Recapping a round??

imagesBrad Feld and I had a quick email over the weekend about recapping a round.  He had heard that I agreed to do it with a company and he was surprised that I said yes.  I told him that I am beyond pissed, annoyed and angry over the entire thing but once I took a deep breath I did it because I wanted to do right by the entrepreneur.  I was pretty much the first dollar into the company at a very low valuation.  I have been there ever since from more capital to many conversations.  Probably not enough questions from their end because maybe this would not have played out as it did.

Since the company started there has been a few rounds done on one note.  I loathe that.  It is messy for everyone involved and the original investors get screwed because they really have zero idea what they own until everything converts.  The company also evolved into what it is today.  I give the entrepreneur huge kudos for figuring it out.  Then along comes a firm (which does many deals a year and will remain unnamed) and says the only way that this company can get money from them is to recap the original investors deal.  The entrepreneur owns too little of the company at this point. Due to several iterations of capital on the same note to figure out the companies direction the entrepreneur got seriously diluted.   That is why I wish more questions were asked over the many times we talked.  Perhaps I could have been of help here but too late.

How do I feel about this?  I am furious.  I feel like I got hosed.  I took a big risk by putting money in early on and now a VC with power behind them comes in and says here is the deal or we won’t let you in to our fold.  What should have the investors done?  Revolt?  What is the point of that?  Then we all lose.  So I did what I believe in first and foremost and that is supporting the entrepreneur.  The one caveat I made with the entrepreneur (which is purely blowing air) is that if this VC doesn’t secure a killer Series A for you then I will personally come out to SF and make this all public and have a showdown.  If you are going to screw me and all the investors who came in around me then you better make it something we can all feel good about in the long run because right now I am just holding my nose.

I just do not see this ending well for the entire industry.  From the SAFE and KISS documents that are like writing an agreement on a napkin to being a bully and screwing early investors is just not pretty.  Having a document to live up to (aka maturity dates and interest payments) and figuring out how to close on one note and create equity before adding another is part of the journey.  It makes the entrepreneur a better business person.  The VC that did this is shooting darts.  I am not a dart shooter.  Every thesis is different.  I think about each investment, I want to help each investment and I want to everyone to move forward with zero interest in screwing my investment colleagues.

Enough said.  I wrote on Brad’s post yesterday that I would take this conversation to my blog instead of ranting on his discussion thread.  Here is Brad’s post below.  As always a worthy read from Brad.   He calls it silly.  I agree but it is worse than silly, but I just can’t come up with the right word without being too dismissive but this VC is certainly taking advantage.

The Silliness Of Recapping Seed Rounds

Here’s the scenario. A company raises $2m of seed money from angels in a convertible note with a $6m cap. Assuming equity is raised at or above that cap, the total dilution, before the new money, is 33% (equivalent to an equity financing of $2m at a $6m post money valuation.The company spends the $2m building and launching their first product. The first release is underwhelming, but they iterate aggressively, with feedback and support from some of their angel investors. The product gets a lot better. They go out to raise a Series A, but there are no takers. The feedback is “come back when you’ve made more progress with customers.” They are running out of money.One of their angel investors, who happens to be a VC firm, decides to invest another $500,000 in the company. But instead of adding it on to the note or doing an equity round with a price, which could still be an early stage price but below the cap, they make the argument that since the company couldn’t raise a round, the company is worthless.

So they recapitalize the company. The term sheet converts all the convertible debt into a post-money valuation of $100, essentially making the convertible debt worthless. The new money comes in at a pre-money valuation of $100, but includes a complete refresh of founder equity to 40% of the company. So the new investment gets 60%, the founders get 39.9%, and the $2m of seed money gets 0.1%.

As part of this, all of the seed investors get a chance to participate in the round prorata to preserve their ownership percentage. But this equity round is going to be controlled completely by the VC who just did the recap.

Yup – this just happened to us in an FG Angels deal. It blew my mind. We signed the paperwork, wrote our investment off, and walked away. We have no interest in re-investing alongside a VC firm that doesn’t respect a $2m investment by seed / angel investors. While we understand the pressure the founder was likely under, we don’t accept the notion of the bribe where the founders get 39.9% and the investors, who put up $2m in a convertible note, get 0.1%.

Sure – it happens. It usually happens in a later round, when the company is in fact worth much less than the liquidation preference overhang and insiders use a pay-to-play and a low valuation to reset the preferences and the cap table. The founders usually get wiped out completely, but existing management usually ends up with new options for between 10% and 20% of the company. It’s not pretty, but it happens.

