Twice in the last month, I’ve had founders tell me they were concerned about taking on more capital in a distant future round because it would dilute their equity below 50 percent. Both times they expressed how bad that would be, because then they’d lose control of their company.
And while this was two different founders of two different companies, they got the same response from me: you’ve already lost control of your company.
If you’ve ever taken a priced round for a startup, you know it’s true (although you may have forgotten). Even if you own 80 percent of your company’s shares, take a look at your financing documents and you’ll quickly realize you’ve given up control over pretty much everything that matters: your ability to sell the company and raise more capital, set executive pay, issue stock, etc. All of that now needs the approval of your PREFERRED shareholders, aka your investors, and while they’ll usually be happy to go along with your decisions, sometimes, they might not.
It’s true that when companies go public, all shares convert to common and ownership percentage can matter. But it’s rare that a founder, or even a founding team, owns anything approaching 50 percent of their company at that point. Even Zuckerberg only owned 28.2% of Facebook (though his class of shares have 10 times the voting power of common shares so he still unilaterally runs the company because when you started Facebook, you can do that).
At the end of the day, if you don’t own the preferred shares in your startup, you don’t have ultimate control of a company. You do still have plenty of say — you are the founding CEO after all — but even if you’re careful about how much equity you sell, you quickly answer to someone else when it comes to selling, raising more capital and taking on debt.
So what do you do about it? Well, just don’t fuck up. Which is often really hard at a startup, but nothing succeeds like success. Lots of little incremental wins keeps a board confident in the management team. If you want to maintain essential control of your company, grow the business and keep your investors happy. They keep telling you, “whatever you want to do, girl. Just keep doing what you’re doing because it’s working out well for all of us.”
Even if you do keep them happy enough to stay out of your way, recognize and prepare for the moments when they might not. A client of mine who runs a profitable two-person (and growing) startup recently had an investor suggest the board set up a “compensation committee” when said founder wanted to start paying himself after two years of building the business. He very politely told the investor that was horseshit. He knew the board had approval for executive pay, but he wasn’t about to set up a committee. The lead investor gave in, and you sometimes have to wonder what they’re thinking.
As you can see, just because investors have the right to exercise these “blockers”, they frequently won’t, because doing so can have a catastrophic impact on the business. Imagine that you have the option of selling your startup and create a life-changing outcome for yourself and a small positive return for your investors, who all think the company still has plenty of room to grow. If they block the sale, are you really going to be motivated to continue building the business? If not, then the investors are now looking at replacing the founder and that isn’t always viable. So more often than not, they’ll let you do what you want. They will simply wield that ability to veto strategic choices to create outsized influence on your thinking.
Auren Hoffman recently wrote an article called 10 Non-Obvious Rules to Raising a Series B. It’s an interesting perspective on terms, in that Auren argues since the vast majority of VC returns come from just a few “big wins,” they should stop worrying so much about downside risk protections because none of them actually matter.
Unfortunately, VCs probably won’t believe him. And even if they do, they won’t stop asking for control, simply because they can. If you want their money, they’ll set the terms, including how their investment is spent and how your company is further diluted over time.
The lesson here isn’t to stop giving out preferred shares, or never take an investment. It’s just to recognize that 51 percent ownership equalling control is a myth. Don’t let the illusion of 51 percent stop you from raising capital. If you’ve got interest from VCs, that’s a good thing. Do what you need to do to grow. Someday when you’re raising your A round, or B round, or maybe hopefully your C, you’re eventually going to drop below that “magic” 50% ownership number.
Don’t get wrapped up in the idea that you’re giving up control, because if you’ve raised a price round, you probably already have. With so many other things in the startup world, keep your head down, do the work that matters and grow your business.
— Eric Marcoullier
It’s rare that investors go completely aggro and try to override your judgement as CEO, but it does happen. If that happens, you’ll want someone in your corner to act as a sounding board. Send me an email or hit me up at my coaching site and I’m happy to help.