
Founder Control - peter123
http://paulgraham.com/control.html
======
grellas
A few observations:

1\. I would say that, even as of 5 years ago, it was rare for a startup to go
through a Series A VC round without the VCs taking at least shared control.

2\. Founders of reasonably strong startups can usually do angel rounds, also
denominated Series A, without giving up board control and have been able to do
so for some years now. These rounds used to be for smaller dollar amounts,
often capped at $500K or so, but this has changed today in an era where
founders can often turn to angels and superangels for larger fundings. VCs
want to stay competitive with the angels at this early stage because, if they
lose out at that level, they find themselves sitting on the sidelines as their
deal-flow shrinks and they lose out on potentially strong investments made at
an optimum stage in promising ventures. To stay competitive, therefore, the
VCs must perforce bend a little on their traditional terms, including their
former obsession with gaining board control right out the gate.

3\. Founders themselves are far more savvy today, on average, than was the
case a decade ago. In the bygone days, only a relatively few serial
entrepreneurs had the sophistication to sit on a reputable board and still add
value to it as founders. Today, the average founder is far better versed on
what it takes to drive a company than was the case before. Thus, it is easier
for VCs (and other investors) to accept the idea of a "founder-driven company"
than it used to be. (Over the years, I have seen all too many "control-freak"
founders and other variations that could only be labeled an embarrassment to
sound management; based on this, I can understand the historic VC attitude,
though of course this all must be counter-balanced by the many ills that the
VCs themselves brought to the process when they would sometimes abuse the
founders in whose startups they invested.)

4\. Founders today have far more control over timing on when to do their
Series A rounds. The cost of launching is far reduced today and the options
for deferring larger rounds are greater, as for example by taking bridge
funding from angels or F&F to allow the company to build value and minimize
dilution before it goes for larger forms of funding.

When all these factors are combined, it seems clear from the trenches that a
profound change is occurring by which founders have more control than ever
before over their ventures. Of course, having this validated by someone such
as PG, who is at the heart of this activity in Silicon Valley, goes a long way
to letting the VCs themselves see it as respectable to accept as a _fait
accompli_ as they move forward.

~~~
dkasper
> "3. Founders themselves are far more savvy today, on average, than was the
> case a decade ago."

I've heard this a bunch of times. Why is this the case? Is it the information
available to founders, the quality of people choosing to do startups, or
something else?

~~~
vidar
In part because of YC, but in general because of, well... the internet.
Stories spread.

~~~
phlux
YC is the way it is because of the people who apply to it - not the other way
around.

~~~
ericd
It goes both ways...

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uuilly
On the flip side, I've seen founders cling too tightly to control. Sometimes
the guy that is really good at getting a version 1 out of the garage is not
the same guy that is good at calling the shots once it's a 60 person company.
Taking the stance that "I want to retain control," is obstinate and
egotistical. The proper stance is, "I want to retain control until someone
better comes along." That may be never. But it's the right attitude to have.
In the end, it's not about who controls what, it's about who's more likely to
make all the time and money that's gone into the company worth more.

~~~
brlewis
Is it really possible to get VC funding when all you have is a version 1 out
of the garage? I was under the impression that investors wanted to see
traction before putting in serious money.

~~~
uuilly
It is, but it's less likely. I should have phrased that better. What I meant
by out "of the garage" was the end of the really dynamic period of the
company. You can be physically out of the garage with an angel investment but
still be constantly changing your mind on macro decisions. By the time you're
at a series A, you're generally more certain of your direction.

From what I've seen, the person who is good at the really dynamic thinking
part is not necessarily good at the focus and execute part and vice versa.
Being a CEO of a larger company can actually be really boring for a dynamic,
hyper-inventive type. I used to fancy myself as a technical CEO until I got a
better understanding of the role. A great CEO is priceless and a great
inventor is priceless. If it's the same person, then great. But there is no
need to force it if it's not.

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tptacek
10 years ago, we had a "2 VC, 2 founders, tiebreaker CEO" board structure that
I think was probably more common than simply "conceding the board to the VC".
(I'm aware of the pitfalls in that structure, too).

My sense of it --- and someone with more recent experience please correct me
if I'm wrong --- is that the shareholders agreements matter as much as the
board structure does. Point being, you wouldn't want to see "founder control"
becoming cosmetic, a fig leaf around the real power the VCs wield.

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faramarz
I wish PG would go into the details of structuring a board control. Perhaps
that's an essay for a another day.

Some context: Founder of Magna International, Frank Stronach, who started his
business some 30 years ago made a lot headlines this past summer due to the
sale of his "special" founder-class shares. I found it remarkable that even
though the company is public, he still had majority interest over the board
due to his share structure. EDIT: Every 1 of his B shares converted to 100
Common Stock (and he had over 700 Class B shares, before he decided to give up
control and convert)

Wikipidia explains:

    
    
      Stronach, who is currently the non-executive chairman of
      Magna International, holds multiple-voting shares of the 
      company, which gives him majority voting power over
      issues brought to shareholder vote. Although he controls 
      the voting power among Magna's shareholders, Stronach 
      owns only 4% of Magna's equity.

