Last week, Acquia's executive team prepared breakfast for the 300 or so employees in our Boston office. It was a lot of fun. A tradition that we started a few years ago to thank everyone for their efforts.
The web felt very different fifteen years ago, when I founded Drupal. Just 7 percent of the population had internet access, there were only around 20 million websites, and Google was a small, private company. Facebook, Twitter, and other household tech names were years away from being founded. In these early days, the web felt like a free space that belonged to everyone. No one company dominated as an access point or controlled what users saw. This is what I call the "open web".
But the internet has changed drastically over the last decade. It's become a more closed web. Rather than a decentralized and open landscape, many people today primarily interact with a handful of large platform companies online, such as Google or Facebook. To many users, Facebook and Google aren't part of the internet -- they are the internet.
I worry that some of these platforms will make us lose the original integrity and freedom of the open web. While the closed web has succeeded in ease-of-use and reach, it raises a lot of questions about how much control individuals have over their own experiences. And, as people generate data from more and more devices and interactions, this lack of control could get very personal, very quickly, without anyone's consent. So I've thought through a few potential ideas to bring back the good things about the open web. These ideas are by no means comprehensive; I believe we need to try a variety of approaches before we find one that really works.
It's undeniable that companies like Google and Facebook have made the web much easier to use and helped bring billions online. They've provided a forum for people to connect and share information, and they've had a huge impact on human rights and civil liberties. These are many things for which we should applaud them.
But their scale is also concerning. For example, Chinese messaging service Wechat (which is somewhat like Twitter) recently used its popularity to limit market choice. The company banned access to Uber to drive more business to their own ride-hailing service. Meanwhile, Facebook engineered limited web access in developing economies with its Free Basics service. Touted in India and other emerging markets as a solution to help underserved citizens come online, Free Basics allows viewers access to only a handful of pre-approved websites (including, of course, Facebook). India recently banned Free Basics and similar services, claiming that these restricted web offerings violated the essential rules of net neutrality.
Beyond market control, the algorithms powering these platforms can wade into murky waters. According to a recent study from the American Institute for Behavioral Research and Technology, information displayed in Google could shift voting preferences for undecided voters by 20 percent or more -- all without their knowledge. Considering how narrow the results of many elections can become, this margin is significant. In many ways, Google controls what information people see, and any bias, intentional or not, has a potential impact on society.
In the future, data and algorithms will power even more grave decisions. For example, code will decide whether a self-driving car stops for an oncoming bus or runs into pedestrians.
It's possible that we're reaching the point where we need oversight for consumer-facing algorithms. Perhaps it's time to consider creating an oversight committee. Similar to how the FDA monitors the quality and safety of food and drugs, this regulatory body could audit algorithms. Recently, I spoke at Harvard's Berkman Center for the Internet and Society, where attendees also suggested a global "Consumer Reports" style organization that would "review" the results of different company's algorithms, giving consumers more choice and transparency.
Gaining control of our personal data
But algorithmic oversight is not enough. In numbers by the billions, people are using free and convenient services, often without a clear understanding of how and where their data is being used. Many times, this data is shared and exchanged between services, to the point where people don't know what's safe anymore. It's an unfair trade-off.
I believe that consumers should have some level of control over how their data is shared with external sites and services; in fact, they should be able to opt into nearly everything they share if they want to. If a consumer wants to share her shoe size and color preferences with every shopping website, her experience with the web could become more personal, with her consent. Imagine a way to manage how our information is used across the entire web, not just within a single platform. That sort of power in the hands of the people could help the open web gain an edge on the hyper-personalized, easy-to-use "closed" web.
In order for a consumer-based, opt-in data sharing system described above to work, the entire web needs to unite around a series of common standards. This idea in and of itself is daunting, but some information-sharing standards like OAuth have shown us that it can be done. People want the web to be convenient and easy-to-use. Website creators want to be discovered. We need to find a way to match user preferences and desires with information throughout the open web. I believe that collaboration and open standards could be a great way to decentralize power and control on the web.
Why does this matter?
The web will only expand into more aspects of our lives. It will continue to change every industry, every company, and every life on the planet. The web we build today will be the foundation for generations to come. It's crucial we get this right. Do we want the experiences of the next billion web users to be defined by open values of transparency and choice, or the siloed and opaque convenience of the walled garden giants dominating today?
