Founders: sometimes NOT fighting is the best way to win.
More than 90% of startups fail. The remaining 10% are in a constant state of flux — founders getting fired, replaced, demoted, and promoted. Sometimes you’re getting screwed and sometimes you’re not — determining the difference is often very hard — especially for a first time founder. What you should really be asking yourself is whether or not you should fight back — in most cases the answer is very simple. If your startup is early stage — i.e. not generating significant revenue or profits — it almost never makes sense to fight — it is a fight you’re going to lose even if you win.
This afternoon a first time entrepreneur reached out to me about a difficult situation she’s facing. Facing a cash crunch she entered into a deal with a strategic investor for a multi-million dollar investment in exchange for 51% of the equity and board control. She was able to remain CEO and negotiated a very lucrative multi-year employment contract. From what I can tell the strategic would have preferred to have simply purchased the assets and hired her as an employee — but this first-time entrepreneur wanted keep building the company.
Despite the legal structure of the company, the strategic has basically been operating the company as a wholly owned subsidiary. They’ve mishandled everything from intellectual property, fiduciary duty, to finances. The entrepreneur feels as though she’s basically been pushed out of her own company — she’s right. The strategic is operating the company as if they owned 100% of the company. She reached out to hear lawyers — a family law practice she’s known for years and they agreed with her conclusion. After talking with my collegues at sumo.vc she gave me a call for advice.
What I took away from our calls was that her “partners” who work for the strategic investor are actually good guys — they’re just neophytes when it comes to starting companies, securities law, and fiduciary duties. The reality is that these guys aren’t “diabolical” business people — they are just inexperienced when it comes to business. They think of the entrepreneur as an employee and as a result if she starts to complain about the various issues I suspect they’ll deal with her just as they would any disgruntled employee.
The reality is that the entrepreneur could hire a securities lawyer like Kevin Vela and demand that her partners fix the various issues (quick note, always use a securities lawyer when negotiating a deal like this). Sadly they would see her demands as a threatened lawsuit from a disgruntled employee. They’re not sophisticated enough to realize that their various fiduciary breaches are freaking their partner out and creating the perception that they’re screwing her over. I don’t think they are.
In this particular case the company is losing money and will continue to lose money for at least another year. They’re going to need to put more money in the company to keep it running — they’ve agreed to do so at a very reasonable price. If the entrepreneur starts to get litigious it would be very easy for them to not fund the company and it would simply run out of money and go out of business. Her best chance of success is to become the BEST employee ever. Find ways to make the company work. Solve problems.
If the company ultimately becomes successful she’ll be in a great place. These guys will likely do the right thing and include her in the upside (they have no personal financial interest if she makes less). If they don’t she has so many potential legal claims against them they’ll have to settle with her in the end. Going to war now will ensure she gets nothing. Sometimes it makes a lot of sense to assume you’re partners are going to do the right thing — especially when they create a plethora potential legal claims on the way.
I’m not sure what the entrepreneur is going to do, but I hope she takes the high road and builds a great company with her partners. In the end I think it will be the best outcome for everyone.