As you set out as an entrepreneur, it is important to remember that, until the day that you either sell to a big acquirer (for many times the invested capital) or you do an IPO, you should consider that common stock is worth zero.
Hard to imagine, isn’t it, because that is what you’re working for, and you keep thinking “look at all this equity that I have” or the infamous “it’s my company”. But the preferred stock that investors get is called preferred for a reason – they get all their money back, up to their investment, plus certain returns (specified in the preferences), and depending upon market conditions, those preferences can, and usually do, eat up all the money in a modest acquisition, a break even or even a collapse, where there might be some cash available to pay off investors. Remember, only 10% of VC deals go big, the rest are “break even” (for the VC) or a total loss, which means that roughly 90% of VC deals should be considered a total loss for the entrepreneur who only owns common stock.
Let’s look at that a little more closely. Here is the inside scoop on a VC’s expectations of success over their investment portfolio.
- Top 10% of deals are home runs (10X to 100X the VC’s investment)
- Bottom 40%-50% lose all of investment from the VC (collapse)
- Middle 40% to 50% = breakeven – that is the VC gets out what they put in
So, if you are the entrepreneur in a deal where the VC loses all of their investment, you can bet you don’t get anything for your common stock. If your deal is a “breakeven” for the VC, that means that their preferred stock gets back what they put in, and this is usually the case in a moderately sized acquisition, the investors with their preferred stock take all of the acquisition value. Again, the entrepreneur who only has common stock, gets pretty close to zero, except for whatever salary they’ve drawn (often at a discount!). Of course, what everyone thinks is that they will be the 10% who wins big!
My advice, plan for the big win, work for the big win, but make sure to get some preferred stock any legit way you can – my advice for how to do that when you create your company in my next post!