Opinions expressed by Entrepreneur contributors are their own.
Recently, I was in a Zoom meeting where a founder was panicking at the prospect of closing his Series A. I was taken aback as I expected him to be proud of this achievement. Immediately, I asked him why he was concerned.
“Taking on this capital requires us giving up a board seat,” said the founder. “This means that the investor who takes a seat on the board will really be able to exercise control. It’ll be over. I don’t know what to do!”
“Calm down,” I said. “Is this really what you are worried about?”
“Yes! I poured everything into this,” said the founder.
I immediately responded, “you know you’re not the first to go through this and there are various mechanisms you can put in place to ensure you do not lose control over the destiny of your business.”
Unfortunately, the above exchange is nothing new for me. Many founders believe that as their business scales, they will inevitably lose control of their board — and thus the strategy and trajectory of their business — to various external forces like investors or other senior executives. They read about the ousting of various founders like Travis Kalanick at Uber or even Steve Jobs at Apple and naturally get nervous.
Unfortunately, the data bears this out. In a study of approximately 5,000 companies, founders generally retained only about 45% of total ownership and had to give up considerable board control after the Series A round.
Fortunately, there are various ways that you can protect and control the destiny of your business even as it scales to new heights and you need to bring on new stakeholders.
The first, and easiest way to do this, is to avoid external capital investment for as long as you can and seek to fund the company through cash-flow or founder investment.
Yet even if you require a capital raise, you can still use various mechanisms to remain in control of the trajectory of their business. These include specific provisions on types of issued stock and board protection clauses.
Lastly, you can recruit a set of outside advisors to act as advisors or even independent board observers or members to retain a level of influence towards the trajectory of your company.
Don’t take the money if you don’t need it
Many founders believe that to grow, they need to raise capital. And that as a result, they need to give up something more than equity in the transaction, like a board seat or advisory position.
While many later-stage financing rounds, especially Series A onwards, require founders to give up a board seat, there is one easy way to avoid this — avoid raising venture capital.
One of the first ways to do this is to get the business to profitability. This means scaling down non-essential functions, non-essential operations, and conducting a detailed audit. Even though you may think your company is incredibly lean, it can always be leaner.
Yet another way to avoid taking on venture capital is to organically fund the business with founder investments. One easy way to do this is to tranche investments at different stages rather than making one single investment upfront.
One great example of the above is Mortgage Automator. The founders have avoided taking on external capital by focusing on both extreme profitability and multi-stage founder investments. Rather than just investing one tranche of capital at the start, the founders have invested successive tranches of capital to grow their business even further.
Mechanisms to maintain control
Due to a variety of circumstances, many founders have to raise venture capital to grow their business.
Fortunately, there are many tried and true mechanisms that founders can employ to ensure they maintain some semblance of power over their business.
First, founders and investors can negotiate board provisions in the term sheet before a deal is completed. Other than investment terms, board control, board member nominations, and board observer makeup are often the most negotiated. Many founders do not realize how much of an upper hand they have in negotiation; which is especially true if many firms have a term sheet out in a competitive bidding process.
Second, founders can alter the type of stock issued in the business. Working with their counsel, founders can create different classes of shares that have “super” voting rightsallowing a small group of shareholders to effectively retain control over the business while also allowing new investors to buy in at a fair market price.
Use advisors to your advantage
Advisors are critical to the success of any early-stage company. From early-stage fundraising and hiring to customer introductions and mentorship, advisors fill critical skills and knowledge gaps to help companies scale upwards.
Advisors can also be crucial independent yet allied board members or observers if investors also demand a board seat during any financing round. By recommending that an additional advisor assume a board member or observer role, founders both even out the playing field and allow an individual with greater knowledge of the business, not to mention a personal relationship with the founders, to assume a role of greater responsibility.
A great case study of this is the advisory board makeup of Reframe Care, an insurance technology business. Reframe focused on assembling a group of advisors before raising capital knowing that having more experienced voices in the room would be advantageous.
The path to security
Many founders are understandably concerned that as they raise capital, they will have to give up control to investors. Fortunately, there are many ways to avoid this including not raising venture capital in the first place, negotiating the right terms with investors, and using advisors to play critical and key allied roles.
You can find the original article here