Let Founders Cash Out

Imagine a portfolio that consisted of Facebook, Twitter, Groupon, and SecondMarket. That would be a spectacular portfolio, even if it included some later rounds. And it’s a portfolio you’d get if you invested solely in companies that cash out their founders. AirBNB just joined that group.

But in the process, they faced a barage of bad press. VC Chamath Palihapitiya argued that AirBNB’s founders shouldn’t be taking money off the table, but relented and got in on the round. And Felix Salmon calls it “evil.”

That’s unfortunate. The argument against dividend cashouts is basically that they deprive options holder of the income. That’s true, but any distribution of cash flows deprives one set of investors at the expense of another; a company that doesn’t issue much equity is hurting its creditors, for example. And a company that reduces risk hurts option holders but helps creditors.

So it’s not especially surprising that an action could help shareholders and hurt options holders. That’s part of the point of having different layers of the capital structure. Shareholders get rights that options owners don’t have (and lenders have rights that equity holders don’t have). In general, it’s better to give extra vetos to people without much upside, and executive authority to people with infinite upside.

Further, it’s important to compare risks. The founding team risked a lot more than their subsequent employees (the ones with the options). At many YCombinator startups, founders earn less than their employees(which makes particular sense given YCombinator’s model of giving up life to work on a startup—living expenses go down when you don’t have a life).

Dividend cashouts should be getting more common, as IPOs get rarer. Traditionally, a company Groupon’s size would be publicly traded, and their CEO would have been able to diversify the old-fashioned way. And while “diversification” is a nebulously invoked pro for public equity markets, it’s not often explored in context. When a CEO has “diversification,” it means being able to bet the company without betting his kid’s college fund. The AirBNB team just won’t have to worry about worst-case scenarios once they have cash in the bank.

There are practical reasons to support cashouts in the current environment, and prudent reasons for thinking that dividend-based cashouts are the most sensible choice. And then there’s the inductive argument: in most cases, things Facebook, Groupon, Twitter, etc. did differently turned out to be the right way to do things.