Prepared by Andrew B. Coburn
As seen in Business Black Box
Q3 2015 Edition
The documents that must be negotiated by an entrepreneur with outside investors can be complicated. To many, they appear like a dark labyrinth that cannot be understood but can only be navigated by blindly following your lawyer and hoping you come out the other side in one piece. Simple or complex, however, most of the documentation boils down to two key issues: control and money. For this column, let’s focus on control.
When we mention control, what exactly are we talking about? Control has many aspects but typically the key issues are: (a) who has the power to remove and replace the board of directors or other governing body or group of the company?; (b) who gets to decide when it is time to sell the company?; and (c) what company actions, if any, require the consent of stockholders, members or other owners? If I am the CEO of the company, I run it day-to-day, but ultimate control is with the board of directors, which can replace me and which must approve certain key actions such as issuing additional stock. If I control the board of directors, my control is still limited if the Series A preferred stock terms require me to get stockholder approval to take out a bank loan or make major capital investments.
Control is such a critical issue because when you give it up, you are now working for someone else. You no longer get to make key business decisions. For example, the private equity fund with control may decide to sell the company to get cash back to its investors at a time when you believe that the company would be worth much more if a sale was postponed for a year until a new product had been launched. Equally important, you also now can simply be fired and no longer even have the chance to work for the company.
So when you do give up control, there are at least three key considerations. First, be very thoughtful about when you are willing to give up control and how much you are willing to give up. Second, unless you are selling your entire interest in the company, you never want to give up control just for money. You want to give control to someone that you reasonably expect will be able to take the company to places that you cannot. Money is important, but you also want the person or entity taking control to have good business judgment, the ability to attract talent, access to technical or other critical expertise and/or other attributes likely to make the company a success. Third, you need to think like an employee and consider whether you can negotiate an employment, severance or similar arrangement to compensate you and protect you now that you have become an employee that can be demoted, moved, paid less or even fired.
You need a good lawyer to explain how all the investment documents affect control, but keeping your focus on the control issue is critical to maximizing your chances for a happy ending. Next issue, we will come back and discuss money.