FanDuel’s $559 million sale: how founders and employees ended up with nothing

Typically, the announcement of a nearly half a billion-dollar acquisition of a start-up would be met with celebration and wealth, however in the case of FanDuel, the founders and employees left with outrage and worthless stock options. The acquisition deal, structured by the company’s investors, had ensured that late-stage investors were the only involved parties who walked away with the $559 million payout. Although the case occurred in 2018 and continues to work itself through various legal systems due allegations of collusion on the part of its investors, its lessons for founders and those interested in start-ups remain relevant, especially for the Imperial grad. 

FanDuel was founded in 2009 in Edinburgh as a daily fantasy sports (DFS) company and quickly rose to prominence. Between 2009 and 2014, it raised $88 million and by 2015, it had achieved a valuation of $1.2 billion after securing a $275 million Series E round from major investors like KKR, Shamrock Ventures (Disney’s family investment firm), Google, and NBC. Yet beneath the surface the company was in trouble. While FanDuel made $124 million in annual revenue, it was spending multiples of that on marketing in an effort to dominate the DFS industry. This led to a significant cash burn, and by 2017, management was running out of options. A failed merger attempt with DraftKings–blocked by government regulators over antitrust concerns–only worsened the situation.

With nowhere to turn, Paddy Power Betfair, now rebranded as Flutter Entertainment, made an offer to acquire the company for $465 million in stock, not cash (the actual sale, however, was $558 million). The value was significantly lower than FanDuel’s internal valuation and would leave the founders and employees with nothing. However, the company accepted the terms, and the group went on to become FanDuel. To understand how the deal came to be and why it was pushed through knowledge of three key terms are required: valuation, liquidation, and drag along rights. 

Valuation refers to the estimated worth of a company and was the beginning of FanDuel’s problems. While FanDuel’s valuation increased through multiple rounds of funding and appeared to indicate the company’s growing success, it was simultaneously raising the price the company would need to secure to return money back to its investors. This could only be achieved in two ways. Either the company would need to sell for a price higher than what it had been valued at, or it would have to go public through an IPO at a valuation that justified the returns expected by investors. As investor money poured in the achievability of either became more and more difficult. 

The next key term to understand is liquidation preference. In a liquidation preference, certain investors are given priority in the event of a sale or liquidation of a company. For example, if an investor has twice the liquidation preference, they are entitled to receive twice their original investment before any other participants. When FanDuel sold for $558 million dollars, later stage investors took the first cut of the money before other shareholders like the founders and the employees could. Once the terms of the investments had been satisfied there was no money left over for shareholders who did not have priority to claim it. 

Given the offer and liquidation preferences which would leave the majority of the stakeholders with nothing – why did the deal go through? The answer lies in drag-along rights and the distinction between preferred and common shareholders. Drag-along rights allow the majority of preferred shareholders to force the common (or “ordinary”) shareholders to follow the preferences of the preferred shareholders. In this case, the preferred majority, represented by KKR and Shamrock who held 21% and 15% respectively of the total preferred shares were collectively designated “dragging shareholders” and could force the common shareholders to accept the deal even if it disadvantaged them.

Though readers and certain FanDuel employees may rightfully feel the deal was unfair, focusing solely on the questionable actions of some of the investors overlooks the more significant errors made by FanDuel’s leadership in managing the company’s growth. They over-raised and took on too much debt. This forced them into unfavorable venture financing deals. Another unusual decision was to turn to private equity (PE) rather than traditional venture capital (VC). The two differ in philosophy and incentives. PE tends to focus on gaining control of the companies accepting investment and then seeking return on their investment, while VC is less focused on control and invests in many companies. Its objective is for an astronomical return from one of their portfolio companies to balance out losses. Founders typically cede less control and have a closer incentive alignment with VC than compared to PE.

From the point of view of ambitious Imperial students, FanDuel is a helpful case study.  One must always ensure a high level of understanding behind the terms of the deal and its incentive structures: the value of your common stock can become worthless, and mismanagement or unfavorable terms can dictate your company’s direction.

While start-ups offer exciting technical opportunities, the smart engineer also understands that knowledge of business terms is also critical. Luckily, Felix’s business section is here to help.