First Round Capital, an early-stage venture capital firm, launched an exchange yesterday that allows the entrepreneurs they fund to pool and hold small amounts of equity in each others’ companies.
It’s a pretty unusual move that would allow founders to diversify their holdings earlier on in the life cycle of their companies. It could also provide an extra carrot for prospective investment candidates to approach First Round over other venture firms. The firm has spent more than a year working out the legal, financial, tax and operating structures for the fund.
Typically, an entrepreneur (if they don’t have other sources of income) will have most of their wealth locked up in their startup. With the odds stacked so unfavorably in a high-risk venture, it puts them in a financially unwise scenario where they have all of their eggs in one basket.
Josh Kopelman, managing director of First Round, wrote:
“I’m excited to announce that First Round Capital entrepreneurs also have the potential to benefit economically from each others success.
This exchange fund was created to allow First Round Capital entrepreneurs to contribute a small piece of the stock they own in their company — and share in the upside of all the other companies. The fund is only available to qualified First Round Capital portfolio companies and First Round Capital does not receive any economic upside from the fund. The goal of the fund is to allow our entrepreneurs to get the benefit of some tax efficient diversification without giving up their upside prematurely.”
Kopelman told us that entrepreneurs have the choice — not obligation — to participate. There are also limits to how much they can exchange to prevent adverse selection and to make sure they’re still properly incentivized to make their own companies succeed. First Round doesn’t charge any fees or take a share in returns from this specific exchange. Kopelman added that the only costs to participating are related to administration.
With initial public offerings and acquisitions taking years to reach, First Round’s move also plays into a broader trend. A number of Silicon Valley companies have been providing unusual opportunities to vested employees to diversify or exit their holdings.
In the last two months, two of the most promising IPO candidates, Zynga and Yelp, have opted to take additional private investment and offer vested employees the chance to cash in. Plus, private secondary markets like SecondMarket and SharesPost have cropped up, letting buyers and sellers trade equity in pre-IPO or privately-held companies.
This First Round exchange would let entrepreneurs diversify in even younger companies. A few comparable exchanges exist already. EB Exchange Funds lets entrepreneurs pool shares and earn interest, but it’s not specific to a single firm.
First Round has offices in San Francisco and West Conshohocken, Penn.