By Firas Raouf – OpenView Partners
Here’s a scenario that some startup founders dread: After years of developing their business and product — and years of accepting rounds of capital investment — a company’s founder wakes up to find that they’re no longer in charge of their startup.
Best case scenario, they’re now a minority owner with some influence. Worst case, they’re relatively insignificant, have lost any and all control of their company, and face a total shareholder takeover. Someone recently posed a similar scenario on Quora, asking how they could avoid a mutiny of their own company.
Truthfully, I’ve been on both sides of the issue. As a co-founder and principal of a startup, I experienced multiple iterations of funding and associated dilution, eventually witnessing the company become majority owned by investors. On the flip side, at OpenView Venture Partners, I’ve been involved with providing multiple rounds of funding to a portfolio company, leading to OpenView’s majority ownership of the business.
So, I could answer the Quora questioner’s quandary with a pretty well-rounded perspective.
There are, in fact, a lot of reasons why founders cede control of their company to the venture capitalists and shareholders that invest in it. The Grasshopper Group, a company that helps entrepreneurs start and grow their business, suggests five main culprits:
- Poor leadership: Founders need to be the person to whom everyone else in the company is held accountable. Some entrepreneurs aren’t cut out for that and, as a result, fail to provide the leadership the company needs as it grows. If investors see that, they may make appropriate moves to put the right people in charge to move the company forward.
- Inadequate systems: Even if a company survives poor leadership, inadequate systems will be its undoing or the cause that necessitates shareholder takeover. If the founder doesn’t understand how to fix those systems, they may eventually lose control.
- No organizational philosophy: A clear, unified organizational philosophy is essential for every startup. If the founder and the company lack a mission, vision, and values, the company will struggle to drive toward achieving long term success (which shareholders obviously want to see).
- Ineffective risk management: Startups constantly face risk. If a founder doesn’t know how to mitigate it or operate with risk in mind, they’re much more prone to gradually losing control of the company or being vetoed out altogether.
- Clinging to an unrealistic idea: Startup founders can be stubborn, refusing to veer from their original vision for the company in spite of market conditions or consumer demand. That’s a recipe for shareholder takeover.
The truth is — whether I’m wearing the investor, board member, or founder’s hat — my advice to startup founders remains the same. There are a few consistent measures that founders can take to maintain control of their business, without stagnating its growth and potential.
Here are the four things that any founder worried about losing control of their company should do:
Don’t raise capital (or raise as little as possible)
I don’t buy the adage that companies should raise as much as they can in as few rounds as possible to avoid the cost and effort of fund raising. That is a nonsense perspective typically espoused by VCs with large funds that need to deploy lots of money.
Yes, the first round of institutional funding is expensive, requires a lot of effort. But once you get the first round done, subsequent rounds are much easier. First, you can raise from current investors without extra effort, assuming they can and want to provide that capital. Additionally, you can raise from other investors much easier because the company’s financial and legal houses were put into order after the first round.
I also think that equity based cash on your balance sheet is an evil force, tempting you to spend more than you should. For more on this, read The Ideal Path to Expansion Stage.
Never get into a desperate financial situation
If you’re running out of money and desperate to raise capital, it’s a recipe for disaster. Part of an effective CEO’s performance involves ensuring that the company can sustain itself without desperation to raise more money.
That doesn’t, however, negate the need to raise capital. But when you do, make sure that you can show clear, sustainable growth and capital efficiency. If you see yourself getting desperate, cut your costs and figure out how to do keep functioning with fewer funds. Once you discover how to grow more efficiently, then feel free to raise the appropriate amount of capital.
Build a balanced and cohesive board
Make sure to allocate board seats to independent board members who can provide an objective and balanced viewpoint. Effective and engaged independent board members are the best remedy for creating harmony between management and investors.
By the same token, the more investors you raise, the more investors you’ll have on your board. With that comes more priorities (and egos) that you’ll need to manage. All the more reason to raise less money from fewer investors. You’re better off having one investor, but make sure that investor doesn’t gain majority ownership of your company from the get-go.
Don’t hold on for too long
Founders need to know when they should step aside and let professional managers run the business. The fact is that most founders will not always represent the best option for running the company. If you’re honest and aware, you can determine that time on your own and avoid a messy shareholder takeover.
At some point, look in the mirror and ask this question: Would you hire yourself as the company’s CEO?
The reality of startup and expansion stage companies is that if they accept capital as a means to grow, they’ll likely begin to share some control of their business with investors.
But sharing control doesn’t have to mean ceding it completely. If a company’s founder is realistic about their expectations and strategic in how they approach the business’s growth, they can remain a key cog. If, however, they remain stubborn and short-sighted, a shareholder takeover may quickly become an inevitability.
Ultimately, if founders prefer to maintain control of their companies, it’s up to them to make the effort to develop their skills from entrepreneurs to senior managers.