Whatever, do the secondary sale

But it should be employees, not VCs, who judge if they're fair.

Scar sold too much.

If you:

1. start a company that grows at like 10,000 percent a year,

2. raise hundreds of millions of dollars for that company,

3. keep some of the money for yourself by selling a bunch of shares in secondary sales,

4. and eventually incinerate the company with mismanagement and scandal, 

venture capitalists will care about these things in this order: 

1. you are a visionary founder who has ideas that can grow at 10,000 percent a year,

2. you are a charismatic fundraiser who can persuade people to give you tons of money,

3. in a distant third—you are prone to distraction and wily tricks, and if you started another company, you might need some supervision to make sure you don’t get too distracted or too wily,

4. and in a very, very distant forth—you sold shares and secured your own financial well-being before securing that of your previous investors.

Of course, this is not what venture capitalists will say. They will likely clutch their pearls and bemoan your wickedness—your bank heist; your behavior unbecoming of a Founder—but they will also be intrigued by your guile, and probably hope that you call them if you found something else. 

This isn’t a statement about values, or what’s right or wrong; it is just what will happen. Take, for example, Johnny Boufarhat, the founder and CEO of Hopin, which was liquidated this week. 

Hopin launched in December of 2019 as a “live online events platform that replicates an in-person event.” On the day of its launch, it was a neat alternative to the sterile broadcast-style webinar, and a bet that virtual conferences might gradually become more popular. Four months after its launch—in an unbelievable stroke of luck for Hopin, and an unbelievable stroke of misfortune for the rest of us—Hopin was, quite literally, life-saving technology that was all but mandated by the CDC.¹

Everyone went berserk.² Hopin raised $6.5 million in February of 2020; then $40 million four months later; then $125 million in five months later; then $400 million four months later; then $450 million five months later. In those eighteen months, they went from 1,800 customers to more than 100,000. The company’s valuation ballooned to as high as $7.75 billion. At some point during those later rounds—which were oversubscribed, meaning investors wanted to buy more shares than were available to sell—Boufarhat sold about 20 percent of his shares for roughly $150 million.

Then, predictably, the pandemic ended. And, predictably, virtual events were no longer the booming business that they were when in-person events had been illegal. And, predictably, a generationally large tech bubble burst. And, not entirely predictably but not exactly surprisingly, Hopin fell apart, sold for $50 million in 2023, and, a few days ago, shut down its primary business.³ And, predictably, venture capitalists are accusing Boufarhat as making out like a bandit, and being for being a “founder put themselves first, above everyone else. Like at WeWork.”⁴

Ok, but, WeWork? Weird example to scare us straight. Yes, WeWork raised more than $20 billion, and yes, Adam Neumann kept close to $2 billion for himself as the company spiraled into spectacular bankruptcy. But Adam Neumann recently raised $350 million from a16z for another company! And famed investor Marc Andreessen said they weren’t writing the “largest individual check Andreessen Horowitz has ever written in a round of funding” despite WeWork, but because of WeWork!

Adam, and the story of WeWork, have been exhaustively chronicled, analyzed, and fictionalized – sometimes accurately. For all the energy put into covering the story, it’s often under appreciated that only one person has fundamentally redesigned the office experience and led a paradigm-changing global company in the process: Adam Neumann. We understand how difficult it is to build something like this and we love seeing repeat-founders build on past successes by growing from lessons learned. For Adam, the successes and lessons are plenty and we are excited to go on this journey with him and his colleagues building the future of living.

So Boufarhat, if he so chooses, will surely have a chance for a second act.⁵ Like Neumann. And like Parker Conrad, who started Zenefits, quickly grew it to a $4.5 billion valuation, nuked it, and had no problem raising money again. And even like David Byttow, who founded Secret, sold $3 million in a secondary sale (the sale that one VC called a bank heist), shut the company down, started a new one, and then raised $1 million dollars from one of Secret’s biggest investors.

Because, for all of the hand-wringing on Sand Hill Road about this stuff, Silicon Valley is really just about making money. Investors don't invest in nice people; they invest in monetizable people. Proving your financial worth matters a lot more than proving your moral worth, to the point that I'm sure some investors like Neumann more for his savvy dismantling of SoftBank. And there are probably some investors who also look at Byju Raveendran—who founded edtech startup Byju’s, raised tons of money, oversaw its collapse, and has invested more than $1 billion of his own money into trying to save it—and don’t see a upstanding fighter, but an unserious patsy who’s being undone by his own pride. 

