June 3rd, 2017 | By: Jonathan Siegel | Tags: Acquisition, Exit Strategy, Customers, Planning
“Because you’re worth it.”
The L’Oréal Fallacy afflicts those founders who find themselves faced with an offer for their company and the chance of an exit.
This is the moment many have dreamed of. But life is no respecter of dreams: the potential exit is often smaller than the founder has hoped. The founder finds himself conflicted: wanting an exit, but believing that the offer on the table undervalues his work and the potential of his company.
The L’Oréal Fallacy is the belief that you should hold out for the exit you deserve—because you’re worth it.
This fallacy corrupts decision making at a crucial point—the point when monetary success is actually a tangible prospect.
First-time founders, in particular, should take their exit when they can. But you should also have a startup exit strategy in place already. Get out, go on a holiday, and then get back in the game. Instead of holding out for a better exit, move on and create one with a new product.
I had followed that path with RightCart (see Fallacy Six), taking a modest exit instead of taking investment and pursuing the VCs’ vision of multimillion success. But I would face a similar quandary with my next startup – and, this time, it would be messier.
Suddenly, after years of failure, I was hot. The success of RightCart made me the archetypal “overnight success” that has actually been ten years in the making.
People wanted to talk to me about “the future of social shopping.” Investors wanted in on the action. Other founders wanted to talk shop. But I wanted out.
As I toured boardrooms seeking an acquirer for RightCart, it seemed obvious that Amazon would be the best fit. I met with their CTO, Werner Vogels, in the fall of 2005.
I pitched him our e-commerce idea, expecting him to be enamored. Instead, he told me to stop thinking of Amazon as an e-commerce company because, under his watch, they were going to become a technology company. They would not be a buyer for RightCart.
At that time, Amazon had quietly launched something called Simple Storage Service (S3). This allowed techies to use Amazon like a giant disk drive that would never forget anything.
Not only is Amazon the largest online retailer, but it is also one of the oldest. They had been running the largest e-commerce site on the planet for, at that time, twelve years. This meant that they needed to be good at storing data. In developing its own solutions for storing vast quantities of data, Amazon (under Vogels) had realized that those solutions would be of value to the market. And, ultimately, that data storage could be of more value than its retail business.
But this was still the early days of that journey—a journey that Amazon was only starting to realize it was on. They would soon become a pioneer in cloud computing, but the term “cloud computing” had not yet even been coined.
Still, Vogels had given me a glimpse of the future. I immediately saw that Amazon’s data storage services could herald a revolution. Unlike the earlier revolution of “Web 2.0” and SaaS (software as a service), this time I was ahead of the crowd. I could see the systemic change coming.
I started using Amazon’s storage services for RightCart. Even though Amazon was in the vanguard of this area, it was not yet actually a “tech” company in practice. Besides storage, web tech required servers and networking, and Amazon hadn’t yet fully developed those. Their technology was rudimentary. So I built my own tools to help soften its rough spots.
Initially, these tools were purely for my own use, but, like Amazon, I soon saw that they could have market value. I merged the tools in a “dashboard” for managing Amazon’s cloud services and formed a company with a colleague, Thorsten von Eicken, to commercialize it. We called it RightScale.
We hired Michael Crandell—the guru who had introduced me to the utility of landing pages (see Fallacy Four) —as CEO and gave him 5 percent. That left von Eicken and me each with a 47.5 percent share.
The industry as a whole was skeptical of the value of early cloud services: the experts thought the inevitable security issues would make it difficult to build consumer confidence in the cloud (the Expert Fallacy again). But to the San Francisco founder and VC communities, it was clear that the cloud would be a new horizon. If I had thought I was hot with the recognition that RightCart gained, this was on a different scale.
Almost instantly, Crandell had an offer of $4 million of investment for the business. And I was approached with offers to buy my shareholding—at up to three times its market value. Suddenly, it looked like this was going to be my long-awaited multimillion-dollar startup exit.
In the meantime, though, once Crandell had come on board as CEO, I had stepped back from the day-to-day to concentrate on other projects. And then I got a call to come in for a meeting.
I knew a funding round was imminent, but I hadn’t heard from the team in weeks. I sensed what was coming: a cram down.
Von Eicken and Crandell sat me down and said they wanted to rebalance the equity in the company to reflect their greater workload and long-term commitment to it.
I went in to the meeting anticipating this and willing to settle for a smaller share. But they pushed harder than I expected. I gave in. I left the meeting owning just 10 percent of the company I had cofounded.
A year later, I decided to realize some of the value of that 10 percent and sell a portion of my shareholding. But they refused to release the shares.
Then they offered me a deal: they would release them, but only if I sold them to their existing investors at a value of less than one-third of what I had been offered.
I called my attorney. He laid out my options:
1. Settle and accept their offer.
2. Hold the stock, despite having no control or influence over the company’s management and direction.
3. Sue them and suffer the damage to the company’s value and to my reputation.
I was caught in a Catch-22. To get my “fair share” of the stock, I would have to sue them. But suing them would lower the value of the stock.
I was furious. I had brought von Eicken and Crandell into my company. I had been in their homes, and they in mine. We knew each other’s families. I had brought them together—and they had ambushed me. But angry as I was at the devaluation of my stock, I was more hurt that they so devalued my contribution to creating and building the company.
