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What do startups do when their investors implode?

When your investor has drama, you have drama.

Social Capital founder and CEO Chamath Palihapitiya
Social Capital founder and CEO Chamath Palihapitiya
Mike Windle/Getty Images for Vanity Fair

It’s hard not to feel a little bad for startup founders caught in the crossfire of a venture capital firm’s implosion — as privileged as they are to have millions of dollars in backing.

It’s not a rare occurrence these days: Young companies backed by Binary Capital had to scramble last year after a sexual harassment scandal blew up the venture capital firm founded by Justin Caldbeck. Portfolio company founders told me then that they were frustrated — caught in the middle of an ugly, bad-headline breakup — but couldn’t really shake it until another investment firm, Lerer Hippeau, effectively acquired Binary Capital’s portfolio months later.

And now we have the slow-motion teardown of Social Capital thanks to disputes about the direction of the firm. It is essentially morphing from a venture capital firm into founder Chamath Palihapitiya’s family office, investing only his own money. I’ve spoken with a bunch of Social Capital founders over the last few months, and more than a few of them are naturally exasperated with all the commotion, as partner after partner departs, sometimes leaving them in a lurch.

The latest evidence came this week with the news that Carta, which makes software to help startups track the ownership breakdown of their shareholders, ironically did some managing of its own investors. Carta raised $80 million in financing and, eager to fit in other investors without creating new shares in the company, asked Social Capital to sell most of its stock to make it happen, as Axios first reported. It was the natural firm to ask, given it is no longer a venture capital firm, I’m told.

Carta is not alone. Mathilde Collin, the CEO of Front, an app for managing emails, last year also asked Social Capital to sell almost all of its shares, as Bloomberg reported. Carta and Front are two of Social Capital’s more prominent portfolio companies, and they’re both asking Social Capital to reduce its ownership in them.

Some other Social Capital portfolio CEOs have told me they’ve thought about similar moves, depending how their next fundraising rounds go and when they happen. That’s especially true for founders who have board members that once worked for Social Capital but who have since defected to other firms. Interests are no longer perfectly aligned.

One startup founder who counts Social Capital as an investor, for instance, said the investment firm told him it would be open to other investors buying them out if the founder wanted that, given the firm’s evolution. (He didn’t.)

The reason not to give them the boot? Founders say that it’s a fight that, frankly, is not worth picking. Running a startup is hard enough without making it a priority to battle with a noisy, small-shareholding venture capitalist. Plus, many still have genuine affinity for the charismatic, historically successful Palihapitiya.

That explains why Carta and Front are the only two to bite the bullet, as far as we know. The current situation isn’t ideal, but it’s tolerable to most of their companies.

The whole saga is a reminder that just as startup drama can be a reputational risk for investors, investor drama can be a reputational risk for startups. That’s true for startups with ties to the Saudi Arabian government, like those backed by SoftBank’s Vision Fund. It’s true for startups with ties to firms accused of bad behavior like Binary Capital.

And while the headlines are very, very different, that lesson is also being learned by startups tied to Social Capital.

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