Still, it is hard to shake the sense that there is some sort of ethical dilemma here. It feels more complicated than “whatever, it's fine, sell your shares whenever.” Right?

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As a brief explainer, most secondary sales typically go something like this: Say one person starts a company, creates 80 shares in total, and grants them all to themselves.⁶ When they want to raise money, they might decide to sell 20 percent of the company for $20 million dollars, which would value the startup at $100 million. For a variety of reasons, rather than selling 20 percent of the existing shares, the company will create 20 shares out of thin air, and sell them to the investor for one million dollars each. Now, there are 100 shares, with the investor owning 20 percent and the founder owning 80 percent, with each share valued at one million dollars. 

Next, suppose that the company gets hot. Lots of people want to invest, and the market—i.e., the price that most investors are willing to pay—values the company’s shares at roughly six times their previous valuation, or $6 million a share. Two desirable investors might want to each buy 15 to 20 percent of the company at that price, and the company would like to take money from both of them. The company could create 50 more shares—for a total of 150—and sell 25 to each investor at $6 million a share, raising $150 million from each one. The founder would still have 80 shares, or 53 percent; the first investor would have 20 shares, or 13 percent; both of the second investors would have 25 shares, or 17 percent each. 

But there’s a problem with this: It dilutes the founder and the first investor by a third. Prior to the fundraise, the first investor owned 20 percent of the company; now, they only own 13 percent. Given how hot the company is, they probably want to raise less money and keep a larger share. And the prospective investors are unlikely to buy smaller amounts—say, eight percent each instead of 17 percent—because VCs typically don’t want to invest in companies if they can’t acquire a meaningful stake. 

One potential solution—and by far the most common one—is to reject one of the two investors. Create only 25 new shares instead of 50, sell them all to one investor for $150 million, and tell the other investor that you’d love to have them involved in the next round.⁷ 

But a second solution is for existing shareholders to sell some of their shares directly to the second investor. In this case, the company still creates 25 shares, and sells them to the first investor for $150 million. And then other shareholders—most likely the founder—sell 25 of their shares to the second investor for another $150 million. 

In both cases, the company ends up in the exact same spot: It’s valued at $750 million dollars; there are 125 outstanding shares worth $6 million each; it has $150 million in the bank; the first investor owns 20 out of 125 total outstanding shares, or 16 percent of the company. The only material difference between the two scenarios is that, in the second case, the founder has $150 million.

And that’s bad, because, as Jason Lemkin says, the founders will be checked out? I think?

I have so many questions, but let's start with this one—if you founded a company, raised money from venture capitalists, and then won $150 million in a lottery, is it unethical for you to cash in the winning ticket? 

I mean, I guess you could argue that it is? At some point before you won the lottery, you probably promised your investors that you were on a mission to create a big, industry-defining company. You probably told them that you were an ambitious builder with a proven track record of success, showed them a five-year plan for growing your company into a billion-dollar unicorn, and said that they were singularly committed to doing everything they could to make everyone involved—you, their team, and themselves—very wealthy.

And if you were suddenly $150 million richer, you’re changing the terms of the deal? When you took their money, you were relatively poor. That poverty made you desperate; that desperation made you hungry; that hunger made you a useful vehicle for highly-speculative capital deployment. If you cash in your lottery ticket, the first part of that won’t be true—you will be rich and not poor—and the second part might not be true—you could become a satiated fat cat with a house in Cabo San Lucas, wasting away in Margaritaville. And because you raised money on the implicit promise that your startup was the thing that could take you from being poor to being extraordinarily wealthy, and because, if you have a $150 million dollars, your startup can only take them from being extraordinarily wealthy to dynastically wealthy, you have a moral duty to turn it down. 

