A new standard for optionality to beat the odds

Grays Sports Almanac for Venture Capital proposes a new risk management strategy for venture capital. In this book, I outline why a venture fund might beat the odds by purchasing 2,208 to 4,416 warrants on startups. Startups would operate under a governance framework called the Founder Friendly Standard, which gives entrepreneurs control of their companies. In exchange, the venture fund would have the option to exercise warrants for 15 years—purchasing discounted equity only in the startups that become successful.

Introduction

In 2017, Forbes published an article called, “Group of White Men in Patagonia Vests Confused for VC Fund, Raise $500 Million.” It took a while for me to realize the article was satire. A year later, researchers from Harvard, IESE, and Yale unintentionally corroborated the Forbes story with the finding that luck and past success are the winning factors for startup investors—not skill (Nanda et al., 2018). Luck and past success can cause venture capitalists to become overconfident and tinker with their portfolio companies. This can be a problem for entrepreneurs and for limited partners (often pension funds and family offices) who trust venture capitalists to invest wisely.

My path to writing this book began years ago when I was squatting in a half-vacant office in Sorrento Valley, California. I didn’t realize it, but I was about to put it all on the line to start a company, raise investment, and then lose control of the company to investors. After I left my operational role, I remained on the board. I was often outvoted as I watched the investors fumble around with “growth.” In actuality, they dragged growth down. The experience made me question everything including the age-old dilemma many entrepreneurs (including me) glaze over in order to get investment: Do you want to be rich or king?

My entrepreneurial soul-searching led me to the stories of Mark Zuckerberg, Jack Ma, Sergey Brin and Larry Page who never gave up the right to lead their companies. Yet, the early investors in Facebook, Alibaba, and Google received great returns. Looking at the Inc. 5000 list, many other founders have remained in control of their companies, especially in Europe. Is the idea that founders must choose between being “rich or king” a lie? 

Grays Sports Almanac for Venture Capital introduces a new model of investing that trades control for optionality. It presents the idea that a venture capital fund could beat the odds by purchasing 2,208 to 4,416 warrants on startups. Startups would operate under a governance framework called the Founder Friendly Standard, which gives entrepreneurs control of their companies. The venture fund would be able to exercise warrants for 15 years—purchasing discounted equity only in the startups that become successful. I believe the value exchange proposed in this book (control for optionality) is a more productive way for founders and investors to work together.