How Can I Prevent Shareholders from Taking Over My Startup?

January 19, 2011

Someone recently asked this question on Quora. I have been on both sides of this issue. As a co-founder and principal of a startup, I experienced multiple iterations of funding and associated dilution and eventually witnessed our company become majority-owned by the investors.

At OpenView, I have been on the other side: providing multiple rounds of funding to a portfolio company which eventually led to our ownership of the majority of the business.

So I think I can say I possess a pretty well-rounded perspective on these situations and how they evolve. Whether I’m wearing the investor, board member or founder hat, my advice to the founder is the same:

1. Don’t raise capital, or raise as little as possible.

I don’t buy into the adage that companies should raise as much as they can in as few rounds as possible to avoid the cost and effort of fund raising. That is nonsense, and is a perspective typically espoused by VCs with large funds who need to deploy lots of money. Yes, the first round of institutional funding is expensive and requires a lot of effort (and is directly proportional to how hot your company is). But once you get the first round done, subsequent rounds are much easier. First, you can raise from current investors without lots of effort (assuming they can and want to). Additionally, you can raise from others much more easily given that you already have your financial and legal house in order after the first round.

I also think that equity based funds on your balance sheet is an evil force, and a force that tempts you to spend more than you should.

2. Never, ever get into a situation where you are running out of money and are desperate to raise more. Ever.

Part of an effective CEO’s performance entails ensuring that the company can sustain itself without resorting to a desperation round of funding. That doesn’t negate the need to raise; however, when you do, make sure you can show clear and sustainable growth and capital efficiency. If you see yourself getting into a desperate situation, cut your costs and figure out how to keep going with much less. Once you discover how to grow more efficiently, go out and raise.

3. Build a balanced and cohesive board.

Make sure you allocate board seats to independent board members who can provide an objective and balanced viewpoint. Effective and engaged independent board members are the best remedy to providing harmony between management and investors.

By the same token, the more investors you bring in, the more investors you will have on your board… and the more investor priorities (and egos) you will need to manage. All the more reason to raise less money from fewer investors. By the same token, you’re better off having more than one investor. If you have one, make sure the investor does not get the majority of your company from the get-go.

4. Don’t hold on to control for too long.

Know when you should step aside and let professional managers run the business. You will not always represent the best option for running the company.

In my role as a mentor to software CEOs, I find myself constantly dealing with these issues. That is the reality of the expansion stage software company. At OpenView Venture Partners, we try really hard to surround the founders with the mentorship they need to evolve and succeed as senior managers of their companies. Ultimately, it is up to the founders to make the effort to develop their skills from entrepreneurs to senior managers.

The Chief Executive Officer

Firas was previously a venture capitalist at Openview. He has returned to his operational roots and now works as The Chief Executive Officer of Everteam and is also the Founder of <a href="http://nsquaredadvisory.com/">nsquared advisory</a>. Previously, he helped launch a VC fund, start and grow a successful software company and also served time as an obscenely expensive consultant, where he helped multi-billion-dollar companies get their operations back on track.