But in this cycle, I hadn’t seen it in a seed round.

When I made 40 seed investments between 1994 and 1996, I had a philosophy that I’d double down on a seed investment. If I put $25k into a company, it made progress, but couldn’t get to the next level where it could raise a round, I’d offer up another $25k at the same price. If I was leading a gang of friends (that’s what I called it before the word syndicate started to be used), and that gang had put in $200k alongside my $25k, I’d encourage my gang to do the same, and they often did. In some cases this turned into nothing, but in a few cases it had magnificent outcomes for me and my gang, along with the entrepreneurs. And, everyone, in either case, felt good about how things played out.

We are big boys and are fine walking away from investments that aren’t working. But it galls us when we make bad people decisions, which happens sometimes, but not that often anymore. In this case, we misread the respect – or lack thereof – that a co-investor and an entrepreneur would have for the other seed investors and the seed capital that helped them get a product built and into customer hands.

While I wish them well as a company, the individuals are no longer part of our gang. And the VC is a firm we have no interest in ever working with again. The entrepreneur and the VC may not care at all, and that’s fine with us, but we’ll remember the behavior for a long time.

In a single turn game, this might be rational behavior. But in a multi-turn game that lasts for a very long time, across multiple contexts, this is a bad strategy. And developing a reputation for recapping seed rounds is, in my book, silly.

Comments (Archived):

  1. Matt Kruza

    The situation surely sucks / is shady by the VC firm. From a technical side, I don’t really get how a SAFE or a note causes this. I mean, you still can get a cram down at any new round right? Even an equity round doesn’t leave you in a better spot… or what am I missing? I think I understand VC / angel funding at a pretty solid level, but I must be missing something, and really appreciate learning why you say that. Only semi-thought I have is with so many notes do the liquidation preferences create some extra big hang over (but this may even be wrong because a note would be debt, and an equity round would still have likely liquidation preferences). Confused here.

    1. Gotham Gal

      The SAFE note was just a throw in on my end. They are just pieces of paper that have no solidity to them. You shouldn’t cram down a round unless it is the only way to move a company forward. This was repriced at a higher valuation so my dollars in own less of the company. It was a way to insure the VC owned more and the entrepreneur owned more on the backs of the early investors by inflating the price of the note

      1. Jess Bachman

        Have you written about SAFEs before? Its not a very google-able word searching your blog.

        1. Gotham Gal

          have not.they are relatively new.

          1. russell rosenblum

            I look forward to it. I learned about them around a year ago, and was a little “taken aback” at the chutzpah. For Jess, you can find a bit more information at

          2. Gotham Gal

            Chutzpah. Perfect description

          3. Jess Bachman

            Thanks, I actually just started fundraising using SAFE, but was curious as to investors hesitation of them.

          4. Gotham Gal

            No maturity dates. No interest rates. I won’t use them.

          5. Matt Kruza

            A few years old, and when run by the most elite accelerator (rightly or wrongly) – YC, they have a lot of power. The ironic thing to me is it sounds like you may have gotten burned here, but it had nothing to do with the note, but the people (the VC and the founder involved). A SAFE would not have made it worse. Overall you have to trust the people you deal with (not lecturing as I know you understand this well. Just pointing out that even priced equity would not have stopped this in any way that I can see)

          6. Gotham Gal

            It’s all about legal documents. Trust is fine but if there is trust then put it down in the paperwork.

          7. Matt Kruza

            Fair enough. I guess agree to disagree (and I realize you have done a ton of deals, while the ones where I have had direct decision are 0 🙂 ). I guess my point, and this may go a little bit more to brad’s post than yours as I feel there are more numbers in his so I know pretty much what happened, but any legal document can be reworked. Even if you had a priced round there could still be a pretty big recap / cram down / threat to shut the company down otherwise. I don’t think notes or safe’s are causing many of the issues, except at the margins

          8. Saul_Lieberman

            Yeah, ultimately this is about the new money having the economic power to say: I don’t care what’s in the terms, do it my way or I walk. And whether that behavior is appropriate.It’s not about whether the prior investment was a convertible note or a SAFE. Could happen to the holders of preferred shares too.

      2. Matt Kruza

        Hmm interesting. Appreciate the response. The eventual answer (10+ years) is market power / funding sources will change enough that VCs as currently formulated will not exist… not just hopeful optimism, the unit economics of VC are long-term unsustainable. The storm is fiercest before the calm.

