HOW DO I KEEP CONTROL OF MY COMPANY?

HOW DO I KEEP CONTROL OF MY COMPANY?

I’ve written before that I think some entrepreneurs are a bit too paranoid about maintaining complete control. The counsel I provided in that blog remains true. If you want to build a team and leverage great minds and great investors, you will only be able to do that if you meaningfully share some of the economic rewards of the enterprise.

At the same time, I’ve seen investors become paranoid as well. Operating Agreements that I have drafted with standard controls on the management have been virtually re-written by investor counsel to unreasonably clamp down on the founders. This is a mistake for two reasons. First, the financial press frequently tells the stories of successful endeavors that needed to make a significant pivot early in the life of the enterprise (this week’s Forbes had a great example). So if you’ve found a spirited, honest entrepreneur it’s probably to your benefit to permit these pivots to occur rather than attempting to micro-manage the company.  Second, entrepreneurs left BigCo to free themselves from the reins of stifling management and I don’t advise structures that drastically restrict their creativity and potential.

If you’re the founder and you want to retain control over the enterprise, there’s obviously the basic, tried-and-true way this has always been done by owning more than 50% of the shares of the company. That, of course, becomes difficult if your enterprise requires significant capital and additional team members to grow.

This article presumes you are creating a company that will require significant capital investment. It also presumes that in order to attract key talent you will need to grant certain shares or options. Here are some mechanisms and ideas to consider which will help you structure your company for optimal control.

  1. Create a class of shares (or LLC membership units) for the founder with multiple votes per share. Some of Mark Zuckerberg’s shares of Facebook have ten votes per share. Even as his share level fell to about 28 percent, he used mechanisms like this in order to keep about 57 percent of the voting rights of Facebook. This structure has fallen in and out of favor over the years as discussed here and some investors may not be receptive to it. In order to address some of their concerns or resistance, consider creating founders shares with multiple votes in conjunction with the creation of another class of investor shares that needs to approve certain defined activities (e.g. further issuances) even though this investor class would not otherwise have the votes to control management authority.
  2. Create a class of shares (or LLC membership units) for employees and advisors without voting rights.  I recently drafted an Operating Agreement that featured a class of units without voting rights and these units are reserved for employees and advisors. The benefit to this strategy is that employees and advisors are not usually investing “hard capital” into the company. Also, while they may own a significant stake collectively, their individual stake is not as significant. As a result, they are generally willing to relinquish voting rights as long as they know they will be compensated when the company succeeds.
  3. Revocable Proxy.  Another mechanism that you may use is the revocable proxy. If your investors insist upon owning more than 50% of the company (which may be reasonable under the circumstances) you may counter by having them execute a revocable proxy by which their voting rights are assigned to you. Such an assignment can only be revoked if a certain milestone is not met. For example, a proxy that is revocable in the event that the company doesn’t meet a certain revenue target by a certain date. This mechanism would probably be used in connection with other mechanisms or anti-dilution protection.
  4. Bet on Yourself and Fire the Investor.  This isn’t a legal advice per se, but it’s important to remember nevertheless. One of my clients in the fashion industry had identified an investor that was very excited. However, as talks progressed into deal terms the investor kept adding to a lengthy laundry list of requirements about when and how the money could be spent.  My client ultimately walked away, found different investment and has recently enjoyed great publicity and overtures from major retailers. Remember, as of the original date of this blog, the rates for US Treasuries are absolutely anemic and they actually lose value if inflation is considered. My point is that safe investments don’t have a returnand if the proposed investor is trying to make this “safe,” do your best to keep them on board by reminding them that high yield investments carry commensurate risk. Ultimately, however, if an investor is demanding too much of the company or too much control, you simply have to find your Buddha and walk away.
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