Here’s How (and Why) Entrepreneurs Are Getting Venture Investors Out of Their Companies
Buffer, Wistia, and other venture-backed founders now want to go it alone.
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Growth--or at least the pursuit of it--was about to break Wistia. The video-hosting company, started by Chris Savage and Brendan Schwartz in 2006, had been profitable, once. But to the entrepreneurship community, the founders recount, the company was too profitable. It wasn't investing enough in growth, and was missing out on opportunities. Savage says he started to think this way too, although in retrospect, he's not proud of it. Wistia hired a big sales team, increased its advertising, and was "trying wild things," according to Savage.
It all felt like a distraction. The company should have been spending its time innovating on its core product, Savage thought. Now Wistia was running at a loss, and employees were complaining that the company no longer felt like the one they had liked for so long.
Then, in 2017, the Wistia co-founders got three buyout offers, all at roughly the same time. They'd ignored such offers before, but having three at once forced them to reconsider. "We were kind of unhappy for the first time in our journey," says Savage. After talking to other entrepreneurs, some of whom had sold their own companies, the co-founders reached an unusual conclusion: They had loved running Wistia, before they adopted a growth-at-all-costs mentality. So they would try to hit the reset button. They would somehow buy out their investors and go back to building an innovative, profitable company that was good for customers and for employees.
In the end, that meant taking on $17.3 million in debt and replacing employee stock options with a profit-sharing plan. It also meant convincing investors, not all of whom wanted to sell back their stakes in the company. Wistia offered them a 10x return on their original investment, and Savage was clear that they would not get another chance to cash out anytime soon. His pitch: "Sell as much or as little as you want, but we are not planning for another liquidity event." Through share buybacks, the founders regained full control of the company.
Landing investors is often seen as a sign of success for young startups. But in the past year, a number of venture-backed companies have done as Wistia has, bought out their investors to enable them to run slower-growing, but profitable, companies. Among them are social media analytics company Buffer; app distribution software company SweetLabs; and interactive content creator Arkadium. Says Savage: "Since we've announced our news, we've been inundated with people asking questions and asking for advice. I certainly wish I had known about this option earlier."
The experience of Savage and his cohorts highlights a common misalignment between entrepreneurs and venture investors. A company that is stable, making tens of millions in revenues, and throwing off substantial profits, can be very good for an entrepreneur. For a venture investor, not so much: "If you, the entrepreneur, can sell for $25 million, that might be transformative to you," says Joe Wallin, a Seattle startup lawyer and principal at Carney Badley Spellman. "But that's a disappointment to the fund."
"Any venture capitalist would tell you that VC is wrong for 99 percent of companies," says Rand Fish, a cofounder of Moz, which raised $29 million in venture capital. He's staying away from venture capital for his newest venture, marketing software company SparkToro, instead lining up 35 angel investors. He and his co-founder structured their company as an LLC, which investors tend to avoid. "But venture capital is the only thing that is marketed to folks in tech and software. We think it is insane to force a single type of success when you don't know what the company might become."
Wallin says the founder community is starting to come around to this idea. "Everyone slowly gets smarter over time and shares information," he says. "If you retain control of the company, you might have an amazing business and a good living for your family and your employees. If you give up control you might not get anything out of the whole deal."
Buffer was in the happy situation of being able to fund its initial share buyback out of cash flow. By the end of 2017, co-founder and CEO Joel Gascoigne had already had some sticky conversations around growth with his investors. Everyone at the company works remotely, and the company is committed to transparency, even when it comes to salaries and company financials. Investors suggested that less remote work and less transparency might improve productivity. They questioned whether Gascoigne was the right person to lead the company.
When Gascoigne broached the subject of a buyback, he had three important things on his side. His A round was relatively small, and those investors owned just 6.2 percent of the company. (A clause stipulated that they would get any return on their investments before any seed investors could.) Second, Gascoigne, knew that if he stopped trying to push the company to grow, it could potentially become profitable enough to buy back the shares without outside funding. Third, when he'd first raised his A round, he was upfront about his goals for the company: He didn't necessarily expect to go public or sell in the next five to seven years. In response, one of his investors asked for a clause giving them the option to get their money out, plus nine percent annual interest, at any point starting five years from the investment. That became a basis from which to negotiate a share price.
"There was a level of disappointment from my Series A investors," says Gascoigne. They had a conversation about MailChimp, which Gascoigne admired because it had managed to innovate without raising money and hiring too quickly. "Even though MailChimp is clearly very successful, the time frame is still quite long from the venture capital perspective," says Gascoigne, and, of course, venture capitalists didn't get to put any money into it. "They don't necessarily see MailChimp as this huge success."
In July, Buffer spent about $3.3 million to buy out about two-thirds of its A-round investors, who ended up with about a 40 percent return. Forty percent may not sound impressive to venture investors, but Bryce Roberts, founder of alternative-investment fund Indie.vc, says that companies trying to buy out their investors are no longer dealing with venture-style arithmetic. "You're in a very different kind of math class at that point," Roberts says. Paying out $2 million compared to $5 million can be hugely consequential to an entrepreneur, "but to a fund, they could care less." Roberts suspects that a lot of companies looking at buyouts, if they could peek into their investors' financials, "would find they've already been written down to close to zero. A venture investor's whole job is to put the most money into the company most likely to have the biggest multiple. It's not to keep everyone in business."
Since the buyback, Gascoigne has heard from seed investors wondering if they'll be able to cash out their stakes, and has been explaining that the company needs to build up its cash reserves before it can buy them out too. Meanwhile, the Wistia founders continue to be surprised at the power of profit-sharing compared to stock options. Most employees never really understood how much their stock options were worth, and knew it would be a long time before they saw any payout. Profit-sharing is much more concrete, and hopefully, paid out regularly. Earlier this year, Wistia's engineering infrastructure team announced it had figured out a way to improve gross margins by two to three points, and maybe more--thus potentially increasing the value of profit-sharing for everyone at the company. "There was a huge uproar," says Savage. "I've never seen everyone super-excited about financials before."