The founder smiled, and the investors panicked.

Written by: Jeff John Roberts, Forbes

Translated by: Saoirse, Foresight News

The startup world is always filled with stories like this: founders work hard for years, tirelessly striving, and finally, when their company goes public or is acquired, they join the ranks of millionaires. Such wealth stories are also common in the cryptocurrency field, but here, the path to achieving massive returns is often much shorter.

A typical example is Bam Azizi, who founded the crypto payment company Mesh in 2020. This year, the company completed a Series B funding round, raising $82 million (which was later followed by additional financing, bringing the total to $130 million). According to conventional logic, the funds from Series A or B financing would almost entirely be used for the startup's business expansion. However, in this case, at least $20 million from this round of financing went directly into Azizi's personal pocket.

This profit came from "secondary equity transfers"—that is, investors purchasing shares held by the founder or other early participants in the company. Such transactions mean that when a startup announces funding news, the actual funds received by the company are often less than the amounts claimed in the headlines; more critically, founders do not have to wait years to cash out their shares but can achieve financial freedom overnight.

This may not necessarily be a bad thing. In response to requests for comments regarding Azizi's "unexpected wealth," a spokesperson for Mesh mentioned the company's recent impressive achievements—including a partnership with PayPal and the launch of an AI wallet—to demonstrate that the company is operating well. Nevertheless, the fact that founders cash out early through secondary equity transfers (a common phenomenon in the current cryptocurrency bull market) has led to some founders accumulating vast wealth before their companies have truly proven their value (or may never prove it). This raises the question: does such cashing out distort the entrepreneurial incentive mechanism? Is the prevalent "get rich quick" culture in the cryptocurrency field reasonable?

A $7.3 million building complex in Los Angeles

Azizi, the founder of Mesh, is not the only founder in the current booming cryptocurrency market who has "secured profits early." This bull market began last year, during which the price of Bitcoin soared from $45,000 to $125,000, and industry enthusiasm remains high.

In mid-2024, the crypto social platform Farcaster completed a remarkable Series A funding round—amounting to $150 million, led by the venture capital firm Paradigm. Notably, at least $15 million of this $150 million was used to acquire secondary shares held by founder Dan Romero. Romero is an early employee of the cryptocurrency giant Coinbase and held equity before the company went public. He has never been shy about his wealth. In an interview with Architectural Digest, he revealed that he is spending a fortune renovating a property in Venice Beach—this complex, consisting of four buildings, is valued at $7.3 million, which Architectural Digest likened to "a small Italian village."

However, while the property renovation is going smoothly, Farcaster's development has not been as promising. Despite a decent initial momentum, reports indicate that the startup had fewer than 5,000 daily active users last year and is now far behind competitors like Zora. Romero has repeatedly declined to comment on Farcaster's performance or his sale of secondary shares.

Although Farcaster raised $135 million ($150 million minus the $15 million cash-out amount for the founder), its predicament is not an isolated case. In the cryptocurrency field and the entire venture capital industry, investors are well aware that the probability of startup failure is much higher than the probability of growing into an industry giant.

Omer Goldberg is another cryptocurrency founder who profited from the secondary equity transfer trend. According to a venture capitalist involved in the transaction, earlier this year, his blockchain security company Chaos Labs completed a $55 million Series A funding round, of which $15 million went directly into Goldberg's personal earnings. Chaos Labs has received support from PayPal Ventures and has become an important voice in the blockchain security field, but both Goldberg and Chaos Labs have not responded to requests for comments.

Venture capitalists and a cryptocurrency founder interviewed by Fortune stated that Azizi, Romero, and Goldberg are just the tip of the iceberg of recent beneficiaries of secondary equity transfers. For the sake of maintaining industry connections, these sources requested anonymity.

Investors point out that driven by the enthusiasm of the cryptocurrency market, secondary equity transfers (which also occur in other hot startup fields like artificial intelligence) are on the rise. Venture capital firms like Paradigm, Andreessen Horowitz, and Haun Ventures are all competing to participate in related transactions.

In this context, if venture capital firms agree to allow founders to cash out some of their illiquid shares, they can secure lead investment rights in a funding round or ensure they have a "seat at the table" in the transaction. The typical operating model for such transactions is that one or more venture capital firms acquire shares from founders during the financing process and hold them long-term, hoping to sell them at a higher valuation in the future. In some cases, early employees of the startup also have the opportunity to sell shares; however, in other cases, news of the founder's cashing out is kept completely confidential from employees.