      3. russell rosenblum

        No love lost regarding the SAFE notes with me. I might prefer a “cocktail napkin” to one of these. The SAFE notes implicitly leave out investor protections. A cocktail napkins MAY leave some of it open to interpretation.As it is, I stomach (“real”) convertibles, and don’t even like those given all of the mystery, sometimes the least of which is price. I don’t even know what instrument I am getting, or what rights it will have. SAFE is just an order of magnitude (or may 2 orders) worse.

  2. Jess Bachman

    Yeah these situations are clearly gross. Id feel terrible knee-capping my angels like that.Out of curiosity, what other options would a company in this position have, prior to re-capping.

    1. Gotham Gal

      There are always options. The company is growing. This was an opportunity for them that they felt they had to take. Nothing is standard. Perhaps there were other creative ways to get the entrepreneur more equity back and to restructure the deal to move forward in a different way.

    2. Matt Kruza

      I think Brad and Joanne are talking the same deal (a little confused but I think they are). I mean what they could have done with the founders having 39.9% is basically along the line of take 29.9% for themselves, a very high amount for such a massive re-cap, and left 10% for individual investors that stood to gain 33% at the minimum ($2m on a $6m post money cap) if things have preceded well. Or even 5%. The entrepreneurs instead I would assume have burned many bridges

      1. Gotham Gal

        Not the same deal but the same VC

        1. russell rosenblum

          Well, at least they found a niche!

        2. William Mougayar

          Hmm. same VC. this prob means it’s a pattern. I sure would like to know who it is, as a warning.

          1. Gotham Gal

            Almost 50% higher than the original cap

        3. Richard Ginsberg

          So he is a Vulture Capitalist?

          1. Gotham Gal

            Nice one

        4. Yinka!

          Wow, I’d assumed it was the same deal. Exceedingly stank behaviour by the VC. I understand why you and Brad Feld declined to name the firm but I hope word still gets around so that other founders know who to avoid! That said, this situation doesn’t speak well of the founders involved, either.

        5. markslater

          no i am curious. We are out raising and i hope to god i’m not talking to them…left coast or right coast?

    3. Kirsten Lambertsen

      re-capping = knee-cappingwell done!

      1. Gotham Gal


  3. Eric Woods

    Excuse my naivete, but why does the industry allow a VC to act like they have fairy dust spewing from their tuchus? Also, is it greed or fear of ‘losing your baby’ that enticed entrepreneurs to do treat the very folks who put them in the game so unfairly? The first thing I learned in the Goldman Sachs training program was to be long term greedy – it seems like neither party has learned that lesson.

    1. Gotham Gal

      Agree. Sometimes you have no choice.

      1. Lisa Abeyta

        I’ve found that if someone is a bully FOR you, they’ll eventually be a bully TO you. I’m hoping your entrepreneur doesn’t eventually end up on the receiving side of those strong-arm tactics. Maybe I’m being naive, but I think there is always a choice. When I presented a predatory offer from an investor that would do something similar to our current investors, my cofounders all had the same reaction. “I’d rather roll up the carpet, go home and regroup than take this deal and hurt the people who helped us get here.” It was a scary thing to walk away from someone waving a check that would have given us needed runway, but we did. And it made it really, really hard. But we survived, found better investors, and continued to grow with their support.

        1. PhilipSugar

          Better said than I posted but we agree completely. If you are already in a rough spot, chances are you are going to be in another.You will get screwed

  4. PhilipSugar

    I have seen this before and it really sucks. This is one of those ones where “you need to leave the field with those you came on with”I always take the side of the entrepreneur but if you can’t get an agreement with your original investors (while you all hold your nose) then you need to turn down the round (as much as that sucks)The only thing I have seen that was left out of this conversation, is what is going to happen to the Entrepreneur and the VC in the future?? That would be my major concern as the Entrepreneur. I am going to burn my reputation and get in bed with somebody that has proven by their actions that they are really willing to screw people over. What is going to happen when we hit a rough patch in the future??? I don’t have to guess, I know.

  5. russell rosenblum

    In response to: “I agree but it is worse than silly, but I just can’t come up with the right word without being too dismissive but this VC is certainly taking advantage.”I might use, “abusive”, “usurious”, or more benignly perhaps “opportunistic”. That said, at the end of the day, if they are the ONLY ones willing to put in money, I suppose it is what it is, but I would think given a little more time, existing investors would have come up with something better to avoid a haircut that severe, otherwise you are writing off the investment anyway.

