"If I take an outside investment, will I lose control of my company?" First-time founders frequently (and perhaps correctly) fret that investors or other stakeholders can wrest control of their company and kick the founders to the curb. The question for founders is, when exactly do they lose their grip? It's a great question with a nuanced answer. I’ll try to provide an oversimplified answer, and then offer some strategies for ways to think about control. (When the time comes, an attorney will be the ultimate guide for the founder.) Generally, three issues determine company control:
% ownership of the total outstanding stock
The breakdown of various classes of stock (Common, Series A, etc.)
New entrepreneurs fixate first on % ownership of the stock, but for early-stage companies, shareholders per se don't typically wield the power. Rather, it is the board of directors who becomes the boss. The board hires and fires the CEO and other top leadership positions. The board determines compensation for the founders. The board is a decision-making body that approves annual budgets, high-level business plans, and major transactions like fundraising. The composition of the board can have a significant impact on the founders' control.
In a public company, shareholders vote for board members, where one share equals one vote. For startups, the process is different. The board is negotiated and prescribed in the investment documents, where founders and key investors are granted a specific number of board positions. Early-stage companies are typically composed of five members: two founders, two investors, and an independent (approved by both the founders and the investors). Founders with a five-member board will need to report back to the board on key metrics but should enjoy a great deal of autonomy.
The five-member board is typical in Seed and Series A companies, but what happens when you get to later funding rounds and expand the number of investors? How do you maintain an even board composition?
Board composition in later funding rounds gets us back to point #2: % ownership of outstanding shares. Generally, the more shares held by the founders the more likely they are to maintain a balanced board of directors. Slipping below 50% ownership of the outstanding stock does not automatically mean that you lose control of the board. However, when investors start to own 70-80% of the company, the founders might find themselves with just one board seat, and three or more board seats assigned to investors. Founders who can grow their business with “Capital Efficiency” are certainly more likely to maintain more ownership of their business, which indirectly relates to a more balanced board composition.
Classes of Stock
Finally, Founders need to pay attention to the different classes of shares. Really big decisions, like taking a significant loan, mergers, acquisitions, and winding the company down typically require the approval of each class of stock (Common, Series A, Series B, etc.). This level of control won't impact day-to-day operations, but founders' plans can be thwarted by the power of each class of stock. For example, imagine that the founder finds what they believe to be a perfect buyer for the company. Despite the founder’s confidence and enthusiasm, the majority of the owners of a particular class of stock could veto your decision.
Tips and Tricks for Maintaining Control
In short, founders can remain in control of their companies even after taking outside investment - but they need to be strategic and aware of the implications of board composition, % ownership of the outstanding stock, and different classes of stock. Additionally, and as promised, here are other tips and tricks for maintaining control.
In the early days (pre-seed), use SAFEs and other convertible instruments for as long as possible. With a SAFE, founders get the cash now but don't have to issue equity (or form a board) until later. When the market is strong for fundraising, entrepreneurs can raise $1m or sometimes much more using SAFEs. It's a great strategy to kick the can down the road for creating a board and the accountability that comes with a board.
Focus on the real risks of running a startup. Some founders suffer because they lose control to outside investors. By far the bigger threat, however, is the entrepreneur's failure to attract customers, lots of customers. The entrepreneur needs to focus on the monster that is going to eat them first, and that monster is too little revenue. Founders who ramp revenue quickly are fine with maintaining control of the company.
Finally, accept the fact that building a great company is always going to be a gradual transition from total control to a miraculous collaboration among founders, investors, customers, and the team. The CEO/Founder is the leader of the stakeholders. The job of the CEO is to communicate the vision, motivate, and orchestrate all their resources toward an ambitious goal. Try not to see the board, the bank, or your strong-willed team members as power usurpers but as part of the beautiful process of creating something lasting.