How to retain control of your startup
Ask any venture capital partner what they look for when considering an investment and they will tell you “team” every single time. If I’ve heard it once, I’ve heard it a million times:
The weird thing about this answer is that ignores the fact that 90% of founders are fired within three years of raising venture capital.
The good news is that there is a solution — founder shares. Smart founders from companies like Google, Uber, and Snap have three-class share structures whereby the founders retain control of the company through the use of shares that have 10x the voting power of the two other classes. My last two startups included these shares and they’re now standard for all Y Combinator deals.
So when you’re negotiating with your first institutional investor and he’s explaining how he’s investing your team and not your idea you can give him the chance to prove it. When I’m talking to investors I explain that they’re going to be investing in me and that if they’re uncomfortable with the the three-class share structure we ought to save each other a lot of time and stop talking immediately. So here is the thing, super voting shares allow the founding team to remain in control of the company, but they aren’t foolproof.
Take for instance a scenario where there are two founders (a CEO and a CTO) who each have 10% of their company. With their share’s 10X power they control the direction of the company. The reality is that professional investors are smart creatures who have been around the block once or twice. The smart investor could easily endear himself to the CTO and subtly begin grooming him for the CEO slot securing his support in a contested shareholder vote. Think Eduardo Saverin from Facebook. It even happened to me…
The solution is a voting agreement. Founders who have super voting rights should ALWAY enter into voting agreements with one another. These are side agreements and they’re both common and legal. The agreement basically says that you’ll ALWAYS vote your shares together. This will make it much more difficult for anyone to create circumstances whereby the founders could lose control. Ensuring that you’re equally yoked and your interests are 100% aligned is the best way to build a company. Anything less and you’re going to lose control. Don’t get me wrong, there are lots of founders who SHOULD lose control, but I’m sure you’re not one of them. ;)