4 Ways to Keep a Big Stake in Your Company

Insider strategies for negotiating with venture fund and angel investors

Q.   What are the different strategies a founder can use to retain the highest ownership stake possible during an investor funding?

A.   I like your question! It's what every self-assured, smart entrepreneur should ask before approaching investors for business funding.

A helpful way to think about your percentage stake in your business is in the form of an "equity pie." Today, you probably own 100% of your business, or the entire equity pie. Each time you accept a check from investors or issue stock options to employees, your ownership slice of the equity pie becomes a little smaller. In venture circles this equity shrinking process of is called "dilution."

As a starting point for developing equity-saving strategies, it's important to make a realistic assessment of your company's life cycle funding needs. A startup bakery may reach positive cash flow with only one round of outside individual investor funding. A big concept technology company will may need several rounds of funding before it is financially stable.

Realistically, most startup entrepreneurs are rewarded for taking a long term view as they negotiate with investors. Here are some strategies to consider:

1. Hire the Best. One of the most damaging decisions startup entrepreneurs make is hiring clearly unqualified staff members to fill management team positions. They naively believe "everything will work out" especially when they hire friends and family members for key jobs. Actually, every time startup entrepreneurs hire so-so employees for demanding positions, the founder's slice of the equity pie is vulnerable to the investor's knife.
2. Here's why. The most expensive, call them "big-slice fundraisings," take place during a company's early days. Young companies need investors' help to pay monthly bills until the business reaches positive cash flow. The longer it takes a company to meet product development schedules or bring in first sales, the more money founders have to raise to cover operating costs. Clearly it's in the founder's self interest to hire talented employees who can meet or exceed all performance targets.
3. Rational first round valuations. I encourage founding entrepreneurs to accept reasonable, rather than premium first round valuations. Ok, I admit this recommendation is not a popular one. Still it is prudent. If a young company fails to reach the higher expectations that go along with premium first round valuations, the second financing round is likely to fall below the company's first round valuation. "Down rounds" as they are called are brutal to a founder's equity stake.
4. Earn Backs. This is an unusual strategy that doesn't get enough play during negotiations with investors. To the extent entrepreneurs accept a very low valuation to secure first round funding, founders can ask investors to escrow or set aside a certain number of shares to reward truly exceptional performance. If management doesn't meet agreed targets, then the low valuation holds. If management beats projections, the founder earns back a greater slice of the company's equity pie.
5. Stock options. With board of directors' approval, companies can set aside a certain number of treasury shares for an employee stock option plan. Because founders can receive annual stock option awards for good performance, stock options can help founders buy back a greater piece of the equity pie long after the company no longer needs investment capital.

Most entrepreneurs fret about the potential of losing control of their business to investors, especially venture capitalists. Here, I always like to remind entrepreneurs that the best way to protect their equity stake is simply to hire exceptional employees and do everything possible to meet cash flow goals in a smart, efficient way. Then, entrepreneurs won't need as much of outside investor money to achieve business building goals.

Do you want to find reliable investors for your business? Write to Susan at susan@takecommand.org for great funding references and tips designed especially for startup entrepreneurs, sole proprietors and fast growth companies.

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