I believe we can achieve a balance between companies' ability to grow, profit and innovate, while still championing consumer privacy, freedom and choice. Thinking critically and acting now will ensure the web's open future for everyone.
(I originally wrote this blog post as a guest article for The Daily Dot. I also gave a talk yesterday at SXSW on a similar topic, and will share the slides along with a recording of my talk when it becomes available in a couple of weeks.)
Contributed modules in Drupal deliver the functionality and innovation proprietary content management solutions simply can't match. With every new version of Drupal comes the need to quickly move modules forward from the previous version. For users of Drupal, it's crucial to know they can depend on the availability of modules when considering a new Drupal 8 project or migrating from a previous version.
I'm pleased that many agencies and customers who use Drupal are donating time and attention to maintaining Drupal's module repository and ensuring their contributed modules are upgraded. I believe it's the responsibility of Drupal companies to give back to the community.
I'm proud that Acquia leads by example. It was with great pride that Acquia created a Drupal 8 Module Acceleration Program, or MAP. Led by Acquia's John Kennedy, MAP brings financial, technical and project management assistance to Drupal module maintainers. Acquia kicked off MAP in mid-October and to date we have helped complete production-ready versions of 34 modules. And it is not just any modules; we've been focused on those modules that provide critical pieces of functionality used by most Drupal sites.
When MAP was formed Acquia allocated $500,000 to fund non-Acquia maintainers in the community. In addition, we have so far invested more than 2,500 hours of our own developers' time to support the effort (the equivalent of three full-time developers).
What is impressive to me about MAP is both the focus on mission-critical modules that benefit a huge number of users, as well as the number of community members and agencies involved. John's team is leading a coalition of the best and brightest minds in the Drupal community to address the single biggest obstacle holding Drupal 8 adoption back.
Drupal 8 has already made a significant impact; in the 90 days following the release of Drupal 8.0.0, adoption has outpaced Drupal 7 by more than 200 percent. And as more modules get ported, I expect Drupal 8 adoption to accelerate even more.
Yesterday, the White House announced a plan to deepen its commitment to open source. Under this plan, new, custom-developed government software must be made available for use across other federal agencies, and a portion of all projects must be made open source and shared with the public. This plan will make it much easier to share best practices, collaborate, and save money across different government departments.
However, there are still some questions to address. In good open source style, the White House is inviting developers to comment on this policy. As the Drupal community we should take advantage and comment on GitHub within the 30-day feedback window.
The White House has a long open source history with Drupal. In October 2009, WhiteHouse.gov relaunched on Drupal and shortly thereafter started to actively contribute back to Drupal -- both were a first in the history of the White House. White House's contributions to Drupal include the "We the People" petitions platform, which was adopted by other governments and organizations around the world.
This week's policy is big news because it will push open source deeper into the roots of the U.S. government, requiring more government agencies to become active open source contributors. We'll be able to solve problems faster and, together, build better software for citizens across the U.S.
I'm excited to see how this plays out in the coming months!
As founders of startups raise money from investors, their share of the company gets "diluted". This means the percentage of the company they own gets smaller and smaller. Last month a friend asked me the following question: "What do you believe would be a good equity position as a startup founder after a Series A? I don't want to be diluted too much.". This week, another friend who is in the process of raising money asked me if he should accept certain "preferences" from his potential investors in favor of a higher valuation and less dilution.
My answer to both friends was: "Well, euh, it's complex!". Because I get asked about this regularly, I decided to write a blog post about this. In this blog post, I'll discuss the dilutive effect of (1) of multiple rounds of funding, (2) reverse vesting, (3) options pools, (4) pro-rata rights and (5) liquidation preferences.
Raising Series A
Let's assume that we have a company, and that our company raised four rounds of financing the past five years:
|Series A||Series B||Series C||Series D|
"Pre-money valuation" refers to a company's valuation before it receives outside financing, while "post-money valuation" refers to the company's value after the capital injection. So, the post-money valuation is the sum of the pre-money valuation plus the capital raised. The pre-money valuation of your company, along with the amount of capital raised will determine the founders' dilution.