Like, someone could argue that, but nobody would? Because it would be insane? Your investors might be quietly bummed if you hit the Mega Millions jackpot, and they may have a conversation with you about how motivated you are to continue working long and taxing hours, but surely they would never go so far as to say that you owe it to them to light your light the ticket on fire, because not doing so could, in indirect and hypothetical ways, harm their investment? Making that argument would not only require a VC to believe that founders are a kind of indentured servant, and that investors have a perpetual claim on their labor until they pay it back with sufficient time or a sufficient exit; nor would it just require believing that founders should maximize their investors’ returns over their own; it would also require believing that founders should maximize their incentives to maximize their investors’ returns. It is not enough for a founder to merely want their startup to succeed; they have to need it to succeed.  

And that seems wrong? Like capital W-wrong? In effect, it’s telling someone that they have an obligation to throw away a winning lottery ticket because it could change the odds that their ticket is a winner too. But—and this is a real question, not a troll—how is pressuring founders not to sell secondary shares, when, as in the toy example above, the round is oversubscribed and it has no material effect on the balance sheet of the business, not doing the same thing? 

The easy answer, I suppose, is that secondary sales are undeserved. The company isn’t big enough or durable enough to justify the founder making money on it yet. I guess, but winning the lottery would be pretty undeserved too? And also, are secondary sales that undeserved? Boufarhat, for example, created something big that the people valued at $150 million dollars, and sold it to “willing buyers at the current fair market price.”⁸ When Bill Ackman top-ticked a market in 2023, the All-In podcast—VCs, all of them, and as representative of elite Silicon Valley opinion as anyone—hailed him as the investor of the year. If the money he made from selling an overvalued asset to consenting counterparties is worthy of a Bestie, why is Boufarhat’s sale of an overvalued asset to consenting counterparties morally reprehensible?⁹ That’s not to say every free-market transaction is fair and just, but shouldn’t those of us who work in the venture capital ecosystem, of all places, at least default to accepting the market as the arbiter of what is?

Moreover, we seem to selectively choose how to view rich founders. On one hand, if founders make a bunch of money through secondary sales, they risk becoming lazy and unfocused. But if founders have a bunch of money, we will eagerly write them checks. Former Salesforce CEO Bret Taylor, who probably isn’t poor, raised $110 million dollars in one round for his new startup. Elon Musk—the literal richest man in the world—will have no problem raising money for his $6 billion dollar AI startup. And while there’s lots to question about Sam Altman’s effort to raise $7 trillion dollars for his AI factories, nobody is saying they won’t invest because they’re afraid he’ll get distracted by the casual half-billion dollars he’s going to make from the Reddit IPO. Again, this isn’t to say that money isn’t a powerful incentive; it’s to say that “money is demotivating” is, at best, inconsistently and opportunistically applied. 

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Another argument people could make against secondary sales is that, as a founder, you owe it to your investors to not take the money. As Lemkin says, “they took a huge bet on you. That used to be a big deal.” They have your back and you should have theirs. “Founders that put themselves last like this, I put first. I’ll have their backs forever. No matter what the outcome or returns.”

But is that argument not self-impeaching? How can a VC simultaneously discourage a founder from cashing in a $150 million dollar lottery ticket—because it might, hypothetically, distract them from maximizing the value of the VC’s investment—say, in the same breath, that they will always have the founder’s back, no matter their own returns? 

Ultimately, rightly or wrongly, most VCs are going to make decisions that protect their investment over a founder’s financial well-being. Sure, they will support their honorable founders as professional friends, making introductions, posting nice things on LinkedIn, and offering their drive-by advice. But in more material ways—like writing checks, structuring investment terms, and deciding when to fire a founder—well, that’s business.

Which, fair! It is business! But then should secondary sales not be judged by the same financial ruler, and not an ethical one?

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The final main argument against secondary sales, which Lemkin also mentions in his post,¹⁰ is that they’re unfair to the company’s employees. Most people join startups because they believe in the company’s potential and the future value of its equity; if founders check out—which, again, is a hypothetical—they’re defaulting on their promises to the people who are gambling the most on the company’s success. 

Which isn’t exactly an argument against founders’ selling; it’s an argument—and a very convincing one—against what founders do after they sell. But founders can work hard for their employees and investors—chase a big, industry-defining company, keep their T2D3 plan, remain singularly committed to doing everything they can to make everyone involved very wealthy—whether or not they’re keeping time with a Casio or a disco ball made of diamonds.

