FilmLoop - A Further Caution to Entrepreneurs

FilmLoop logo I wrote earlier about the costs and benefits of taking venture capital funding (or any outside funding for that matter). It basically boils down to control of your company. Obviously outside investors want to be compensated for their investment in your company, and you satiate them with equity. However, by giving up equity, not only do you give up a portion of the business’s profits, you also give up control. Not only do larger stakeholders control more votes, outside investors may also require you to sign special agreements that give them first rights to the proceeds if your company is ever liquidated or sold. This means that if they invested $10 million, and your startup is liquidated for only $3 million, you don’t get anything, the entire selling price goes to recoup the outside investment.

FilmLoop.com provides a horror story about what can happen if you give up too much control to outside investors…

Over the past year, 3 year old company FilmLoop experienced first hand many of the worst case scenarios an business risks when they sign on the dotted line with a venture firm. FilmLoop raised $12.5 million in funding through two rounds, the first with Guy Kawasaki’s Garage Ventures($5 million), and the second, a $7.5 million round, with ComVentures in May of 2006. Things were going well in August 2006, when the company launched version 2.0 of their web app.

However, in November of 2006, ComVentures received pressure from it’s limited partners to consolidate its portfolio and squeeze cash from non-profitable startups. This seems to have included FilmLoop. ComVentures needed its money out of FilmLoop, and the only way to do that was through a sale. They told FilmLoop they had to sell by the end of the year, leaving the team only 6 weeks to find a buyer, negotiate a deal, go through due diligence, and finalize the sale. Not surprisingly, no buyers stepped forward on such short notice. Except one.

Fabrik, another one of ComVentures portfolio companies, was suggested by the ComVentures partners as a possible acquirer. With FilmLoop unable to find any other interested parties, the venture capitalists on FilmLoop’s board force its sale to Fabrik for just over $3 million - only slightly more than FilmLoop possessed in cash - in December, 2006.

Because of the equity and influence FilmLoop’s external investors received in exchange for their investment, the FilmLoop team was able to do little to prevent the sale. But that’s not the worst of it. Because of a liquidation preference agreement FilmLoop had signed when it took ComVenture’s investment, the founders and employees walked away with nothing. ComVentures took the entire $3 million to recoup its investment, and Fabrik (ComVentures owned) got FilmLoop’s technology.

So what can we as entrepreneurs learn from FilmLoop’s loss?

When you sign on the dotted line, don’t let the venture gold blind you to the fine print. Most term sheets have a number of trapdoors and parachutes to allow the investor to bail early and as safely as possible. Always be sure exactly what you’re getting, and exactly what you’re giving up to get it. When picking an outside investor, don’t just examine their offer’s monetary value. Make sure you know and trust everyone that will have a hand in your business.

Thanks to TechCrunch for the scoop on FilmLoop.

Thanks for visiting! To stay updated, subscribe to my

RSS feed. You may also be interested in some of my more popular articles:

You can also check out some posts related to the one you're reading now in the "Related Posts" sidebar section. Once you've found what you're looking for, please join the discussion by leaving some comments of your own!