What is an earnout?

An earn out is a financial structure used in acquisitions. The acquiring company sets aside some part of the cash or stock (the "earn out") that would otherwise be paid as part of the sale. A contract, which is generally a set of targets or a formula, determines how much of the earn-out is paid out to the owners of the acquired company over time.

Usually earn outs are based on financial targets, such as revenues from the company's products.

In theory, earn outs can help lower the risk that an acquirer takes on in an acquisition, allowing the acquirer to pay a higher price, which can be especially important if there's a lot of competition for the acquisition. However, they misalign incentives between the acquired company and the larger company. For example, if most of the value created by the acquisition is due to synergies created through integration between the acquired company and the larger company, the employees incentivized by the earn out will push for more integration and promotion than might make sense for the larger company.

In practice, after an acquisition with an earn out, there is often a lot of contention over how much of the earn out is paid, which results in lawsuits. For example: http://boston.bizjournals.com/bo…

There's a saying that earn outs are "always paid, but never earned."

Did the VCs (Sequoia) force a sale of Zappos too soon?

It's very hard to have all the information as an outsider, but since Tony Hsieh believes it, I'd posit the answer is almost certainly yes.

It would seem that board members, specifically the VCs at Sequioa, believed the US economy and the financial climate for supporting busineses like Zappos had irrevocably changed and that a sale was critical to prevent collapse (which, in their minds, was high probability).

What's hard to understand is how they could be so short-sighted. This might not be entirely fair to them (and I've met with several folks at Sequioa multiple times and they've struck me as relatively smart and logical), but I think they might have drank too much of their own "RIP Good Times" Kool-Aid. Fear appeared to be the driving factor in this decision, and that's a very poor motivator.

On the other hand, if Sequoia and the rest of the board didn't believe in Tony's vision or support his unique value proposition for Zappos, then maybe he had to sell anyway, if only to find supporters/believers. I seriously hope Jeff & Amazon are those people. The message is very compelling and I'd love to see a company play by those rules and see how far it takes them.

What is a "recap" in the context of venture capital?

I am not a lawyer but my practical view of recaps is that it is an unnatural modification of the capital structure of the company.  

Imagine a current ownership structure of say 100 shares.  A "natural" course of events: you want to raise more capital so you decide to sell some more equity in the company.  The sale of 10 new shares (at any price) results in the dilution of all existing share holding (by %).   So if you as a founder held 10 out 100 shares previously you would now hold 10 out of 110 shares.   Note that I have not mentioned valuation here – it is entirely possible that this round happens at a share price less than the previous round, but that in and of itself does not constitute a recap.

However, ownership of the company can change in several other ways:

  • Investors typically seek protection from dilution by future sale prices being at prices lower than what they paid ("anti-dilution clauses" in share purchase agreements). If any such anti-dilution clauses get triggered, new shares are issued to reduce the effective share price of the protected investor and hence every body else gets disproportionately diluted.  Ownership levels have changed although no cash was raised by the company in this case.   In the above example, say 50 additional shares were issued to previous investors as a result of anti-dilution protections then you would be left with 10 out of 160 shares (100 + 10 new shares + 50 anti-dilutive shares).
  • When a company is in distress (typically), certain investors can choose to participate in a round but others may not.  In such scenarios the participating investors can choose to ascribe superior rights to the newly issued shares such that all other shares see their economic interests diminished.  In the above example, the recap could then look as follows:  everybody who bought 10 new shares get disproportionate rights to any cash at exit, and founders or important employees can get options or RSUs on a new class of shares.  So as a founder your original 10 shares could be devalued all the way to zero, or you may get a new set of shares which are in no way related to your original shareholding.  Everything is up for negotiation all over again!
  • The third (more drastic) method is when the original company is pretty much shut down and the team and/or technology re-emerges as a brand new company with new investors and brand new ownership structure.

All three scenarios (and I am sure there are others) are "recaps" and are legal minefields but have been tried and tested often enough that there is a level of comfort among practitioners and their lawyers.

How do you ensure project success?

Project completion and campaign success are 2 very different things.

One of the most common pitfalls is focusing more on the project rather than the outcome. The use of “project” as a term contributes to this.

Let’s use weight loss as an example. The person got so obsessed with practicing a certain diet. He followed it diligently, but it didn’t change his waistline.

The same goes for business. You can obsess with your logo all you want. You can obsess with building partnerships all you want.

At the end of the day, completing that project doesn’t mean you won the campaign to convince customers.

Who invested in Foursquare?


– Union Square Ventures
– O’Reilly AlphaTech Ventures
– Jack Dorsey (Twitter (product) creator)
– Kevin Rose (Digg)
– Joshua Schachter (Delicious)
– Alex Rainert (Dodgeball)
– SV Angels / Ron Conway
– Chad Stoller (friend)
– Sergio Salvatore (friend)

What does "pro rata" mean in the context of investing in a company?

It means in proportion to how much was invested. For example, if a group of three investors A, B, and C, agreed to split legal fees "pro rata", and A invested $200k, B invested $100k, and C invested $100k, and the legal fees were $10k, then A would pay $5k, and B and C would pay $2.5k.

How much money has SpaceX raised, and who from?

March 2006 – SpaceX starts with $100M in seed funding from Elon Musk himself.

August 2008 – SpaceX raises an addition $20M from Founders Fund.  FF includes two ex-PayPal guys, Peter Thiel and Dave McClure.

June 2009 – Steve Jurvetson, through his investment firm DFJ, lead an undisclosed round of financing including Founders Fund.  The round executed at least $15M of the proposed $60M.  Crunchbase says it was $30.4M, but I can't find any evidence solidly backing that up.

That puts total funding to date between $135M and $180M.

What are the parallels between attracting women and attracting venture capital?

Balance of Power – Almost always, someone is chasing and someone is being chased.  If you don't feel like you're being chased then it's pretty likely that you're the one doing the chasing.  The key is try to figure out how to be on the side of being chased vs. the other way around.  There are a lot of different ways to do this, some of which are very tangible (e.g., revenue and profits) and others which are much more intangible.

Social Proof – Guys like girls more when they know that other guys like them and vice versa.  The same thing is usually true when attracting capital.  The more an investors knows that other investors are interested in you, the more likely they are to be interested in you.  This isn't a knock on investors.  Investing is tough and knowing that other respectable people are interested in your company is a good sign that you're likely to be a winner.

It's a Numbers Game – If you're single and only go out on one date a year, you're a lot less likely to attract someone then if you go out on three dates a week.  Same is true with investors.  You want to build lots of relationships with many potential investors because, unless you have one of those rare deals where everyone wants in, many investors are likely to say no for a variety of reasons.