Losing Controlling Interest in a company, can that be bad?


16

Basically I have been lucky to get spotted by some angel investors and will be signing £60,000 for 60% of my current business come thursday, which will really boost my start-up massively and hopefully make it 'big'.

So It will be split:

30 - investor /
30 - investor /
40 - me

Is this a problem? - Is there a way that they can 'flush' me out of the business or something so I lose out? - I do understand there are contracts and a lot more legal stuff in place. But in a nut-shell, is this possible?

(if it helps - it is all 'ordinary shares')

Contract Equity Angel Investors

asked Jul 4 '12 at 07:18
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Owen O'neill
83 points
  • Voting to close: this is a matter for legal advice. – Marcin 8 years ago

5 Answers


23

In my opinion, these figure seem very very investor-friendly. Basically, you're valuing your business at only 100K. It's hard to tell if that valuation is in line with your business but a 100K valuation is pretty low. If ordinary shares in the UK are the equivalent of common stock in the US, then that point is good for you. But I'm pretty sure you'll also have to sign and agree to some terms as well and those terms, if you're not the one drafting them, might contain some provisions that may or may not be in your favor. Considering the very low valuation you're currently being offered, I'd read those carefully and make sure that you understand what they really mean. So in terms of the equity split, I don't know how fair it actually is but I think it's on the very low side of things. Usually savvy investors make sure to take only 20% - 30% of a company because savvy investors know that taking any more will risk discouraging the entrepreneur. As for losing control of your company, that may very well happen. But it's usually not through share ownership that it happens but rather through control of the board of directors. Basically, shareholders create a board and it's the board that decides who and how the company is run. So if the board is composed of 3 people or 5 people, it's whoever controls the majority of the board seats that will eventually decide your fate as well as the fate of your company. And if you only control one seat, it's not going to be a very friendly board for you.

As for being "flushed-out", it usually works like this. At the beginning, it sounds like "no, of course you're secure, we're investing in your company because we actually believe in you, otherwise we wouldn't be investing." But as the plot unfolds, you're going to make a mistake; it's just part of entrepreneurship, it's inevitable. If anything, strive to make small mistakes, ones that are easilly recoverable and that have low down-sides. However, on one decision, the investors will call it black, you'll call it white, and facts will later prove you wrong. And that's when you'll be at risk of being "flushed-out"...In business, there are no friends, just people whose interest can be aligned with yours. Ask yourself this: if one day these investors were in a position to screw you, what do you think they would do then? So, if your concerns are your equity position and your control of the company, with just what you've shared so far, I'd be very concerned. In my opinion, these terms look very much to be in your disfavor. Good luck.

PS: If you've already found investors willing to invest in your company, I think it's worth more than you think. And as a CEO, being prepared to walk away from a deal and say no, is a key skill that'll save you and your company when bad deals come along.

answered Jul 4 '12 at 08:04
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Frenchie
4,166 points
  • Loved your answer! Very well explained! – Saurabhj 8 years ago
  • Why doesn't it have a +5 button on this platform? :) – Johnjohn 8 years ago
  • great answer! Thank you very much! Well thought out and made it clear to me, cheers buddy! – Owen O'neill 8 years ago

15

At a basic level, with that shareholding configuration, they can band together and out vote you 60% to 40%. This is a concern but relationships and getting everyone onboard with direction before discovering it is the wrong choice should cover this.

You need to match this against "where would I be without it".

I would be trying for 40% to them, holding over stock for the next round investment.

Can you be kicked out? They can vote to remove you from your CEO position, but you still own 40% and they have to buy those off you at a valuation reflecting the value of the company. There are lots of ways of measuring specific to the circumstances surrounding the company at that point. As of the investment your company is valued at $100K because someone was willing to pay for it.

Future considerations.

You will likely need further rounds of funding as $60K doesn't go far, at this point you will all be diluted again as someone else buys in ... and so on. Your shareholding will go to 30%, then 20% etc.

This doesn't really make much practical difference until you go to sell the company for $10M in 10 years ... then you pay out the shareholders and you discover that your now diluted shareholding meant you earned around $150K per year instead of the LOTS you have been dreaming of.

answered Jul 4 '12 at 10:14
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Robin Vessey
8,394 points
  • Thank you very much for the reply Robin! Very much appreciated, my only concern was that the only way I would lose out on decisions would be from a directors board perspective. I am aware of 60k is not much, but over a course of 18months this will be 'drip feed' per-say and would allow for advice from them as the existing company does indeed have zero revenue and zero profit as it is a 100% start up. All I have is a very basic prototype, I would like to think the company would start earning revenue very soon as the real product isn't up yet. – Owen O'neill 8 years ago
  • @Robyn - Thanks for all this by the way, I just wanted to ensure that I cannot lose my 40% somehow, as this is all very new to me. The way I see it, we are all in it to make money, and the investment is set up as 3 rounds of investment of 20k each. 60k as the worst case scenario, i.e last round of investment. Plus, there expertise are no-where in my field what-so-ever, so without being ridiculous, the company very much rest on my shoulders as they do have contacts/links but are 100% unable to continue without me doing the programming. – Owen O'neill 8 years ago
  • @OwenO'Neill well it sounds like you both need each other equally which is the best position to start from. – Robin Vessey 8 years ago
  • To your first comment, I have another post on this site about the amount of money it takes to make a startup work, http://www.brightjourney.com/q/startups-need-much-moneyRobin Vessey 8 years ago
  • Brilliant! Cheers Robin! A little bit of inside helps a lot! – Owen O'neill 8 years ago
  • -1 "[T]hey have to buy those off you at a valuation reflecting the value of the company" What is the legal basis for this statement? This is not a standard right of minority shareholders in UK companies. I'd award a second -1 for not noticing what currency this transaction is in. – Marcin 8 years ago

3

Here's Paul Graham's (founder of YCombinator) take on the matter:
http://paulgraham.com/control.html Keep in mind he's talking about a much larger A round -- not an angel round.

In another essay:

A typical big angel round might be $600k on a convertible note with a valuation cap of $4 million premoney. Meaning that when the note converts into stock (in a later round, or upon acquisition), the investors in that round will get .6 / 4.6, or 13% of the company. That's a lot less than the 30 to 40% of the company you usually give up in a series A round if you do it so early. [5] http://paulgraham.com/superangels.html $600k for 13% vs. $60k for 60%?
30-40% in a large A round vs 60% in a small Angel round?

My take? Push back to regain much more control/stock or walk away.

answered Jul 5 '12 at 04:37
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Refiner
31 points

1

Here's the thing (assuming the sterling figures indicate a UK company): it depends on the articles of your company as it stands now, any amendments that the investors demand, and whatever all of you put in your shareholders agreement (which I assume you have). It is impossible for anyone not familiar with the documents to give you an answer, and you should not pay attention to any definite answer given here.

If you're asking these sorts of questions here, then I assume you don't have a solicitor. You need a solicitor - this sort of company law is extremely fact-specific, and requires specialised knowledge and experience. You specifically need a solicitor who holds themself out as having experience with this sort of work.

Finally, do consider the valuation you are putting on your business. Is it really only worth £100K? You may need professional advice on this aspect also.

answered Jul 5 '12 at 23:39
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Marcin
526 points

0

Can't the 60% percent issue new stocks thus forcing him to buy to keep the 40%?

answered Jul 12 '12 at 07:02
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Johnjohn
187 points

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