How Founders Take Back Their Companies Without Angering Investors
During the last few months, a flurry of companies have bought out their investors. Some companies are realizing that they no longer want to deliver the hyperbolic growth that investors demand. Instead, they want to build long-term, sustainable companies and not exit. If the founder is lucky, the “divorce” will be amicable.
“The last thing investors want is to drag the founder team kicking and screaming to an exit or another funding round,” said Lori Hoberman, a lawyer who provides advice to founders and VCs. “It’s not constructive. The idea of being able to buy out an investor is a really good solution to a divorce.”
Arkadium is one of the companies that broke up with its investors by buying them out. The founders hit a couple of speed bumps, which stalled its hyper-growth trajectory, but not its long-term prospects for high growth.
Jessica Rovello and her then-boyfriend, now husband, Kenny Rosenblatt, started Arkadium in 2001 just before the dot-com bubble burst. The company develops content for publishers and brands that build engagement, revenue, and traffic. Equity financing had dried up so they started the business with no outside financing. “The business has taken lots of zigs and zags along the way, but we are still very much in the gaming and engagement space,” said Rovello.
They were fortunate — then and now — to have Strauss Zelnick as a mentor. He is the interim chairman of CBS, has a private equity firm, Zelnick Media Capital, and is president and CEO of Take-Two Interactive. His advice was: If you want to maintain control of your business and have options in terms of how you work, who you hire, what you do and how you grow, then stay independent for as long as you possibly can.
During the next 13 years, Rovello, CEO and cofounder, and Rosenblatt, president and cofounder, bootstrapped Arkadium, which grew to 150 employees located in three countries, generating close to $10 million in revenue. Arkadium was hired by Microsoft to develop pre-installed games, such as solitaire, mahjong, and minesweeper on what was then its new operating system, Windows 8, introduced in 2012. Rovello and Rosenblatt thought the sky was the limit.
The duo felt the time was right to supercharge the growth of their company with outside venture funding. Like many founders, “we drank the Kool-Aid,” said Rovello. “We were very excited for introductions, an outside opinion about the business, and just to operate in a different way.” In 2013, Rovello and Rosenblatt raised $5 million from Edison Ventures in a Series A round. Because the company was already sizable, profitable, and had strong revenue growth, the founders were able to maintain majority control of the company.
Life doesn’t always happen as planned. As it turned out, Windows 8 was not the massive success prognosticators predicted. Then, in 2014, the Russians took over part of Ukraine and the US put sanctions on companies operating in Crimea. Arkadium had a 100-person team based there, which it reduced to 50 and relocated. “This was a catastrophic event,” said Rovello. Rather than selling or recapitalizing the company, the pair wanted to rebuild a high-growth but not a hyper-growth company. Arkadium and Edison Ventures were no longer in alignment.
An honest discussion and, ultimately, negotiations began. Like all good negotiations, it was a balancing act. Rovello thought that the company could have a good deal even if they were not 100% happy or significantly upset with the outcome. “You need give on both sides,” said Hoberman. And, yes, Arkadium did provide a return on investment to its investor.
Others are providing lessons in breaking up, too. Joel Gascoigne, CEO and cofounder of Buffer, a social media management platform, raised $3.5 million in a Series A round on annual revenue of $4.6 million. Gascoigne investors received a 6.2% stake in the company on a $60 million company valuation. He writes that he was able to maintain control of the company and not be boxed into an IPO five to seven years from raising funding. Because he was upfront with his investors that the company might not be acquired or go IPO, his investor asked for a right to claim a return of 9% annual interest on their investment at any point, starting five years after the initial investment. Though not unheard of, this was unusual. This clause served as a negotiating starting point when Gascoigne wanted to buy out his investors.
To buy out his angel investors, Chris Savage of Wistia, a video software company, raised $17.3 million in debt from Accel-KKR. Taking on debt is unusual in the tech sector, where the venture model is so pervasive. The company had a $32 million revenue run rate with 40% growth over the last 12 months. Wistia was able to provide a good return to its angel investors.
It’s too soon to say if buying out your investors to pursue steady, sustainable and profitable growth is a trend but market conditions could fuel a wave. According to PitchBook and the National Venture Capital, 2018 the VC industry with more than $130 billion invested in US companies, eclipsed the previous record of $100 billion set during the dot-com boom in 2000. “This is a hugely company-favorable investment market,” said Hoberman. It seems that the economy is doing well and entrepreneurs may be able to afford buying back their companies.
Will 2019 see more founders buying back their companies from investors? If yes, lessons are emerging from founders who have blazed the trail. Which path will you take?