Still, I understand the perception. If I worked at Hopin, and found out that Boufarhat had taken home $150 million in secondary sales, would I be upset? My guess is yes, though perhaps not because he sold, but because he either sold and disappeared, which there’s no evidence that he did, or because he sold some of his shares and didn’t give me a chance to sell some of mine too. 

The good news is that this suggests a possible resolution to all of this: Secondary sales are fine, so long as everyone in the company is told about them. Give employees an implicit veto over selfish and undeserved sales, by subjecting them to the court of public opinion.

The most useful heuristic I ever found for making backroom decisions was this: Assume everyone will find out. Assume the decision is public, in Slack, on Twitter, and written up in The Verge. Assume that, partly because it may well be public one day,¹¹ and mostly because it will compel you to do the right thing. “You can lie to yourself and your minions; you can claim that you haven't a qualm; but you never can run from nor hide what you've done from the eyes” of your employees.¹²

So if you’re a VC, let people sell. But let employees, who aren’t just betting one piece of their portfolio on their executives but their entire careers, decide if a sale will cause them to check out. Let employees, who are logging the hours, decide if it’s fair that leaders got to sell and they didn’t.¹³ And let employees, who have a better appreciation of a founder’s work—or lack thereof—than anyone, decide how much they’ve earned. 

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Some personal-ish news

To address the obvious question that some of you may have: Yes, I sold some Mode shares in a secondary sale; no, it wasn’t nearly as much as any of the sales that make the news (or nearly as much as many of the sales that don’t); no, I didn’t announce it to the company because these things tend to be done quietly by default, though in hindsight, I think that would’ve been the right thing to do; yes, I probably wish I could’ve sold more. 

I would’ve sold more for one primary reason: If you gambling at a casino for years, with all of your chips on the table the whole time, the stress will eventually eat you alive. Nothing is more terrifying than knowing you could still walk out a loser; nothing will burn you out faster than wondering if your payout for years of work will be years of regret. Like, sure, stay motivated; stay ambitious; all of the clichés. But there’s a fine line between being hungry and being starved, and you’ll make good decisions and be a good leader on only one side of it. 

1. Or, as TechCrunch put it in a staggering understatement, “COVID-19 was an accelerant for Hopin, it appears.”

2. “Life's too short to not go for broke, so everybody, everybody, go berzerk.”

3. Though this was probably also predictable, since I’ve heard rumors that one of Hopin’s major late-stage investors pitched hot companies by promising that they’d do very little diligence before they offered them a term sheet.

4. Oh, and what a time we had
I drunk the drinks, I shook the hands
And I believed the plan, oh
But it broke my heart in 150 million ways.

(New Griff! Leave this dumb blog! Go listen!)

5. Eh, maybe. Investors may actually see Boufarhat’s initial success as nothing more than an incredibly good luck, since started a company that perfectly timed and was perfectly positioned to monetize the biggest global event of at least the last two decades. That one is gonna be hard to run back.

6. This entire bit is an oversimplification that ignores option pools, share classes, and a bunch of other complications, but close enough.

7. “It’s a bit too early for us, but we’ll be rooting for you from the field.”

8. Margin Call is a bit of a cult movie in Silicon Valley, and Jeremy “Sell it all!” Irons is the hero, not Kevin “Yes, but at what cost?” Spacey.

9. Of course, if he torpedoed the company after selling, sure, that’s different. But there’s no evidence that he did, and he only sold 20 percent of his shares. At least eighty percent of his paper net worth was still tied in Hopin equity.

10. Well, sort of. Lemkin does say that the team should comes first, but kind of contradicts this point by never explaining why secondary sales are bad for them, and only talking about why they’re bad for investors. “The investors make nothing, the product is in trouble, and yet the founder cashed out $100m+ and moved to the beach in Spain.” (In the linked podcast, he mentions tender offers for employees, but he still says it's investors who are getting abused.) And that kind of gives away the game, doesn't it? No matter what investors say, they’re mostly focused on their return.

11. For example, one of our lawyers physically mailed Mode’s entire capitalization table to the wrong employee’s house. 

12. Like I said, a banger.

13. And let them sell too? Boards typically don’t allow this, but if founders had to tell employees about secondary sales, things would probably move toward a more inclusive equilibrium.