  6. William Mougayar

    Of course this sucks a lot, and it’s making me dislike convertibles. Curious, what % hair cut did you all get in this re-capping?

    1. Matt Kruza

      I don’t really get the whole hating on convertibles (in this context). Anytime you raise new money dilution can / will happen, and especially in a down type round. How is equity different? One potential argument is that in equity you have negotiated more terms around anti-dilution (but almost certainly not “full-ratchet” protection, but likely some form of weighted – anti-dilution)., but in ANY deal things can always be renegotiated. Mark has made some good arguments around being anti-notes, but it seems to be in vogue to hate on notes even when the exact logic doesn’t seem to comport. Very curious William as I know you have a lot of deal experience what perhaps I am missing here

      1. Saul_Lieberman

        agree with Matt. But maybe it’s easier to get away with this in the early rounds as the new money only has to face down the little guys. Later, it’s more likely to be a VC.

  7. Brandon Burns

    I used to read stories like this and say to myself, “Whatever, folks who do things like this don’t win in the end, so it’s all good.”But not only is that not true, we’re in a culture where Travis Kalanick, who the consensus believes is a shady asshole, is seen as the ultimate CEO.That’s when you see the toxicity of the overall startup culture is the root of the problem that lead to your investment situation, diversity issues, contract worker issues, etc. A culture that values above all else — as one investor put it to me — the unfair advantage. The thing you do / have / are that gives you a 10x leg up on everyone else. And that just makes people look for the fastest, easiest way to the most unfair advantage they can get. Taking advantage of loopholes in laws, instead of doing what’s right. Hiring people from your own network, instead of going beyond its narrow reach. And now, recapping a round, instead of honoring prior investments.That’s the culture. And you *really* feel it in SF. You’d easily walk into a coffee shop there, and overhear this story about recapping a round being told with laughs and high-fives.Sad.

    1. Gotham Gal

      Unfortunately you are spot on

    2. Kirsten Lambertsen


  8. kevrmoore

    Thank you for speaking out and taking up this fight, Joanne! Disappointing behavior if it’s one rogue institutional manipulating a green founder. But, this behavior could reverberate throughout the ecoystem with major ramifications if it was a high volume influential player in SV. Oh wait….gulp.Me thinks the pendulum has swung too far, and a shakeout is due. My bar has now been raised for seed. Play the long game. Some are optimizing for the short game, and they will likely lose in the end. Great post!

  9. markslater

    wow thats unbelievable. aweful.Reason number 1496 why i count my lucky stars i have rich levandov and colleagues as investors.

  10. David Waxman

    Please name this VC. I understand wanting to do right by the founders, but the VC should be called out so the rest of us can avoid working with him. (Going out on a limb here with my gender pronoun.)

    1. mike

      my suspicion is Keval Desai

  11. William Sacks

    Thanks for sharing Joanne. Sorry this happened. I’m just completing a round wherein I did 50 meetings across NYC, Boston and SF/Bay area. From my perspective, the difference in culture between these three ecosystems seems extreme. I’m happy to be based in Boulder where authenticity and honestly, and an appreciation of long term relationships seem to rule.

    1. Gotham Gal

      Extreme is correct

    2. Steven Kane

      please say more – in your experience, whats the differences between NY, Boston and SF?

      1. Kirsten Lambertsen


    3. Bon (Yan) Lai

      Could you share more insights on this too please?

  12. Mike Porath

    Hard to put myself in their shoes without knowing more about the company’s situation, but from where I sit this looks so short-sighted by both the founder and VC. Guessing this does not end well for either.

  13. John Minnihan

    this VC’s name is already widely known + this story is being shared directly, but privately, w/ founders

  14. BostonBizPerson

    If what you did was to participate in the down round, on a company you like, with founders you like, you did a right thing! It is never unfair for a new investor to say “after so many dilutive pivots/events this is underwater and we will only invest if there is a restart to put more of the company in founders’ hands.” If you disagree, find a different investor! If you don’t have any other term sheets, then they are quite probably correct. So many times, a company that hits bumps as it struggles will accumulate great dilution and a fat pile of liquidation preferences that exceed the company’s value. The founders are trapped yet keep struggling to make good on the company, while the investors turn a blind eye to how the stock options they are using as currency are mostly worthless. So kudos to the new VC to ensure that the balance sheet is healthy and will provide sustainable motivation to the founder. They forced everyone to mark to market. The only unfair act would then be to try to keep angels from participating at the new lower valuation. It sounds like the angels had that chance, so was the VC behavior really that bad?

