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The Lawyers Look At The Aqui-hires « Uncrunched

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Whether an entrepreneur will be able to raise funds for a new venture will depend, at least in part, on his relationship with the investors who had funded his last venture. “When you start a company,” we were told, “the first place you look is to the people who funded you the last time.” Even if these previous investors decline to invest, their opinions will still affect the ability of the venture to obtain funding. In Silicon Valley, previous investors often vouch for an entrepreneur and also provide leads and recommendations for funding when they are unwilling or unable to invest themselves.

Entrepreneurs who aspire someday to start another venture will therefore desire to remain on good terms with their previous investors. In game theoretic terms, the relationship between the entrepreneur and the investing community in Silicon Valley is a multi-stage game where the optimal strategy may not be to maximize one’s winnings in the first round of the game. A desire on the part of the entrepreneur to maintain his reputation, we were told repeatedly, can and does serve to check his incentive to extract everything he can from the current venture. This may explain theprevalence of the acqui-hire structure, in which part of a portion of the compensation package is effectively deflected to the investors, as contrasted with the defection model, in which the newly- hired engineer keeps everything.

The power of reputation as a check on entrepreneurial opportunism appears to vary with the prominence of the investor in the original venture. If the investor is Sequoia Capital—perhaps the best-known venture capital firm in Silicon Valley—then we were told that the entrepreneur will go to great lengths to end the current venture on good terms. In the acqui-hiring context, this would mean making sure that Sequoia received a payout from the buyer large enough for Sequoia to feel as though it had been treated fairly. If, on the other hand, the investor is a small-time angel investor, then the entrepreneur will be less concerned about leaving on good terms. Such an angel investor might be unable to finance any future ventures and, moreover, would be a small enough player that any negative assessment would not generate traction in the Silicon Valley investor community.123 Between these two extremes—Sequoia and the novice angel—there is obviously a wide range. In all cases, however, it seems that entrepreneurs try to figure out, as one interviewee put it, “the lowest amount that can be paid to investors so that they don’t squawk.”

It's all game theory.

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