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Cautionary tale for investors: Parakey

September 25, 2007

Earlier this year we considered selling one of our investments and it came to light that the buyer would need our involvement in the deal on a go-forward basis.  We only own half of the business and our partner (the money) owns the other half.  Our partner was concerned that we would be able to negotiate a non-50/50 deal due to the fact that we had something the buyer wanted or needed (i.e. us).  Then I read about the Parakey/Facebook deal that took place this summer. 

Mike Arrington wrote about the deal earlier today in a post titled, "Parakey: Did Investors Get Left Out in The Cold?"  Parakey’s investors sold the business to Facebook for $4MM after pumping slightly less than $2MM in the company six months earlier.  Not a bad return, but as Mike explains they weren’t ‘popping the champagne bottles.’  Why not?  Turns out Facebook paid cash for the business (no stock), but hired the founders Blake Ross and Joe Hewitt with very handsom stock options (based on Microsoft’s recent valuation of the company $10B+ they are worth a fortune).  Fair?  Mike explains,

Some of those investors clearly weren’t happy with the fact that they were getting a 2x cash return while the founders received different, and likely far more lucrative compensation. Their preference would have been to receive Facebook shares or simply to have kept Parakey as an independent entity with a chance for a larger liquidity event down the road. But reputation matters in silicon valley and they made the decision not to disrupt the deal to avoid being labeled as difficult investors. Clearly, though, it left a bad taste in their mouth.

In this case I am not sure this isn’t a fair result.  The investors received a 2x return in six months (hardly time to build much of anything) and the founders got a great new job at the hotest web property on the net.  Basically Facebook was buying Blake and Joe out of their ‘contract’ and offering the investors a $2MM placement fee (Heidrick & Struggles would be proud).  Of course in our case we have spent years building the business and it wouldn’t seem fair to negotiate a separate deal.  But I can assure you it isn’t a cut and dry process.  The deal, to close, must include our future participation.  Should we share our future compensation with our investors?  Should we negotiate away future compensation to be shared on the frontend?  Mike sums up his post,

It is often hard to muster up much sympathy for the venture capitalists that fund all of the startups popping up in silicon valley and elsewhere. But their money keeps the system running smoothly. If they don’t see a fair return based on the risk they are bearing (most startups fail outright and are a write off), that well oiled machine could come to a grinding halt. In this case its not clear that investors were treated unfairly. They did get double their money back for a six month investment, after all. But the Parakey acquisition is an important data point that will be considered by others in the future. Just because Facebook comes knocking on your door doesn’t mean its going to be a big payday for everyone involved.

 

Written by Alexander Muse · Filed Under Blog 

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