    1. Gotham Gal

      it was not a down round. it was a re-capping of a round at a higher valuation to dilute the early angels to make it work for the VC.

      1. BostonBizPerson

        What am I missing? If they invest $500K for 60% post, then the pre-money is $333K. As you all invested $2M, it sounds like a down round?

        1. Gotham Gal

          You are missing nothing since I did not clarify. It was not a down round. It was a dilute round for the early investors so that the VC coming in could own a % of the company to benefit themselves.

  15. Jacob Gordon

    I feel your pain, but since when has investing been about fairness and what’s right (I certainly wish it was)? I’d love to hear the other side of this story. I don’t think people are talking enough about the fact that this company needed that VC money to survive, yes it was an unfair deal, but as everyone knows its all about survival and if the founders/investors truly felt this was a bad deal then they should put up the money themselves or find another VC. This is a risky business, shit happens, I don’t think calling people out helps (you didn’t mention them by name but you’ve started a bit of a lynch mob). Ultimately its all about learning from your mistakes and I’m sure this will help you and the entrepreneurs you back in the future.

    1. Gotham Gal

      I said that from the onset of this post. I did it because I want to support the entrepreneur. I want the company to stay afloat. No need to call anyone out by name. I write about it because everyone should learn from it. Shit happens. Very very risky business.

      1. Jacob Gordon

        Thanks for writing about it, its super educational, stories like these are the best teaching tools. I love your blog, thanks for sharing your perspective!

        1. Gotham Gal

          thanks Jacob.

  16. Conrad Ross Schulman

    Spread the word!!! Everyone spread the word!!!!!If we do something about this today, these MOFO VC’s won’t be around in 10-20 years.GothamGal, we stand here supporting you.

  17. Clayton

    One important difference with a SAFE (basically useless) and a true convertible note is preference of debt in bankruptcy over shareholders. Although you want to support founders, if you invest other people’s money, you also have duties to your investors. The IP of a non-VC financeable company could still have value. The threat of enforcing those rights as a note holder may give the early stage investor more leverage with the new money. We view a SAFE basically as just an option. Sort of interesting East Coast vs. West Coast dichotomy on this.

    1. Gotham Gal

      I get it b/c at the end of the day if the company doesn’t work out it is still like taking blood from a stone but the notes should have some meat regardless.

  18. P.K. Fields

    As for the entrepreneur I wouldn’t want to be them at the next family and friends holiday dinner.

  19. Melinda Byerley

    In the end if you have a company making money, you have the luxury of being nice, and kind.If you are losing money, it’s every man/woman for themselves, and that’s when the knives come out. Guy Kawasaki says “sales fixes everything.” True in publicly trade companies too, up until the point when the stock isn’t splitting every few months.Per Brandon’s excellent comment; Investors don’t pick founders who are “nice” or Kind or even ethical. They self select for ruthlessness and results. They make startups pay for all the legal work to do contracts, so OF COURSE bootstrapped founders will go for SAFE or other low cost solutions, because before you get to product market fit it doesn’t matter. I had all of these documents in a row upfront when I tried to raise money, to show I was an ethical person. No one cared.There are too many really wonderful and ethical founders who can’t raise money to work on a real product because the investors are so focused on this other pattern. The bad actors, the hucksters and over confident people take all the attention. And many investors want the quick buck, they don’t want to invest in a person, no matter what they say.Joanne I only know you by your excellent reputation, so I’m not talking to you specifically; but for some others who are crying tears, I am reminded of the old story: “you knew I was a scorpion when you let me on your back.”

    1. Gotham Gal

      You are right. This is extremely layered.

  20. fc

    You were lucky. In our case the CEO hooked up with one of the VCs on the board. Combined they had control and proceeded to run the company out of operating cash. They then limited rounds to two small emergency rounds to meet payroll and payables but after each raise promptly ran the cash dry. When no one wanted to put in any more money, they did the recap and wiped the board. CEO got a ton of options and a contract. Under Massachussetts law, courts defer to management decisions, so could not even sue…

    1. Gotham Gal

      it is sometimes not pretty out there.