Either way, they had called my bluff. I took their offer and walked with just short of a million dollars.
That was far less than I was worth on paper. It was far less again than I had been worth before I had agreed to allow my shareholding to be reduced to 10 percent.
It was also far less than typically commands respect in the sector. A million-dollar exit does not generate the attention of the tech press or accolades from the founder and VC community.
I had been lulled into anticipating a multimillion exit—one that would make my name and fortune. At first, I struggled to accept that I had been denied that by some unseemly corporate wrangling. I questioned if had I made the right decision.
But as I dedicated myself to other projects—free of the mental weight of the RightScale politicking, and now protected by a million-dollar cushion—I realized that I had made precisely the right decision. And I had learned a valuable lesson in the process: don’t hold out for your ideal startup exit.
The mistakes had come earlier, and it took me years to recognize them and to be able to see things from the other side. The top-tier VCs that von Eicken and Crandell were courting did not want a substantial portion of the stock—and the associated financial reporting rights—in the hands of third parties. Having an absentee shareholder who was committed to other projects rather than the company could prejudice future financing rounds. And in any case, my early contribution to the company diminished in importance as time went on: I had put in the first sprint, but those who were building the company and steering it to steady success were putting in the real hard yards.
I wasn’t wrong to divert to other projects: that, I learned, is my strength. And I wasn’t wrong to divest substantial equity when I did so; although that laid the seed of my subsequent forced exit, it also laid the seed for the company’s success. Where I went wrong, I think, was in simple personal relations. As I had done previously with the VCs backing my games studio turned dot-com (see Fallacy Three), I had failed to keep key people abreast of my movements and my plans. That meant that when I sought to divest my stock and break with the company, it came as a shock. Both sides reacted badly and relations broke down. That was unnecessary, and it hurt.
Today, RightScale has hundreds of employees and von Eicken and Crandell continue to run the company. I have no doubt they will steer it to even greater success and, hopefully, an incredible outcome for them personally. My journey took me elsewhere, and I have no regrets about that. My only regret is that I lost the friendship of two teammates and mentors.
Meanwhile, RightSignature’s largest competitor, DocuSign, followed a radically different (and more conventionally successful) path: they raised over $500 million. That means their only way out is via what would be a record-breaking acquisition or by going public. It is all or nothing for them. In a market that has been prey to boom and bust, it is nerve-racking to watch DocuSign wait out their L’Oréal moment.
As an angel investor and a mentor and friend to younger founders, I’m regularly exposed to founders faced with an offer for their company or their stock.
This should be a cause for celebration. More often, it’s a source of stress.
This is typically their first encounter with a company valuation—the first time they have a concrete value put on their share, and the prospect of converting that share into cash.
Most founders, in my experience, think that cash value is embarrassingly low. It may be $100,000, $1 million, or $10 million—irrespective of the figure, they will quote it to me with something approaching derision, as if I might think them insane for being tempted by it.
Their perspective is distorted by two things in particular: one to do with the past of the company and the other to do with its future.
How the founders’ perspective on their startup’s value is distorted:
By the past: Only they know truly how much they have put into the company, how dependent it is on them, how difficult it has been to get this far. They overvalue their own input and therefore the company as a whole.
By the future: Precisely because they are excessively aware of how much they have shaped the company’s past, they fail to realize how dynamic and unpredictable is its future. The team, board, and investors may have facilitated the vision of the founders to this point, but that can change: their work may inhibit or obstruct the founders’ vision in the future (particularly if there is a conflict between the ambitions of investors and the founders). Unpredictable events, from economic crises to terrorist attacks to natural disasters, can knock markets radically off course. Closer to home, competitors can emerge and market trends can shift, greatly altering the perceived value of a company. Because the founders have already successfully nursed the company through a series of obstacles, they underestimate the size of the obstacles ahead.
But let’s say your perspective on these things hasn’t been distorted—but you still think the value being placed on your stake is too low – it is objectively too low, in other words. Take the offer, I say.
It proves you have a cool business head; hubris drives too many founders to self-implode in pursuit of vainglorious ideas of their worth.
It proves you can take a business from conception to exit.
It frees you to go back and start again, celebrating the raw creativity of tech entrepreneurialism unhindered by the accumulated expectations of a team and investors.
It gives you a cash cushion to support that.
You can boost your exit value through concrete, commonsense steps, such as strategically approaching potential competitors rather than blindly taking the first offer.
But be careful not to blow that first offer by treating it with derision. It may be the best offer you get. It may be the only offer you get.
Most importantly, it’s a chance to prove to the market (and yourself) that you’re a closer. You’re not simply another founder with dreams that are deeper than the market’s pockets. You’re someone who has developed and delivered a startup to an exit—a rare thing.
It may not have made you a millionaire. You may not be ready to retire. But why would you want to retire? This is what you do.
An exit gives you the chance (and some funds) to start again. You’ve had your first success: the second should be easier. Better to be out there creating anew than stewing over your first creation and trying to sweat the maximum return from it.
I’ve stopped relying on what I think I’m worth. My equity is worth what the market will pay and only worth that when the market will pay it.
Jonathan Siegel is the founder of RightCart, RightSignature, and RightScale. He is chairman and founder of Xenon Ventures, which specializes in the acquisition, acceleration, and exit of high-margin Software as a Service companies.
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