A new initiative from the London Stock Exchange (read here) has got the BTV team thinking… Is the creation of a special market for private companies to trade their shares publicly on the exchange on certain days a good idea or not? And, just what should a fair reward for founders look like? Our MD, Lisa Smith joins our CFO in residence, Fiona Kinghorn, in this insightful discussion.
Lisa Smith: I’m fully behind this new initiative from the London Stock Exchange. My view is that founders and seed investors make high risk investments in their start-ups, but are typically the last to see a return. They usually have to wait until the whole company is sold, as all investment up to that point is used to fund growth. This means that founders, who often sacrifice salary to start their companies, sometimes have to wait seven to nine years before seeing any pay-out. If there was a way for a founder to sell a few of their shares at each stage of the start-up’s growth, then they would have a fairer distribution of income. And more equitable income means that more people would be able to risk building a high growth business, which is better for the economy.
Fiona Kinghorn: I’m not sure I completely agree with you on the LSE’s latest plans. While it sounds like a great idea in principle, there have been numerous attempts to provide a market for unlisted companies over the years, and most of them have bitten the dust. There was the Unlisted Securities Market (USM) which was replaced by AIM, as well as the ill-fated GXG. There are complex problems with managing insider trading and market making. But I do agree that if someone can figure out a reasonably priced way to do this, it would be significant shift in the funding landscape. It would be a huge help to VC funds wanting to clean up cap tables, as well as founders wanting to realise a small part of the value they have worked hard to create.
LS: What I like about the LSE initiative is that building a secondary market is one way for shares to be sold without an arduous or expensive sales process. It also allows investors to more easily build a portfolio of investments and therefore risk-mitigate their portfolios.
FK: I wholeheartedly agree with you about ensuring that founders get more equitable share of the value that they’ve created. Typically, by the time it comes to an exit, the founders and seed investors have been significantly diluted. There are a few non-cash ways of rewarding founders such as setting up an option pool which enables founders to offset the dilution effect by enabling them to access shares at the previous premoney valuation subject to the next successful round. We could also create a put option which enables funds to sell some shares to incoming investors at the previous round price subject to certain criteria.
LS: Thinking through how to manage access to this secondary market without spooking incoming investors is an area that needs to be well thought through. I like your suggestion of a put option. This would have restrictions on proportion of shares permitted to be sold, as well as providing reassurance on specific performance concerns. But it simply cannot be a free-for-all, or else the very commitment that incoming investors are seeking from founders is dramatically reduced. There’s certainly a lot of food for thought here. I look forward to reading the BVCA’s commentary on this one!