Moscow-based Digital Sky Technologies has come out of nowhere to become the investment firm du jour, beating out other investors to win the hands of Facebook, Zynga and Groupon in the past year.
The firm bought $200 million in Facebook preferred stock last May, grabbing a 1.96 percent equity stake at a $10 billion valuation. It also agreed to buy at least $100 million of common stock from current and former Facebook employees. Last December, the firm led a $180 million round in social gaming company Zynga. To top that off, DST also led a $135 million investment in social buying startup Groupon earlier this month.
So what’s the four partner-firm’s secret?
As initial public offerings have been pushed back farther in the life of a company, there are several high-profile consumer web companies that have such a strong position that much about them–their revenue models, strategy and products–is already public or not that hard to find out.
Provided it has the capital, a firm like DST can come in and behave almost as if were a passive, common-stock investor. That’s attractive to companies like Facebook, because the company doesn’t have to hand over the same kinds of voting or decision-making rights they might to a more traditional firm. Plus, filing for an offering can be a huge distraction from scaling a business.
DST’s ability to snag these deals is even starting to impact how other competing late-stage players behave.
“More and more investors are willing to match DST’s terms which are passive,” said Eric Lefkofsky, a Groupon co-founder. “For a truly great company that’s fairly far along in its curve, they’re willing to give up many of the rights that investors have historically wanted.”
After talking to a few people with first-hand knowledge of the deals, here’s what makes DST different. (We reached out to DST and when they give a full response, we’ll either add to this post or write an entirely new one.)
1. No board seats: DST isn’t as aggressive about demanding seats on a company’s board of directors, allowing the founders and earlier investors to maintain more control. “They want to cooperate with management and have a direct line to them, but they don’t necessarily want to be on the board,” said another source. “They want to be a good partner to the management team and develop trust and a strong relationship.”
2. Weaker rights: Normally, later-stage investors reap the proceeds of an initial public offering before earlier investors on the assumption that they’re carrying more risk by coming in last at the highest valuation. They also normally have more say and the greatest ability to block an initial public offering among all of a company’s investors. DST doesn’t push for these protections and the waterfall, or the order in which investors get paid, is different from other deals at this stage.
3. One to two-page term sheets: The terms sheets are compressed down to a few pages with agreement on key, high-level economic terms. That’s not to say DST isn’t a sophisticated investor. Two of the firm’s four partners come from Goldman Sachs’ investment banking and private equity divisions.
4. Deals happen quickly: From start to finish, DST can ready the paperwork and have the deal done in about a week. After an informal courting process, DST brings in partners from the San Francisco branch of the Goodwin Procter law firm and has the papers put together in days.
5. Cash outs for early employees and founders: This is one area in which DST is leading a strong, emerging trend. As initial public offerings have become less attractive, a company still needs to provide exit opportunities for its early employees. While there’s an emerging secondary market for shares of privately-held companies through SecondMarket and SharesPost, the volumes usually aren’t enough create a truly liquid market where employees can easily sell their holdings at a fair price. DST’s cash provides relief for this pent-up demand. The amount early employees can take off the table varies widely on a deal-by-deal basis, we’re told.
6. Experience scaling and monetizing social networking businesses: The firm’s founding partner Yuri Milner was chief executive of Russia’s mail.ru and built the site into one of Russia’s largest online properties. The firm had also invested in a number of European properties before looking at U.S. companies.
7. Cold, hard cash: Who can resist $100 or $200 million? “DST invests at a valuation that seems shockingly high today. But what they’re thinking about is what Facebook will be worth in three years. What will Zynga or Groupon be worth in three years? They think there’s plenty of road ahead for companies to grow with much higher valuations.”
Tags: Venture Capital
Companies: Digital Sky Technologies, DST
People: Eric Lefkofsky, Yuri Milner