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I've Got A Secret: How To Make Millions From A Failed Venture

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This article is more than 8 years old.

The anonymous social networking app Secret shut its doors recently, but the founders made off like bandits. Of course, they didn’t literally steal other peoples’ money, but their exit could be perceived as a sophisticated form of highway robbery.

Secret founders Chrys Bader and David Byttow conceived and started a venture that attracted millions of users and venture funding exceeding $35 million from some of the top VC firms in Silicon Valley. Among those who participated in the B-round financing were Index Ventures, Kleiner Perkins Caufield & Byers and Google Ventures.  At its peak Secret was valued north of $100 million.

Bader and Byttow exited the venture in an entirely legal way, but their method should be a stark lesson to any startup investor. As part of their Series B financing, the founders carved out a payday of $6 million for themselves—just 11 months after launching the revenue-neutral company. What? The sophisticated investors who allowed this early cash-out by the founders should be embarrassed.

In a blog post announcing the decision to shut down, Byttow wrote:

After a lot of thought and consultation with our board, I’ve decided to shut down Secret...Secret does not represent the vision I had when starting the company...Secret, Inc. still has a significant amount of invested capital, but our investors funded the team and the product, and I believe the right thing to do is to return the money rather than pivot.

“Return the money rather than pivot.” Sounds noble, right? Not entirely. Byttow and Bader have no intention of returning the $6 million they carved out of the $25 million B-round financing.

To be fair, the Secret founders are merely the poster children for an increasingly common form of Silicon Valley financing that enables founders to extract cash from investor financing. Some speculate that this practice is partially because of the crush among VCs to invest their money into the next unicorn. In the frothy tech startup market, VCs are eager to gobble up significant ownership stakes in startups with little or no current revenue. In turn, this eagerness has led to the novel strategy used by Bader and Byttow to sell some of their own shares to the zealous VCs.

Of course, there is some risk for the founders who negotiate such deals. It is possible that their ventures could become wildly successful, which means the stock they sold would be far more valuable at a future date.  Still, one wonders about the motivational effects on some entrepreneurs who, without having proven a business model, become overnight millionaires. My hunch is that the motivation to persevere through the inevitable trials of starting and operating a venture is decreased.

Another form of this VC over-eagerness is evident in the advent of the Simple Agreement for Future Equity (SAFE) vehicle. This instrument allows startups to raise capital without parting with equity or making interest payments. A SAFE is a warrant allowing investors to vest a share of the company at some future event—an investment round, IPO, or acquisition—based on the amount of the SAFE and the valuation at that event.

Perhaps Secret did need to shut down for a variety of reasons. Nonetheless, Byttow wrote that he closed the doors merely because the current direction of the venture doesn’t jibe with his founding vision. This reasoning sounds like a parvenu kicking old friends to the curb. Who needs to put up with the headache of operating a venture, dealing with demanding investors, or pivoting to a new model when exit money has already been pocketed?

The early exit model, similar to SAFE agreements, shifts risk from the entrepreneur to the investor. Likely, VCs are watching these trends unfold with interest. The old adage that investors bet on the jockey, not the horse, is apropos. In the run for the roses, the jockey shouldn’t be adorned with the rose bouquet until the race is finished. When it comes to investing in startup ventures, it appears the traditional approach in which founders don’t reap their reward until a proper exit remains a best practice.

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