The repricing is, in effect, a form of settlement agreement with the company's preferred stock investors.
What the former CEO did amounted to a form of fraud on the investors. They thought they were investing in a company they thought was worth x but whose real value was less than half the value of x. The company had actual or constructive knowledge of the facts underlying the fraud, to wit, that there was in place an automated program that facilitated and attempted to cover over blatant regulatory violations. This was a material fact known to the then CEO and the company, legally speaking, is charged with his knowledge. Therefore, it constructively knew the truth as well and failed to disclose it to investors when they invested in the prior round (Series C). Since this was highly material to their investment, the sale of securities to such investors without such disclosure amounted to securities fraud.
Now, when something like this has happened, people can sometimes let it slide but the impact here was huge and the investors have easily lost at least half the value of their investment.
So what does new management do? With the historic problem cleaned up, it reprices the shares in the previous round to set the valuation at the level it should have been (or least much closer to it) had all facts been known and disclosed to investors. This is speaking hypothetically, of course, because investors of this type do not invest in a company that is committing serious legal wrongs and they would not have actually invested here had they known all the facts at the time of their original investment. But, given that the damage had already been done, the proposal made to investors gives them the chance after-the-fact to affirm their investment, release their legal claims, and take the hypothetical value that presumably would have more accurately reflected the real value of the company at the time of their investment had all facts been known and disclosed to them.
Is this a perfect solution? No, of course it cannot be. This is a real mess and the wrongs committed were serious. But it gives investors a path through repricing to get more than double the shares they had bought at the prior pricing. The trade-off: they must release all legal claims against the company.
Now the carve-outs: if any given investor sees this as an imperfect solution, they can always just say no and file suit against all parties, including the company; and, even for investors who take the deal, there is no absolving of the former CEO in that the release of claims does not extend to him - hence, they reserve all rights to sue him if they like.
On top of all this, employees are given RSUs that help minimize the effect of the dilution that is built into this for the benefit of investors. Again, not perfect but another indicator that this has been carefully thought out. If the company revives and its stock value goes up, the employees will essentially be paid bonuses via the RSUs to help make up the difference.
This is actually a pretty elegant attempt to salvage what must have been seen by many as a situation beyond repair, first (and formally), by setting up a mechanism to prevent the company from being swamped by lawsuits and, second (and much more importantly) by taking a good faith (and, for the company, painful) step in order to save its relations with its key investors.
People should not flippantly dismiss this action just because it is unusual. It may wind up being right or it may wind up being wrong but it clearly is a carefully thought-out attempt to deal with an exceedingly difficult set of circumstances in a creative and constructive way. If it does work, it will be because the investors perceive the business model of the company as fundamentally sound in spite of the earlier illegality and corner-cutting. It is their opportunity to register a vote of confidence for new management to give it another try, this time with an honest respect for the relevant regulatory environment even as the company attempts to disrupt its target market.
One interesting fact this analysis is missing is that the board that must have approved this deal is mostly series c investors. Even if the deal is a good way to right past wrongs, it is still an instance of a board paying itself. Still, very nice thoughts. I agree that this is likely what happened.
That said, there are some assumptions in here that we need to remember are assumptions. We don't know for sure what was and was not in the disclosures. And, thinking back on the news about the actual software program, I don't remember that it "facilitated and attempted to cover blatant regulatory violations." Didn't it just run down the clock on an online course but NOT go through any material or take tests? Maybe it was not as obviously material as it seems now.
You appear to be factually incorrect when you say that their board is mostly Series C investors. The board makeup pre-deal was (i'm pretty sure):
David Sacks (CEO)
Laks Srini (co-founder & CTO)
Lars Dalgaard (Andreessen Horowitz - Series A)
Bill McGlashan (TPG - Series C)
Peter Thiel (Founders Fund - Series C)
Antonio Gracias (Valor Equity - Independent Seat)
Good point. But Andreessen also put a lot into the series C round. I don't have all the numbers handy to do the math on whether approx. doubling their series C interest cancels the dilution of their series A and B interest. I just kind of assumed that it did. Sorry if I am wrong.
I did find it very surprising that a16z was getting their stake increased here. They were on the board for years. Whatever happened, happened on their watch. Highly unusual.
The primary value of boards is a sanity check for the top layer of management. As an investor you want a board looking after the investors interests. You can find plenty of company's that where gutted by overly permissive boards handing out ridiculous compensation packages for example.
PS: You can compare the performance of public companies with various board makeups, it's not a meaningless topic.
The purpose of a board is to look out for owner's interests. That is not exactly the same thing as investor's interests. That is why boards aren't made up of just investors.
I never said that was their purpose, just what you want as an investor.
You can have a board focusing on balancing public good with profit, if that's what the companies charter says. But, that's probably not a great investment.
CEO and CXX of company A is on company B's board.
CEO and CXX of company B is on company C's board.
CEO and CXX of company C is on company A's board.
Now, no direct conflict of interest, but you can see the issue. Especially when CEO of company A also sit's on company A's board.
So, yea on it's own the co-founders on the board is not a big thing. But, looking into the board should be part of due diligence.
