Information

Liquidity Pool FAQ

2014-08-09: by Jonathan Greechan

Description:
A guide to explain the Shared Liquidity Pool of the Founder Institute.

Get an overview of the Graduate Liquidity Pool here, or read below for an in-depth explanation. 

The Founder Institute asks every Founder to incorporate their business during the program and issue a Warrant or Option for 3.5% of the equity to join a Shared Liquidity Pool (AKA "Bonus Pool"). The Shared Liquidity Pool provides Founders, Mentors, Directors and the Institute with shared equity upside from all of the companies created during the one semester. So, if one of your peers if successful, everybody in your semester shares a small part in the financial upside. This shared upside is designed to increase camaraderie and reduce risk. Let's review how it all works.

 

Allocation

You allocate 3.5% of your company to the Founder Institute through the form of a Warrant or Option, and the Founder Institute then contractually allocates any money that is generated from the Warrants or Options to various stakeholders. The Founder Institute is your one official shareholder for easy corporate housekeeping, but the contractual allocation spreads returns from the Warrants or Options with others, allowing you have the benefit of multiple shareholders without the complexity. Here is how how the 3.5% gets allocated:

Each Founder that contributes a company to the Shared Liquidity Pool receives an equal share of the 30% allocated to Founders. If there are 10 Founders in the Pool, then each Founder gets 1/10 of the Pool, or 3%. Co-Founders split their allocation. So, If there were 13 Founders contributing 10 companies, and one of 10 companies had three Co-Founders, then each Co-Founder would get 1%, while all other single Founders would get 3%. Since value in the Shared Liquidity Pool is derived from companies, shares in the Shared Liquidity Pool are allocated for each company contributed.

 

Returns

Even in small acquisitions of $5 MM os less, the financial return from the Shared Liquidity Pool far exceeds the average Course Fee by multiple times. Below are four hypothetical situations where a Founder in the Shared Liquidity Pool sells their company for anywhere between $5 MM and $250 MM. The models assumes that the Shared Liquidity Pool will be diluted over time as the company gets larger and brings on investors, senior employees and partners. The model also assumes that there are 10 graduating Founders, each getting 1/10 of the Shared Liquidity Pool 30% allocation to Founders, or 3% each. Please note that Shared Liquidity Pool returns are paid out to individual Founders, not to their companies, so returns can be used for anything that you want, from paying rent to investing in your startup.

Exit Valuation $5,000,000 $75,000,000 $150,000,000 $250,000,000
Warrant or Option Strike Price $1,000,000 $2,500,000 $2,500,000 $2,500,000
Initial Bonus Pool % 3.50% 3.50% 3.50% 3.50%
Dilution of Bonus Pool % 0% 35% 40% 45%
Final Bonus Pool % 3.50% 2.28% 2.10% 1.93%
Total Bonus Pool Return $140,000 $1,653,000 $3,097,500 $4,776,750
All Founders Bonus Pool Return $42,000 $495,900 $929,250 $1,433,025
Personal Bonus Pool Return $4,200 $49,590 $92,925 $143,302.50

 

Processes

There are two key processes with respect to the Shared Liquidity Pool, joining the Pool and achieving liquidity from the Pool.

When a Founder completes incorporation during the program by the deadline, they are invited to join the Shared Liquidity Pool. To join the Shared Liquidity Pool, Founders are asked to customize, sign and upload the appropriate paperwork, which varies from country to country. Normally, the paperwork is a Warrant or Option and a Board Consent. Founders that do not wish to join the Shared Liquidity Pool need to withdraw from the program before the last 45 days of the program.

When a Founder in the Shared Liquidity Pool achieves a liquidity event by selling their business or by going public, the Founder Institute distribute the proceeds to the stakeholders through the following process. The Founder notifies the Institute that there is an impending liquidity event, and the Institute will provide some strategic advice on closing the deal for the best terms. The Institute will also work quickly to provide any necessary signatures and approvals. When the transaction is completed and a payment is sent to the Institute, the Institute then takes the total return and divides it up by the contractual allocation, which is stored in our systems and checked by our accountants. Individual distribution checks are then cut for all of the stakeholders and mailed along with a nice letter. In the future, the Institute may switch to PayPal for convenience.

 

Diversification

By joining the Shared Liquidity Pool, you are diversifying your startup risk. You share a small part of your company for mentorship and for upside in your peers. The likelihood of one company being successful is small, whereas the likelihood of there being one successful exit out of 10 companies is very high.

