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In early 2005, a new company called Facebook brought in more than $13 million in investments.
This was a big chunk of change for the then 21-year-old Mark Zuckerberg, a college student who started Facebook in his dorm room. But the actual cash wasn’t the most impressive part of the investment deals.
Sean Parker, a 24-year-old computer whiz who built the music-sharing company Napster, helped negotiate arrangements with Facebook’s investors that allowed Zuckerberg to retain total control over his company — something that almost never happens for startup entrepreneurs.
If Zuckerberg had let his investors have more of a grip on Facebook’s steering wheel, they could have forced him to sell the company to Yahoo! or Microsoft, offered Facebook stock to the public, or even ousted him as CEO. In other words, if the young company founder had accepted more typical investment terms, it’s likely Facebook wouldn’t be what it is today.
This story serves as both creation myth and Holy Grail for other startup entrepreneurs. Raj Krishnan, the 28-year-old CEO we’ve been following as he launches his own biotech company, said when he brought in investors, he wanted to be sure he and his co-founders “would have at least some say in the direction of the company.” Krishnan wouldn’t say if he was after the Zuckerberg level of absolute control, but even if he were, it would be very difficult to achieve.
Entrepreneurs have been with their companies from the beginning, and so understandably are very attached to them. For many, handing over their company’s reins — even just a bit of the reins — to someone else is like a parent leaving his kid on the first day of preschool.
At the same time, entrepreneurs need money, and they usually need it fast, so they cannot be too choosy in their deals with investors. They have to give up some control, usually in the form of seats on a board that votes on the company’s actions. Company founders can be both frantic for and resistant to investors, leaving their negotiations with as much desperation and awkward navigating as a middle school dance.
Most investors won’t open their checkbooks unless they can have a say in where the company goes — a level of control that provides assurance they will make a profit off their investment.
Steve Flaim, the president of local investment firm Tech Coast Angels, said when he decides to loan money to a new company, he wants to be guaranteed a seat on that company’s board and an assurance the CEO is “coachable.”
“We need to be convinced that when we provide advice to a CEO, he’ll listen to it and act on it,” Flaim said. “If we’re not convinced senior management leaders are coachable, we won’t invest in the company no matter how good the deal is.”
Apparently that wasn’t the case for Facebook’s investors. But investors’ willingness to accept unfavorable terms only happens when an opportunity “is so attractive they will do anything to invest,” said Steve Hoffman, a serial entrepreneur who created the networking group Founders Space to help startups.
Since most entrepreneurs need money quickly, when they’re presented with an investor’s offer, they often have little choice but to take it.
“In the real world, you usually need money right now, because if you don’t get money, your competitors will move ahead of you,” Hoffman said. “So you better grab it.”
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This money-hungry desperation hung thickly in the air at the first meeting of the San Diego chapter of Hoffman’s Founders Space. As one young entrepreneur, R.J. Hernandez, tried to describe the goal of his new business, a more experienced company founder cut in.
“I can’t tell what your business does from what you’re saying, and if I were an investor, I’d walk out of the room right now,” said the seasoned — and blunt — entrepreneur, Ray Hivoral.
“When I’m listening to you, I’m going, ‘Man, I hope I don’t sound like that.’” Hivoral paused for a second, and maybe because he realized how harsh he sounded, he added, “In a good way.”
Hernandez handled the criticism gracefully, thanking Hivoral for his suggestion to get “media training,” which would help him explain his business plan more coherently. The group agreed that at its next meeting, it would use Hernandez as a case study and hopefully help him land investors.
Bringing in investors was less of a problem for Krishnan, the CEO we’ve been following: In the midst of the recession, he netted $2 million in a little over seven months.
Krishnan’s sales pitch — he hopes to figure out if you have cancer using only a few drops of your blood — probably has a lot to do with his ability to reel in investors. He is also so confident he sometimes teeters on the edge of cockiness and makes jokes constantly while still preserving the sense that he’s extremely intelligent.
If anything, Krishnan scored his investors too quickly, said Flaim, the Tech Coast Angels president who also served as an advisor and mentor to Krishnan.
“Raj is such a compelling sales person for his technology, so he would stop someone in the hallway, tell them about idea, and within three minutes that person is sold on his technology and is ready to invest,” Flaim said. “Because he’s so effective at attracting funding, he was able to quickly bring in some high net-worth individuals, but they’re not sophisticated investors.”
Flaim said while Krishnan got money from these investors, he won’t get the experienced business advice firms like Tech Coast Angels could offer. (Tech Coast Angels ended up not investing in Krishnan’s company because it likes to get in on the ground floor before a company has raised a lot of its money. Flaim said he opted not to invest his own money in Krishnan’s company, but that he “regrets it.”)
The terms Krishnan negotiated with his investors are secret, but so far he said he’s happy with how things have worked out. Krishnan counts Zuckerberg as one of his role models, but whether he’ll still be in charge of his company — and whether it will be successful — in five years remains to be seen.
But who knows? Maybe Krishnan will be the source of a new startup company creation myth. We better start thinking now about who will play him in the movie.
Please contact Claire Trageser directly at claire.trageser@gmail.com or follow her on Twitter at twitter.com/clairetrageser.