Keep Control of Your Venture

Every founder I work with is concerned about control. And rightly so, given that their new venture is their baby and the beneficiary of a lot of sweat and money out of their own pockets.

Usually the discussion gets interesting when the company begins issuing shares to employees or raising funds, but sometimes we dig into it right at formation. There are various creative methods to approach the issue.

Some traditional methods include implementation of voting agreements or the like, but for a startup looking to add and retain employees in a competitive market those methods may not be an ideal approach, plus they can be overly complex and it can become a burden making sure every employee signs an agreement that nobody other than legal counsel understands. Another method is to implement a dual-class of shares to give one or more founders the sole vote or “super” voting rights.

Here are the basics of one type of dual-class structure, by way of example:

• Company creates a separate class of stock with multiple votes, let’s say 10 (which is pretty typical) per share.
• Company issues to founders an aggregate of 250 shares of the separate class of stock.
• Company issues to employees (and maybe even angel investors prior to a preferred round) an aggregate of 750 shares of regular common stock with one vote per share.

In the example above, the founders would own 25% of the Company, but they would also control the shareholder vote with an aggregate of 2,500 votes, or 77% of the voting power. An even more founder-friendly alternative is to create a separate voting class of common stock for one or more founders, and then create one or more non-voting classes of common stock for all employees and common stock investors. In that scenario, the founders would control 100% of the shareholder vote.

In both cases discussed above, we accomplish the goal of retaining control for founders, but is it really the best idea? Short answer: it depends.

First and foremost, founders need to be wary of fiduciary duties and be sure that any decision to implement a dual-class structure is with the best interests of the Company and its shareholders in mind. Second, founders need to consider their employee base. Do employees care about having any voting control of the Company or are they only interested in their ownership percentage and the economic upside if the business is successful? It’s important to be transparent, especially with key employees. Third, founders should also be thinking about their future financing needs, as a cute structure could become a hurdle for capital. A sophisticated venture capital investor may balk at the structure or require that it be reconstructed or even completely thrown out (even if the VC is getting a preferred class of stock) as a condition to its investment, unless the founders are proven entrepreneurs with a successful track record. 

So, if you are a founder working on your next venture and you are concerned about control, consider the dual-class structure, but also be sure to consult your legal counsel to make sure you properly consider all of the relevant factors and legal implications.