If our company raises its first round of funding (Series A) with a pre-money valuation of $4 million and the Series A investors were to commit $1.3M, the company would have a post-money valuation of $5.3 million. In the example, the Series A investors would receive 25% of the company ($1.3 million is 25% of $5.3 million).
|Series A investors||25%|
In an earlier blog post, I recommended a specific formula for deciding how much to give up to an investor in each round. For consistency, this post follows that formula. I consider this formula to be an ideal scenario, and recognize that most founders will be in a situation where they have to give up much more, or even be in a situation where they want to give up more. Don't get hung up on the actual numbers used in our example.
You would think that in our example, the founders would be left with 75% of the company after raising their Series A. Unfortunately, this is not usually the case; investors will often insist that an "option pool" is created. An option pool is an amount of the startup's common stock reserved for future employees. Investors expect the employee option pool will equal 10%-20% of the company post-investment; they also expect these shares will be set aside from the founders' equity.
Let's say that the Series A investors' term sheets requires a "15% fully diluted post money option pool" to be setup. This means that the investors want 15% of the company, after the financing is closed, to be in an option pool that will be granted to future employees. The "capitalization table" of our company after the Series A would look like this:
|Series A investors||25%|
|Employee option pool||15%|
The bottom line is that instead of owning 75% of the company, the founders will end up owning 60% of the company, and the investors 25%. For the founders, the $1.3 million financing was not 25% dilutive but 40% dilutive.
As an entrepreneur, I think it is flawed to take the option pool out of the founders' equity; the option pool should be carved out after the financing and dilute both the founders and the investors. After all, future employees who are granted options after the financing add value to the post-money valuation of the company. I'll leave that gripe for another blog post but for the purpose of this blog post, the key take-away is that creating an option pool is usually dilutive for the founders and an important part of the negotiation with investors. The option pool size and the pre-money valuation need to be looked at together and can both be negotiated. Investors should price on the basis of a complete team needed to execute on the opportunity. If the founders have done a good job of hiring that team, the pool size should be smaller. If there are still a lot of hires needed to create a full team to execute, then the pool needs to be larger.
Stock options provide employees the right to purchase a set amount of shares for a set price in the future. To encourage employees to stick around, they don't gain control over their options for a period of time. This period is known as the "vesting period". Once the options are vested, they can be exercised. When you exercise the stock options, you buy shares in the company, usually at a very low price.
Founders are different from employees because they received their shares when they started the company -- they don't usually have stock options. To make sure that founders stay with the company, investors will set up a "reverse vesting" strategy. This is similar to "stock option vesting" except that it gives investors the right to repurchase shares already owned by the founders. The "vesting period" in this context measures how many shares the company can repurchase from a departing founder. The longer a founder stays with the company, the less stock the company can repurchase if a founder were to leave.
A founder who remains with the startup through the end of a particular vesting period -- typically four years -- will be fully vested and retain all founder's shares. The founder who leaves before the vesting period expires will most likely be diluted as the company repurchases some founder's shares.
Raising Series B
As our company grows and the time comes to raise a Series B, the expectation is that the valuation of our company has increased. Let's assume we used that $1.3 million well, and that the value of the company grew from $5.3 million to $13 million.
If we raise $3,250,000 additional capital in a Series B financing on a pre-money valuation of $13 million, then the series B investors will get 20% of the company. In the Series B, the founders, the employees (option pool), and Series A investors are all diluted. Often the new investors will require that the option pool is increased. Let's say they want the option pool to remain at 15% -- in this case, the founders, employees and Series A investors would suffer additional dilution on top of the 20%. In our example, the total dilution will be a little over 23%. The new capitalization table looks as follows:
|Series A||Series B|
|Series A investors||25%||19%|
|Series B investors||20%|
|Employee option pool||15%||15%|
It's not always as simple though. Investors will usually insist on "pro-rata rights". Pro-rata rights give investors the right to invest in a startup's future rounds and maintain their ownership percentage as the company grows and raises more capital. It is an important tool for early stage investors, as most of their investments fail. Pro-rata rights allow investors to "follow" the investments that are doing well. Their ability to double-down on winners is important to compensate for their losses. I believe it is fair to give early investors pro-rata rights; they are a reward for backing you early. But as I've learned, this is also where things get complicated.
