Freada Kapor Klein warns of ‘vulture capitalists’ during pandemic

'We have seen a lot of VCs acting incredibly badly in the last couple of weeks'

The tech industry experienced turmoil before during the dot-com bust and again during the 2008 economic downturn. But this time it’s a bit different, according to Kapor Capital founding partners Freada Kapor Klein and Mitch Kapor.

“What’s different this time is that it is society-wide,” Kapor Klein said during an Extra Crunch Live appearance this week. “It’s not just the dot-com bust or its not just financial services. It is much more widespread. But again, as you point out, tech is in a much better position because tech is related to the things that are thriving.”

Kapor, formerly a partner at a Sand Hill Road VC firm during the dot-com bust, said it’s similar in that it’s an “enormous disruption with great uncertainty about what will be on the other side of it.”

The details, however, are very different. Assuming there will eventually be a vaccine, Kapor said he believes things will be able to get back to some sort of normal, “notwithstanding the irrecoverable disruptions of permanently-closed small businesses.”

In the two previous downturns, there was something inherently wrong with the economy, but that’s not the case right now, he added.

“The good news is that, to the extent to which the pandemic gets under control, the economy should restart,” said Kapor. “The question, though, is on what basis and do we use this as an opportunity to rethink some fundamentals. Are we actually serious about treating essential workers better, really having a safety net and paid sick leave and universal health benefits and childcare — where we can see and feel now the absence of that is hurting the people we depend on four our lives. But it is not a certainty. This is the other thing about these great disruptions. We have some agency about what happens next. And so it’s almost a cliché now, but it’s terrible to waste, you know, a crisis. Our hope is that coming out of this, as a society, we make some different decisions about how we allocate resources and what we think the baseline is that everybody is entitled to.”

But while we’re all still knee-deep in the pandemic, there are ways to ensure employers treat workers fairly and VC firms treat founders with respect and don’t take advantage of them during these vulnerable times.

Below you’ll find some more stellar insights from the duo that touch on making tough decisions to layoff or furlough employees and how to do it in an equitable way, as well as the rise of what Kapor Klein refers to as “vulture capitalists.”

Equitable layoffs

Laying off or furloughing employees isn’t fun for anyone, but there are ways for leaders to make it less painful. That means looking at the circumstances of each employee, said Kapor Klein.

“Lots of companies, for instance, are doing across the board pay cuts. Some salary levels and some individuals can sustain that and others who are already at the lower rungs of startup pay, equity is not much good when you need money to pay rent and groceries. So those that are already fairly low in salary and that are supporting many family members who’ve lost their jobs, a pay cut isn’t very helpful,” she added. “And so to think about for which employees you may want to do an earlier than absolutely necessary layoff with generous severance and continuation for a long time of healthcare benefits. That might be the best thing for some employees, rather than waiting til the absolute last minute when you lay everybody off with two weeks’ notice.”

Kapor said layoffs and other cost-cutting measures are sometimes necessary, “but something Freada taught me… when we started working together 35 years ago was that being fair does not necessarily mean treating everybody the same because people have different circumstances and different needs.” Kapor said founders should consider more options than staff reductions, including furloughs, severance and “constructing a more custom program that winds up reducing expenses, and sometimes it does involve layoffs — that’s much more the direction to go.”

“But I think you can do things where you can ask employees to opt into giving you information,” said Kapor Klein. “You can ask employees to opt in, for instance, to being furloughed now. If employees need certainty, a furlough perhaps with some severance. And one of the things I’ve learned is a furlough means you can keep them on benefits, but they can still get unemployment. So if you think about what it is that your employees need — do they need a longer runway to look for a job?”

When navigating layoffs, ‘one size fits no one’

Also on the topic of layoffs, it’s important to note that there’s no specific playbook.

“One size doesn’t fit all,” Kapor Klein said. “‘One size fits no one’ is sort of what we’ve been saying. From my vantage point, you want to consult an employment lawyer, if at all, last, not first. And too many companies start with their lawyers. This is not about how do you want to be remembered by all of your employees who are staying as well as those who are going. How do you want to be seen in a year, in two years, in five years when there’s another boom and everybody’s having a quote-unquote, war for talent again.

Why would anybody want to come work for you based on how you conducted your layoff? So I think we want to think about every action and inaction and what message it conveys. I also think too many first time founders focus on, ‘this is hard for me.’ That’s not the point. You still have a job, you’re making the decisions, you have the power. Go to other founders and go to your VCs for support.

Do not go to your employees for support. Convey how and why you made the decision, what’s the fundamentals underlying it in terms of the business, how you made decisions about preserving as many jobs as possible, about giving as much severance as possible instead of waiting til the last minute, helping with benefits and with leads to other jobs. All of those things I think are really important.”

She added that startup founders have the option of extending the time employees have to exercise their options. “There are many things you can do that convey empathy, which has been in too short supply in tech for a long time,” Kapor Klein said.

Keeping up with increased demand amid the pandemic

While some startups are struggling, others are seeing an uptick in demand.

“The first question to ask is how are these business units or products affected by the pandemic because often there are some initiatives that are important but not urgent, and are more long-term,” Kapor said. “You could pull people off that and deploy them in the short term where there’s the urgent demand knowing that over time, they’ll be able to go back to what they were doing before. But it’s this sort of, you know, intelligent redeployment of people where they are most needed is one tactic.”

Beware of the ‘vulture capitalists’

“We have seen a lot of VCs acting incredibly badly in the last couple of weeks — taking advantage of startups that are in a precarious position,” Kapor Klein said.

“Let’s say you were a founder and you were doing great and you were on track and you were going to start raising your Series A or Series B, you know, in May. Well, you’re screwed. And so we see VCs sitting on the sidelines, waiting for the startups to almost go under and then put the most draconian term sheet in from of them where they wipe everybody off the cap table, where if you don’t put in your pro rata — we’ve got one of these going on right now — if you don’t put in your pro rata, we’re going to lose at least 90% of our investment.”

She added that some VCs are telling founders across the board that they must drop valuations if they want to proceed with their raise. “So what it means is that a VC who’s raised a lot of money can come in and with lots less capital, have a much greater ownership stake in a company and it’s just an accident of timing that a company was doing fine and was planning to do their raise in May or June or July instead of completed their raise in December, January or February.”

This particular example was an edtech company, Kapor Klein said, which meant that its students ultimately had the most to lose. But the VC, Kapor Klein says, will either insist they’re a good business person or hide behind the rationale that they have a fiduciary duty to their LPs.

“This is how we can connect the dots,” she said. “We can say VC needs to be done on different terms. And if you think about who are LPs, the majority of institutional LPs — they’re university endowment, they’re foundations, they’re public pension funds. All of those are mission-related. If you’re giving money to your alma mater, you can say to your alma mater, ‘I want my university endowment invested in ways that are gap closing, not gap widening.'”

To combat this right now, Kapor Klein said she tries to organize with like-minded co-investors to try to put an alternative term sheet down.

For founders who care about impact, Kapor Klein recommends reestablish their startups as public benefit corporations so “it’s in the charter of the company that they have to pay attention to more than just finances — that they have to pay attention to the impact.”

“And then it will not be as possible for a vulture capitalist to swoop in and reorient the company,” she said. “The other thing our founders are being told is take impact out of your deck. Don’t focus on impact. You can make a lot more money if you give up impact.”

Kapor Capital, which focuses on impact, makes as much money as any top-quartile VC, said Kapor Klein, “and we are doing a lot of good and closing a lot of gaps in society.”

You can check out the entire conversation below via YouTube for the rest of our conversation with Kapor Klein and Kapor.