Doing The Right Thing In A Recap

Six weeks ago I wrote a post titled The Silliness Of Recapping Seed RoundsI described a situation that occurred in one of our FG Angels investments that I thought was short sighted on the part of the VC involved and the CEO of the company. I characterized the situation as “silly” and specifically didn’t call out the people as my goal was to be instructive around the startup landscape, not to complain (we are big boys and will deal with whatever) or to try to generate a different outcome. I accepted what happened, wrote my post, and moved on.

Over the next few days I had a few emails and phone calls with the VC and the CEO. I was told that my post generated some attacks, both professional and personal, and plenty of thought and reflection on the situation.

I was willing to engage (even though I said I was done in my post) due to my “fuck me once” rule. If you aren’t aware of it, I wrote a chapter about it in Do More Faster (although Wiley made me call it the “screw me once rule.”) While the exchanges had a little emotion in them, they were generally calm and rational.

At some point, I was asked directly by the CEO what I would have done in the situation. My answer was simple – I would have given the early seed investors some percentage of the company as part of the financing. Given the amount raised, the new financing, and the cap, I would have asked the seed investors to waive the terms and instead accept a smaller percentage of the company than they would have otherwise gotten. Instead of pricing the new round at $100,000 pre-money (effectively wiping out the several million dollars of seed money already raised and spent), I would have set a higher pre-money but sized it to be reasonable given all the other dynamics.

When asked what the range I would give to the seed investors post financing, I said 10% – 15%. I didn’t do spreadsheet math to get there – I just figured that the economics of the round ended up with the seed round getting about 33% (the max I think most seed rounds should end up getting) and then take meaningful dilution from there.

The CEO committed to doing something here, which I told him I respected. Yesterday, I got the docs giving the seed investors, which included the FG Angels group, 12% of the post money cap table.

I’m glad the CEO and the VC investors did the right thing. I also appreciate it as it sets an important tone in the seed stage ecosystem. And, most of all, I’m happy to give them all another chance in my book.

  • Matt Kruza

    Very fair outcome. Pretty much happened because other people called them out right? That is the benefit of transparency even though you didn’t have to do it directly

    • I’m sure the post had some impact, but I don’t know the level of causation vs. correlation.

  • Travis_D

    Sounds like there are two scenarios: (1) The CEO was open to the idea to begin with; or (2) the quasi-anonymous shaming caused a reversal. #2 definitely fits your “fuck me once rule”…. but #1 sounds like a breakdown in transparent communication between CEO and investors — a failure of both parties?

    So my question: How much of this could’ve been avoided through better upfront discussions?

    • Lots could have been handled through more clarity in the communication up front (including from me).

      • Ah communications – that dreadful word that often fixes much when given a chance! 🙂

        This was a very cool story to share.

  • Michael_blend

    Curious…does your same philosophy hold true for early employees who hold common shares? I have seen (and had happen to me) the common get wiped out in a recap, followed by a 5x up round 6 month later

  • Daniel Kraft

    Looks like a lot of stepping up has happened. Admitting to be wrong (or at least off) by one side, giving another chance on your side. Feels a little like applying “give first” on a different level (forgive first). Have been on both sides and know it forms character.

  • Well done! If seed recap becomes a common practice, it will effectively screw up the entire ecosystem of angel funding. I’m glad too that the CEO and the VC investors chose to do the right thing as well, I hope this starts a permanent trend.

  • Smart move over the long term, and most probably a lesson learned along the way. Nice to see that moral fibre is still alive and well with some people.

  • Great blog! Nice! Yep bad behavior (or mistakes, as sometimes not always seeing full impacts) can often be reversed with proper conscience, integrity, and action to do so. Kudos to the CEO and VC that fixed this bad deal to now a more decent deal. Let them be an example.

    Screwing people – especially when obvious – is just plain wrong, and there’s usually always ways to compromise in a more right way.

  • David Wieland

    Thanks for helping us out on this one, Brad. I was very disappointed by the shitty recap terms, shitty suddenness, and generally shitty communication leading up to the recap. Chalked it up to an inexperienced CEO and greedy investors.

    Was later quite surprised by the “thank you” to early investors, which was clearly a response to your article. Drinks on me sometime.

    • Kind of like Brad’s “fuck me once” rule, you only get to use the “inexperienced CEO” card once. I’m glad you used it wisely.

      Props to the early investors who thanked you. Count them as wise, cultivate them and you’ll likely be surprised again.

      Remember to always pay it forward.

      • David Wieland

        Donald, to be clear, I am not the ceo. I’m an investor in brad’s syndicate who invested in this deal.

  • As they say in french, Tout est bien qui finit bien.
    Or, All’s well that ends well.

  • Amazing! Really impressed the CEO and VC(s) came around here… their reputation lives to see another day.

  • Chris Tragos

    Piling on with Michael Blend’s unanswered comment – I was part of the entire founding team whose common got wiped out. Since everyone is getting ‘fucked’ in a recap, I’m thinking the preferential treatment of VC preferred holders over founder common holders is really less about doing the right thing and more about leveraging a future financing carrot. But I suppose why not if you can do it – shows your co-investors that you can mitigate some of the risk.