How to Keep Control of Your Business While Raising Capital

April 16, 2014

Google recently launched a new nonvoting stock in a two-for-one split.  Larry Page and Sergey Brin remain in control, and existing shareholders get a one-time dividend of one new nonvoting share for each share already owned.  There’s really nothing new here.  Facebook, LinkedIn, Yelp, Comcast Corp., and Discovery Communications already operate in similar ways.  

Why do we watch?  It’s probably not because your small business is contemplating a stock split, involving voting or any other kind of shares, but because you might like to get there. Getting there requires retaining control of your business. This actually has two aspects.  The first, of more immediate concern to startups, is to manage the way in which the business grows.  The second is closely related, and has to do with retaining control over what you have built.  This is clearly where Page and Brin are thinking.  Anticipate success even in the early days of your business, and be mindful of the power of equity structure, voting agreements and shareholder/member agreements to secure control when it’s time for the stock split.

Three Ways to Raise Money and Keep Control of Your Business’s Growth

Bootstrapping, crowdfunding and venture capital are three approaches to growing your business without giving it away.

Bootstrapping, or reinvesting all the profits back into the business, is probably what you are doing now.  Nothing else allows greater control, but it can be a slow way to grow.  It can also put personal assets at risk.  There is probably still some juice left in this orange, though. The suggestions about how to get more out of bootstrapping typically focus on prioritizing time commitments, leveraging technology, making use of social networks, bartering resources, and an occasional publicity stunt. Most entrepreneurs start this way.  By itself, it may not be a long-term strategy.

As a concept, crowdfunding probably works better for charitable non-profit ventures than it does for raising equity capital.  New SEC guidance about retail crowdfunding may be available by later this summer, so it’s worth watching. We are all eagerly waiting to find out what a “registered funding portal” is.  In the meantime, under newly re-designated SEC Rule 506(b), it is still possible to raise money from friends and family, so long as you neither advertise nor solicit.  For all its apparent promise, nothing new has happened here yet.

Polish your elevator pitch because venture capital is where the money is.  It’s also the riskiest.

The first step is to research venture capital firms.  Some commentators suggest purchasing a database, such as VCgate or Growthink Research from which you can identify a smaller subset of firms that have made similar investments. Pay close attention to location, business sector and growth stage.  Vet the reputation and recent activity of those firms thoroughly.

Approach a relatively small number of firms.  Indiscriminate pitching will make your proposal look shopworn.  If you get an invitation, assume that you will have only one shot, so be fully prepared with a business plan and a presentation.  Work with an attorney who can help you negotiate the best terms possible and who can tell you exactly what a deal does before you sign anything.

Three Ways to Retain Control of What You Have Built

By holding certain classes of stock and participating in voting and shareholder agreements, a stockholder (or member in the case of an LLC) with less than a majority interest may still be able to control the management and Board of Directors.

Classes of stock.  We tend to think in terms of common and preferred shares, with the former often having greater voting rights.  Corporations can actually design different classes of stock in many different ways.  This is usually done to ensure that voting power remains with a certain group. Google now has Class B shares with ten times the voting power of Class A shares and the new Class C shares with no voting rights.  Guess who owns most of the Class B stock.

Voting Agreements.  The holders of any stock with voting rights can enter into voting agreements with one another. Even before Facebook went public Mark Zuckerberg entered into voting agreements with other Class B shareholders (a class that, as with Google, had greater voting rights than Class A).  This gave him voting control over the company that was even more extensive than the control he exercised simply by virtue of holding Class B shares.

Shareholder Agreements.  Shareholders or members may enter into agreements with respect to a wide range of provisions that affect decision making within the corporation, including the power of certain shareholders to designate an individual for election to the Board of Directors, the requirement of a super majority for certain key decisions or the allocation of certain roles and responsibilities.

Growing your business, including finding the right investors, is an enormous task.  Make sure you are also prepared to hold on to what you have built.

Nasir Pasha

By

Nasir N. Pasha is the managing attorney of Pasha Law, providing essential legal services and support to businesses and corporations in California, Illinois, New York, and Texas. He oversees all of the firm’s operations and is a pivotal force in maintaining client relationships and ensuring that each transaction is brought to its best possible conclusion.

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Legally Sound Smart Business is a podcast by Pasha Law PC covering different topics in business advice and news with a legal twist with attorneys Nasir Pasha and Matt Staub.
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