers, then I'm sure there would be no one willing to buy a first class ticket.

Private Equity 20 lectures, Silicon Valley investors' legal musts, I'm U.S. attorney Liu Xiaoxiao.