Do you Really Have to Give Up Control to Get Screwed?

So a great friend of mine called me the other day. He is a CEO of a software company that he co-founded with a few friends ten years ago. Awhile back, my friend took some money from venture capitalists to grow the company. Since then the economy has tanked, and now they are looking to make some major changes.

The venture guys want to bring in new management, reformulate the board and basically redo employment agreements for all the founders. So, what do the founders think? They think that this may not be a bad idea. Since they will still own 51% of the common stock, they will not lose their assets while the company goes through an overhaul. Ding! Ding! I heard this story and the alarm bells went off.

I like to call this “How to Screw an Entrepreneur 101”—convince the founders that change is needed to help the company succeed instead of facing the fact that the market hit you upside the head and it will take time to recover.

There are FOUR ways to lose your company. 51% ownership should be the least of your worries. Here’s how it happens:

1) You lose the stockholder votes — 51% of the voting stock. Voting stock is tough to define if the company has raised money, so make sure you know the number. Often timesoutside money comes with a stock conversion that is different than the 1 share = 1 vote idea.

2) You lose the ability to approve financing — Often founders are required to give up the right to approve new financing without the approval of the current investors. The problem comes when you need money in a tough time, and your current investors do not want to take a write down of their investment, so they will not allow it. Without cash you may not survive.

3) You lose the board votes — If your board consists of five people and they are all investors, they have the ability to vote against you. This means that if you are trying to get a budget approved or hire a sales guy, they can vote against it. You may have limited ability to run the operations of your company day to day.

4) You lose your job as CEO — The new CEO must be given the right to hire and fire individuals at will in order to grow the company. No decent CEO would agree to anything less. If you report to a new guy and he fires you after 30 days then you will be left out on the street with no control over the success of your company’s stock. Now if the company raises a little money under the guise that the new “CEO needs more room to grow the company” then your stock is crammed down to less than 51% ownership – you lost your company.

Is your company facing a similar situation?

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