This diversification strategy has been successfully leveraged by top startup CEOs in Exchange Funds. The problem with traditional later stage Exchange Funds is that it is very hard to value the private equity provided by the different CEOs into the fund when the companies are funded and have revenues. As an example, the Founders of Google tried to join an exchange fund, but they had disputes with the organizer over valuation.

The Institute innovated on the Exchange Fund model by taking very early stage companies and mandating that each Founder or Founding Team gets one share of the Shared Liquidity Pool in exchange for one fixed amount of equity, 3.5%.

 

Questions

Q: Do I have to Join the Bonus Pool to graduate?
Yes.

Q: Why does the Founder Institute require that I incorporate?
In order to be a "Founder," you must found a company. If you are working on a business, there are many important reasons to incorporate a company. First, a company provides a Founder with liability protection against mistakes, accidents, lawsuits and other unknowns. Second, a company collects the intellectual property produced by a Founder and various associates or freelancers, which is important for investment, partnerships and acquisitions. Third, a company is required for any semi-professional or professional investment, as well as many other reasons.

Q: Why does the Bonus Pool last 10 years?
The Institute set a realistic timeframe for companies in the Bonus Pool to achieve some type of liquidity event, such as a merger, a sale or a public offering. The vast majority of businesses will either fail or succeed within 10 years.

Q: Why is the Bonus Pool 3.5%?
The Institute analyzed multiple equity programs, and choose 3.5% as the smallest amount of equity to contribute that can still return reasonable value to the Bonus Pool. As one example, setting up an advisory board normally requires 5% of a company to attract 5 or 6 advisors, and the Institute wanted to be less than 5% to attract over two dozen Mentors during the program. As another example, most funding incubators purchase approximately 10% of a company for approximately $20,000, and the Institute wanted to be less than half the equity for these type of programs. At 3.5%, Founders in the Bonus Pool can get $100,000 in cash returns from low a nine figure exit.

Q: Why does the Bonus Pool use Warrants or Options, versus Equity?
The Institute holds Warrant or Options in the Bonus Pool, versus holding equity, for two reasons.

First, Warrants or Options provide the right to purchase equity, and this means that the Institute is not an formal shareholder in your business today. By not being a shareholder, the Institute does not have information rights. The Institute is not a fiduciary. The Institute does not have a vote, and the Institute can not hold you up. The Institute has economic upside without the complexity of being a shareholder.

Second, by owning Warrants or Options, the Institute does not have to value your business. The strike price for the Warrants or Options are set by external investors. If you are unable to secure investors or you build a business without investors, then the strike price for the Warrants or Options is set at $1,000,000 USD. For example, if you build a fantastic business and a group of investors values the business at $10,000,000 USD in the first financing, then the strike price will be set at $10,000,000 USD. Until the company is purchased for more than $10,000,000 USD, then Warrants or Options will not be worth anything. By using Warrants or Options, we let the market decide your value.

Q: How does investment work with the Warrant or Option?
There are two types of investments done by Founders, either a convertible investment or an equity investment. The Warrant or Option only matters with respect to a qualified equity investment, which is defined as any equity investment for $100,000 USD or more completed by external investors, people other than the Founder or Founders themselves.

When a Founder in the Bonus Pool completes a qualified equity investment, the shares in the company are given a value by the outside investors. At this point, the strike price of the Warrant or Option is set. The number of shares of the Warrant or Option is also set at 3.5% of the company after the investment is complete. Hundreds of Founders have raised capital with the Founder Institute Warrant or Option in place. Most investors are used to investing in companies with Warrants or Options present.

Q: Will the Institute buy the Warrant or Option?
The Institute does not intend to purchase the Warrant or Option until a liquidity event occurs with a greater value than the strike price, at which point the Institute will purchase the Warrant or Option to return value to the Bonus Pool.

Q: What is the $100,000 fee if I am removed from the Board of my company?
This is a poison pill clause to prevent your Board of Directors from terminating you. Two out of three Founders get terminated from the company that they build, normally by their investors seeking to maximize returns, So, the Founder Institute as introduced a term to make it prohibitively expensive for investors to terminate you for the first few years. The Institute does not intend to collect the money, and, if the money were collected, it would be allocated back to the affected parties.

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