PS: You can also see issues when VC's make up the majority of the board, but that's less common with public companies. (Let's buy up little company X that my firm invested in.)
That's very likely what occurred and I've been pretty impressed with how the Co has handled the turnaround however---
Could the former founder make an argument the valuation and structure was artificial. It sounds like they basically diluted him to oblivion by ramping up RSUs and doing a down round. That would open them up to litigation as well.
Perhaps the end result is- Conrad doesn't want to get sued - and so they are gambling that he won't sue himself. That works as long as everyone is on board or they get a release from Conrad (in turn he'd want one as well).
Sacks is the perfect person to figure this out. Lawyer, consummate CEO, keen product mind, huge network. He's got a product that touches 100% of employees and can be given away for free and still make $1000/head. After Yammer he could easily of retired.
But, how is it that the company still exists at all? Should it have not been deprived of its licence to operate / sell insurance once the fraud was discovered?
How is it that its competitors didn't try to make it happen / sue it out of existence, even if the regulator was lenient?
I am so glad Pied Piper Inc. didn't raise the Series B based on the uptick from the click farm in Bangladesh, or else they could be in the same situation.
Excellent analysis as usual! If this type of rewriting the cap table is legal, then what is/are the defining factors of illegal manipulation of the cap table?
It could have happened anyway because the Series C investors could have sued. The company (obviously) didn't disclose any of the fraudulent behavior when they raised the C round (= they can get sued). Doing it like that is cleaner and makes sure that the company has a future.
Interesting. I had a hunch that this was what they were up to since it wasn't a market based repricing. You spell it out much more clearly. The company would die if there was a protracted investor suit. Many companies can't survive proven fraud. This shows that the CEO is on his game.
I suspect that the value of the stock will fall even further. They're cutting a tremendous amount of people, and many of those are revenue producers. I've been flooded with Zenefits resumes, including people who stayed after "The offer". They haven't hit the bottom yet.
I was about halfway through reading this comment without noticing who wrote it and thought to myself "This is a very insightful comment, I bet grellas wrote it".
In a nutshell I think the main diference of RSUs is they compensate based on the full value of the stock, whereas NSOs (Nonqualified Stock Options) only compensate on the stock's appreciation in value.
Which means the employee has to realize income tax on the stock immediately under an 81-b or after vesting, correct? That would be an annoying and surprising tax bill, if the employees are mostly familiar with ISOs or NSOs.
What the former CEO did amounted to a form of fraud on the investors. They thought they were investing in a company they thought was worth x but whose real value was less than half the value of x. The company had actual or constructive knowledge of the facts underlying the fraud, to wit, that there was in place an automated program that facilitated and attempted to cover over blatant regulatory violations. This was a material fact known to the then CEO and the company, legally speaking, is charged with his knowledge. Therefore, it constructively knew the truth as well and failed to disclose it to investors when they invested in the prior round (Series C). Since this was highly material to their investment, the sale of securities to such investors without such disclosure amounted to securities fraud.
Now, when something like this has happened, people can sometimes let it slide but the impact here was huge and the investors have easily lost at least half the value of their investment.
So what does new management do? With the historic problem cleaned up, it reprices the shares in the previous round to set the valuation at the level it should have been (or least much closer to it) had all facts been known and disclosed to investors. This is speaking hypothetically, of course, because investors of this type do not invest in a company that is committing serious legal wrongs and they would not have actually invested here had they known all the facts at the time of their original investment. But, given that the damage had already been done, the proposal made to investors gives them the chance after-the-fact to affirm their investment, release their legal claims, and take the hypothetical value that presumably would have more accurately reflected the real value of the company at the time of their investment had all facts been known and disclosed to them.
Is this a perfect solution? No, of course it cannot be. This is a real mess and the wrongs committed were serious. But it gives investors a path through repricing to get more than double the shares they had bought at the prior pricing. The trade-off: they must release all legal claims against the company.
Now the carve-outs: if any given investor sees this as an imperfect solution, they can always just say no and file suit against all parties, including the company; and, even for investors who take the deal, there is no absolving of the former CEO in that the release of claims does not extend to him - hence, they reserve all rights to sue him if they like.
On top of all this, employees are given RSUs that help minimize the effect of the dilution that is built into this for the benefit of investors. Again, not perfect but another indicator that this has been carefully thought out. If the company revives and its stock value goes up, the employees will essentially be paid bonuses via the RSUs to help make up the difference.
This is actually a pretty elegant attempt to salvage what must have been seen by many as a situation beyond repair, first (and formally), by setting up a mechanism to prevent the company from being swamped by lawsuits and, second (and much more importantly) by taking a good faith (and, for the company, painful) step in order to save its relations with its key investors.
People should not flippantly dismiss this action just because it is unusual. It may wind up being right or it may wind up being wrong but it clearly is a carefully thought-out attempt to deal with an exceedingly difficult set of circumstances in a creative and constructive way. If it does work, it will be because the investors perceive the business model of the company as fundamentally sound in spite of the earlier illegality and corner-cutting. It is their opportunity to register a vote of confidence for new management to give it another try, this time with an honest respect for the relevant regulatory environment even as the company attempts to disrupt its target market.
Whether it works or not, only time will tell.