For investors, secondary equity transfers carry significant risks: they receive common stock, which comes with far fewer rights than the preferred stock commonly seen in funding rounds. Meanwhile, the cryptocurrency industry has a long-standing history of "over-promising and under-delivering," and secondary equity transfers have sparked a debate: how much return should early founders receive? Do these transactions affect the future development of startups from the outset?

Cryptocurrency founders "are different"

For those who have long observed the cryptocurrency industry, the scene of founders amassing vast wealth during a bull market may seem familiar. In 2016, the ICO boom swept through the industry, with many projects raising tens of millions or even hundreds of millions of dollars by selling digital tokens to venture capital firms and the public.

These projects often promised to "pioneer revolutionary new uses for blockchain" or "surpass Ethereum to become the global computer"—they claimed that as the projects attracted more users, the value of the tokens would rise. Looking back now, most of these projects have "vanished." Some founders still appear at various conferences in the cryptocurrency industry, while others have disappeared without a trace.

A venture capitalist recalled that investors at the time tried to constrain founders' behavior through "governance tokens." In theory, holders of governance tokens have the right to vote on the project's development direction, but in practice, this constraint was almost non-existent.

"They're nominally called 'governance tokens,' but they don't actually serve any governance purpose," the venture capitalist lamented.

By the time of the next cryptocurrency bull market in 2021, the financing model for startups began to align more closely with traditional Silicon Valley models—venture capital firms received equity (though token sales conducted in the form of warrants remain a common component of venture transactions). In some cases, founders also, as they do now, received substantial returns early through secondary equity transfers.

Payment company MoonPay is a typical example: the company cashed out $150 million from its executive team during a $555 million funding round. Two years later, this transaction caused a stir—media investigations revealed that just before the cryptocurrency market crash in early 2022, MoonPay's CEO spent nearly $40 million on a luxury home in Miami.

The situation with the NFT platform OpenSea is similar. This once-prominent startup raised over $425 million in multiple funding rounds, a significant portion of which flowed into the pockets of the founding management team through secondary equity transfers. However, by 2023, the NFT craze had plummeted, and OpenSea announced this month that it would shift to a new strategy.

"You're engaging in personality cult"

Given the tumultuous history of the cryptocurrency industry, it is natural to wonder: why don't venture capital firms require founders to adopt more traditional incentive mechanisms? As one venture capitalist noted, under traditional mechanisms, founders can obtain enough funding during Series B or C rounds to alleviate living pressures like mortgage payments, but to achieve "substantial returns," they must wait until the company goes public or is acquired.

Derek Colla, a partner at Cooley LLP who has participated in designing several transactions in the cryptocurrency industry, stated that the rules in the cryptocurrency field are inherently "different." He pointed out that compared to other startup fields, cryptocurrency companies operate with "light assets"—this means that funds that could have been used to purchase hardware like chips can now be directly allocated to founders.

Colla added that the cryptocurrency industry heavily relies on "influencer marketing," and there are many willing to "throw money" at founders. "Essentially, you're engaging in a personality cult," he commented.

Glen Anderson, CEO of Rainmaker Securities, which focuses on secondary equity transfers, believes that the core reason founders can obtain substantial returns early is simple—"they have the conditions." "Whether in artificial intelligence or cryptocurrency, many fields are in a hype cycle," Anderson said, "in this market environment, as long as the story is well told, it can be sold at a high price."

Anderson also stated that founders selling shares does not mean they have lost confidence in the company's future. However, an unavoidable question is: if the company the founders are trying to build may "amount to nothing," do they morally deserve to acquire eight-figure wealth?

Lawyer Colla believes that such cashing out does not extinguish founders' entrepreneurial enthusiasm. He cited the example of MoonPay's founder, who faced media backlash for purchasing a luxury home, yet the company's business continues to thrive; and Farcaster's difficulties are not due to founder Romero "not working hard enough"—Colla stated that Romero "works harder than anyone."

However, Colla also acknowledged that the best entrepreneurs typically choose to hold their shares long-term—they believe that when the company goes public, the value of the shares will far exceed what it is now. "Truly top-notch founders will not choose to sell shares in the secondary market," he said.

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