At times, new investors don't want older investors to participate so that they can take more of the round. Usually, the new investors will insist that they put enough money to work so they can own a substantial-enough share of the company to make the investment worth their time and effort. In this case, the new investors will try to force the old investors to give up their pro-rata rights. Other times, the new investors want early investors to demonstrate their confidence in the company by participating in the round, and to show that they are not overpaying. To facilitate the "pro-rata dance" between investors, and to satisfy both the old and new investors, founders are often required to take more dilution and to give up more of their company. For simplicity, I ignored pro-rata rights in our running example, but founders need to be aware of how pro-rata rights can impact dilution in later funding rounds.
Raising Series C and Series D
Our company continues to grow and goes on to raise Series C and Series D:
|Series A||Series B||Series C||Series D|
|Series A investors||25%||19%||15%||14%|
|Series B investors||20%||16%||15%|
|Series C investors||15%||13%|
|Series D investors||10%|
|Employee option pool||15%||15%||15%||15%|
In our example, the founders would end up with 34% of the company after four rounds of financing (assuming no additional option grants for the founders). As mentioned above, I consider that an exceptional outcome for the founders. Most founders will own substantially less at this point. For example, Aaron Levie, founder of Box, owned about 4% of Box when the company made its public offering in 2015. Zendesk founder and CEO Mikkel Svane owned about 8% at its IPO in 2014, and ExactTarget's co-founder owned 3.8% at the time the company filed its S-1.
But there is more -- I warned you it's complex! When investors put money in your company, they will require the company issue them "preferred stock". Investors' preferred stock has various "preferences" over "common stock", owned by founders and employees. One of the most common preferences are "liquidation preferences". A liquidation preference helps investors make sure that they'll be paid before common shareholders when a company is sold, declares bankruptcy, or goes public. This is especially important when the company is being liquidated for less than the amount invested in it.
If our company was to sell for $75 million, you would think that per the table above, the Series D investor would make $7.5 million (10% of $75 million) and the founders would make $25.5 million (34% of $75 million). However, if our Series D investor negotiated a "liquidation preference" equal to their $10 million investment and the company is sold for $75 million, they will be guaranteed their $10 million back. The remaining $65 million would go to the other shareholders. This is called a "1x liquidation, non-participating preference". In the event the company sells for less than the valuation at the time of the investment, the Series D investors will make more than their percentage ownership, and the founders will make less than their percentage ownership. In other words, when your investors have liquidation preferences, your percentage ownership isn't always what it looks like on paper (or in a capitalization table, to be exact).
Sometimes, investors want "participation rights". In the case of "participation rights", the investors would be entitled to the return of their entire investment prior to the distribution of any proceeds to the common stockholders. However, the preferred stockholders would then also be treated like a common stockholder and would share in the remaining proceeds. If our company sells for $75 million, the Series D investors would get their $10 million out first, and then get their 10% share of the remaining $65 million for a total return of $16.5 million ($10 million + 10% of $65 million).
There is also a concept called a "multiple". Where founders and employees can get really hurt is when preferred stock owners have a 2x or 3x multiple. If our Series D investors have "3x liquidation rights, participating", they would be guaranteed $30 million back (3 times $10 million) and take 10% of the remaining $45 million. The founders would make $15.4 million. Instead of their 34% share, the founders only get 20%. So, before you agree to any liquidation multiple or participating rights, you should run a few models to understand how much you and the other founders will receive based on various liquidation scenarios.
Because of the preferences, the price or market value of common stock is typically much smaller than that of preferred shares -- especially in the early days. Because common stock is worth less than preferred stock, your percentage ownership is often meaningless. This is often evidenced either by a 409(a) valuation in the USA, or the market price of common stock when sold to a third-party. Preferences generally expire at an IPO, at which time preferred stock converts into common stock. At that point, common and preferred shares have the same value.
In summary, valuations, multiple rounds of funding, option pools, reverse vesting, pro-rata rights and liquidation preferences can all have a dilutive effects on startup founders. As a founder, it can be difficult to predict or plan how much dilution you will suffer along the way. As with everything, the devil is in the details -- and hopefully this blog post helped you be a bit smarter about raising money and negotiating term sheets. In general, I don't think founders should worry about dilution too much but that is a topic for a future blog post ...