The Illusion of Control

Owning the majority of the voting shares enables you to control your own destiny as a startup CEO, right? Wrong. 51% is not the magic control button you might think it is. The reality is that a pre-profitable startup is at the mercy of its ability to attract investors for the financial fuel to keep running.

Many founders and first-time startup CEOs suffer under the illusion that somehow stockholder voting rights provide control over the startup’s destiny and the CEO’s job security. I think the source of this perception is often news articles about pivotal proxy fights at public companies or reading the certificate of incorporation and bylaws that stipulate that a majority of shareholders must approve certain actions. While, technically, there are shareholder voting hurdles that must be met for certain corporate actions, the thinking that these requirements mean that a CEO or group of cofounders holding a majority of shares is enough to exercise actual control is often not true.

Why 51%+ Ownership Does Not Equal Control

The thing is that, for a startup, 51% stock ownership by the CEO or a group of cofounders does not equal control. I vividly remember my corporate attorney’s words the first time I raised a minority (less than 51%) stake from outside investors: “Now they can fire you.” As my experience grew and as I learned the stories of other founders and startup CEOs, I saw how valid this declaration was. The reason is that investors have many levers of control that they can use to force management to act or vote the way they want them to.

The most fundamental lever is that what makes a high-potential startup a startup is that it has not yet achieved the self-sustaining state of being profitable. That means it is dependent on regular infusions of cash to keep going. Unless the founders are sufficiently wealthy to self-fund or secure resources from non-dilutive sources like grants or contracts, they must depend on convincing existing and potential investors to support the company. That dependency means a management team can be forced to go along with investor wishes (including changing management) to get the funds required to continue. Imagine the scenario when investors say that for them to make a needed investment in the company, there needs to be a CEO or strategy change. The choice for the CEO is not to get the critically needed funds or to go along with the investors’ demands.

The same concept holds in resolving differences between cofounders who own different percentages of the company. Imagine that a CEO/Cofounder and a CTO/Cofounder each own 51% and 49% of a startup’s equity, respectively. In theory, the CEO can outvote the CTO. However, if decisions are coming down to a pissing match of “I can outvote you!” the death spiral in that critical partnership has already begun. In this case, the CTO holds the ultimate trump card of quitting rather than going along. This means that alignment with a cofounder or other critical team member must be achieved through logic and persuasive argument rather than the cudgel of voting rights.

The Best Ways to Retain Leadership of Your Startup

While the following can certainly increase your chances of continuing to lead your company, there are no guarantees, so do your best to:

• Execute your plan with excellence

Hitting your major milestones will demonstrate your startup leadership effectiveness, developing company traction, and exciting future potential more than anything else you can do. First, those will be product development milestones, then product-market fit milestones, and then revenue scaling milestones. These are the things that investors and cofounders are looking for to feel good about the trajectory of the company and the capabilities of its CEO, who is responsible for the organization’s overall performance.

One relevant challenge to remember is that plenty of investors believe that the skills of startup CEOs are limited to only certain phases of their startup’s growth curve. This may be true in some cases – and if so, then there will undoubtedly be an opportunity for conversations that enable an orderly transition. Sometimes, however, I think that investors inappropriately apply patterns that may not fit and sacrifice deep institutional memory and relationships for a false perception of a need for change. The best defense against such investor mistakes is to build and sustain substantial momentum and demonstrate a clear grasp on the next phase both strategically and from a team-building perspective.

• Collaborate with your Board of Directors and Major Investors

Keep them informed about the business’s ebbs and flows so they are not surprised and can contribute their wisdom and ideas. Solicit their support and contributions to help solve emerging problems while continuing to lead. Demonstrate trustworthy leadership. Seek consensus. Do not be an arrogant jerk.

Giving up on a startup and its leaders is harder if you are bought into the plan and can see the diligent and effective execution.

• Get the business to be self-sustaining to defang investors’ power

Note that investors may push you to take more money to grow faster, and only you can evaluate the relative merits of that option.

Yet, the only way to eliminate the threat and overpowering control of fundraising is ultimately to build the business to the point that you no longer NEED to raise money. This means achieving sufficient scale and efficiency to be profitable enough to continue to grow. Profitability removes one of the most potent tools investors have: their threat not to continue investing to support a pre-profitable growth business. Profitability at scale is also a tremendous accomplishment!

Have Some Contingency Plans in Place

As a startup leader, some things will never be in your control, which means you can never be entirely sure of what will happen despite your best efforts. Luck, timing, and competition are always in play and can undermine the best-laid plans and purest intentions. Smart CEOs will hedge their bets to soften the impact of a possible unexpected move by the Board of Directors to change the startup’s leadership. Here are some possible tactics to consider:

• Know and accept that it CAN happen to you. Everyone can be replaced – and only time will tell if a change was wise or foolish. The perspectives and pressures on your Board of Directors can sometimes be a bit of a black box and do not always align with how you see things. Conversations can begin happening behind your back. So make sure you do a bit of contingency planning – and act with integrity to preserve your reputation if the unexpected happens.

• When closing an institutional fundraising round for an established startup, negotiate a without-cause severance provision into your employment contract. This is often not easy but can be done in some circumstances if investors are eager to hang on to the startup’s highest or most critical leadership at that point in the relationship. If they aren’t, that can be an important heads-up. A severance provision can provide a bit of a landing pad and be linked to the duration of separation agreement terms like non-compete, non-solicitation, and liability releases. The case to make to investors is that it allows you to stay fully focused on building the business.
  
  
• Establish a relationship with an experienced personal attorney whose firm has no relationship with your startup. If your Board “invites” you to leave, you will not have time to search out an attorney as you will need to be able to respond quickly, and having established not-conflicted counsel in your corner can be essential.
  
  
• Squirrel away savings for a possible rainy day so that you have resources available if you must find your next gig. Startup founders often invest a great deal of their own resources and the entirety of their focus into getting their startup off the ground, so it is important to try replenishing those rainy-day funds as soon as you can so you have something to fall back on.

• Always maintain a personal database of your contacts and a personal email since leaving your startup will mean leaving behind your corporate email, contacts, and other information.

• Routinely invest time establishing and maintaining your personal network of professional contacts, so you have potential references who can speak positively about your capabilities to future employers, partners, and investors. These relationships can also be instrumental in your future networking efforts.

This is not an exhaustive list, however, it should give you some ideas to keep in the back of your mind if you have undertaken the challenges of building a high-potential startup. May they never be needed!

Do not over-worry. Keep your eye on the ball of building success for all your stakeholders – and do not rely on voting rights to keep your job as a startup CEO!