Business Insider recently ran the story telling the world about the acquisition of Huddle, an enterprise collaboration vendor that I’ve been covering for many years. It seems like only yesterday that I was sitting down at a park in San Francisco with Huddle co-founder Andy McLoughlin, who had recently shifted from the UK to the US to grow the business. McLoughlin actually left Huddle a couple of years ago and (ironically as readers will see later on) started working as a Venture Capitalist.
According to the story, the San Francisco-based private equity company Turn?River acquired Huddle for a figure rumored to be around $90 million, a far cry from the reported $300 million valuation of its last funding round. Apparently, Huddle has struggled for some time – no surprises since the space they’re involved in (enterprise collaboration and file sharing) is hugely competitive. Everyone, from the platform players Google and Microsoft to pure play vendors Egnyte and Box, wants a piece of the action. So the fact that Huddle failed to gain escape velocity, isn’t overly damning. Indeed, the fact that they managed to get any kind of an exit should be seen as positive – far more companies fail outright than get any sort of a positive outcome.
The manner of the deal and how it happened was a little strange, however. Per the Business Insider story, the image below shows a published, and then deleted, blog post on the Huddle site announcing the acquisition.
Outside of the announcement, however, there was a depressing piece of news for Huddle investors. On Monday, the company sent a letter to its shareholders, (including employee shareholders), telling them about the acquisition. The letter also informed said shareholders, that the acquisition would leverage he “drag along” rights that preference shareholders had. Essentially what a drag along clause does (and, for any entrepreneur thinking about venture investment, this is important since most VC term sheets include them) is to give majority shareholders the ability to force minority shareholders to take a course of action. If a majority shareholder wants to accept an acquisition offer, for example, they can force all the minorities to do so.
At first blush, that sounds fair enough. After all, what minority shareholder wouldn’t want to enjoy the fruits of a successful buyout? And that’s where things get unfortunate for those people who, through the best of intentions, backed Huddle in its earliest days. You see the VC rounds introduced preferential shares, whereby the VC backers took preference in the event of any sort of a sale. This clause, highly protective for the VC’s interests, ensures that should a sale happen below a certain value, that all sale funds would come to the preferential shareholders first. What this means is that the regular old shareholders (you know, plain employees or non-professional early investors, might see nothing.) IN the case of Huddle, according to the letter sent to the shareholders:
[The] holders of Preferred Shares have a priority right to receive from the total consideration payable for the Shares an amount equal to the Preference Amount for each Preferred Share that they hold. As the consideration payable for all of the Shares is less than the aggregate Preference Amount due to the holders of Preferred Shares, no consideration is due to the holders of Ordinary Shares.
In Huddle’s case, the preferential shareholders made a decision, one that could be seen as generous if you think that way or one which might be taken as a trifling token gesture if you’re harsher in your outlook. The preferential shareholders agreed that Huddle would pay its ordinary shareholders the princely sum of $100 (yes, one hundred dollars, or about enough for a decent cup of coffee in San Francisco’s heady economy.)
A cautionary tale
As a mentor, adviser, and sometimes angel investor, hardly a week goes by without me having a conversation with an entrepreneur about their fundraising strategy. Many of these first-time entrepreneurs see a VC round as the Holy Grail, an anointing, an arrival on hallowed ground. True, VC funding can give a company the fuel to scale and grow and can be the difference between floundering and success. But like all things in life, there are two sides to every story, and it is critical that entrepreneurs (not to mention the people along for the ride) have their eyes wide open when signing a VC term sheet.
The problem in the sass industry today is growth at any cost and that means taking more money than needed. Every time an entrepreneur takes more money the less control it has.