What is Stock Swapping?
Stock swapping is basically exchanging entity’s shares for another entity’s shares: “I give you some of mine – You give me some of yours.”
Stock swapping has been around for decades. Usually, it involves a merger or acquisition between two large companies. It is not common with startups. However, there are some great success stories of startup stock swaps.
With large companies, the stock swap (equity swap) can help companies to avoid using cash to conduct the transaction.
Startup1 believes that a stock swap offers a unique advantage to early stage startups. It allows for a hedge that decreases the variance of (negative) outcomes.
The Painful Truth About Startups
The vast majority of startups will fail after 5 years. This includes startups that receive investment. Most of these founders put their blood, sweat, tears and family into these startups. Many of these failed startups are created by top-notch talent with excellent teams. And, many of them are great ideas that just never stuck. These founders are left with zero business and zero equity after five long, hard years.
Mathematical and Organizational Solution
What if there was a way to increase the likelihood of success for startups and founders? We believe that we have found the solution to the problem.
By creating a venture fund that allows for the exchange of equity between startups, we decrease the variance of possible outcomes. In a zero sum game where there are many losers and only a small percentage of winners, offering a swap of ownership with other ‘players’ allows for more positive outcomes.
Professional Poker Players and Stock Swapping
Professional poker players have been using the concept of “action swapping” to increase their odds of success. Top players know that that their chances of winning the jackpot are not 100%. These players will cut a deal with competitors of similar talent to “Swap action” with them.
Scott and Joe are competitors in a poker tournament. If Scott wins, Scott will give 10% of his winnings to Joe. If Joe wins, Joe will give 10% of his winnings to Scott.
Swapping action increases the likelihood that neither player will leave empty-handed.
Startups and Poker
While running a startup is not exactly a ‘zero sum game’, startup companies and poker tournament players have several similarities. Startups compete with other startups for resources (funding, talent, media play, etc.) Startups also usually experience one of two extreme outcomes: Total failure or great success. For tech startups, the polarity of these outcomes is significant with successful acquisitions occasionally yielding >$200 million.
Beyond the mathematical benefits of stock swapping for startups, there is an organizational benefit that is unparalleled for entrepreneurs. Because accepted applicants in the Startup1 Fund own a piece of the other startups in the fund, they have an incentive to seeing the other startups succeed. This promotes a sense of community, family, or tribe within the fund. Founders will share expertise. They will share solutions. They will share success.