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GavinB
Is this happening because start-ups are getting series A financing later in
the life of the company? It used to be that you needed VC just to build and
launch a business, but these days the business can be much more real and the
founders more proven by the time they're ready for VC.

Startups are getting further and further on seed and angel funding due to
advancing technology.

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lkozma
I wish PG would write more about painting and hacking and education and lisp
and history and psychology and philosophy and literature and politics and a
bit less about investments. Seriously, quite a dry topic..

~~~
pg
So do I. But you have to write about what you're thinking about, and this is
what I end up thinking about lately.

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yurylifshits
Zynga Founder Mark Pincus - Control Your Board
<http://www.youtube.com/watch?v=r0lUNFHD-iM>

(from Startup School 2009)

~~~
rexreed
Great video -- but how exactly did the Marks (Pincus and Zuckerberg) manage to
retain control of their boards? What are the specific things that need to be
done in the negotiation phase that will lead to that outcome?

~~~
ssclafani
This Venture Hacks article explains how to go about it:
<http://venturehacks.com/articles/board-structure>

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snewe
Perhaps the ycfounders list is a selected sample: it produces or selects
above-average quality founders that are more likely to get a good Series A
price (in terms of both control and pre$). I suspect that YCombinator's focus
on founders for investment decisions also results in start-ups with assets
closely tied to the individuals who run things (rather than say a patent).
This leaves future VCs with less bargaining power when forming boards.

~~~
pg
While I would like to believe it's because YC-funded startups are better, the
fact is that for any startup to raise Series A, the VCs have to believe
they're so good they could one day go public. So my guess is that the reason
so many YC alumni have been able to retain control is that they are so well
connected. They have the other alumni (many of whom are very sophisticated
about fundraising) to give them advice, they get hooked up with the best
lawyers, etc.

~~~
snewe
Now that is one area the academic literature on venture capital and
entrepreneurship hasn't studied: the social networks of entrepreneurs and
bargaining power. Putting that on my list.

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chrisduesing
Can someone explain the power dynamics of a board, vs that of the
shareholders? I always assumed that retaining a majority of shares between the
founders would keep them in control of the company, but is it the case that
the board has more actual power.

For instance; 2 founders hold 60% of the shares of their company collectively
after a Series A. The investors hold 40% (lets ignore option pools etc). Now
if each side had 2 board seats (plus a 5th seat held by a brought in CEO),
does that mean the founders can in fact be outvoted?

~~~
3pt14159
Yup. Shareholdership only matters in so much as your shareholders agreement
dictates that it does. I could have 1 share of your company and control a
hundred board seats, it doesn't matter. There are some things in law that make
ownership of a certain % of shares important, but really its all about the
shareholders agreement.

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matt1
As I'm reading this article and nodding my head, I realized that I don't
understand what _controlling_ a board actually means.

It sounds like its written in the term sheet somewhere--what does that look
like? _Joe Startup will maintain control of the board..._? Would it be correct
for a founder to say "I have control of the board so..." or is it more of a
perceived power as a result of other negotiated terms?

~~~
drusenko
Usually, important decisions in a company require a majority vote of the board
of directors to approve them.

Control of the board is then defined as a majority voting ability for an
individual or aligned group of individuals. For example, 2 founders with equal
equity stake will _usually_ have the same incentives. Therefore, a board that
has 2 founders and 1 investor is "founder controlled".

Between being completely founder controlled and completely investor
controlled, there is a "split board". That means equal number of founders to
investors, and one mutually agreed upon independent party that could
technically vote either way -- often times a person previously very successful
in business with insight into the startup's market.

In practice, a split board usually means investor-controlled, for a couple
reasons: \- The independent board member is usually suggested by the investor
\- The independent board member usually has a stronger incentive to side with
a powerful investor

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gms
This essay makes VC's seem like a necessary evil that founders have to
tolerate through gritted teeth, as opposed to something more benevolent like,
say, YC.

Do I have the wrong impression?

~~~
pg
A lot of VCs are good guys. The difference between us is largely that we're in
different situations. VCs invest 100x as much as us. Larger amounts of money
will inevitably have more constraints attached.

------
fleaflicker
_In a dozen companies we've funded, the founders still had a majority of the
board seats after the series A round._

Out of how many series As total?

~~~
fleaflicker
Answered here, he says "around half":

<http://news.ycombinator.com/item?id=1976417>

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kapitti
Isn't a dozen a small percentage of total YC companies?

~~~
pg
It's a large percentage of those who've done series A rounds though. Around
half.

And practically all the pre series A companies still have board control,
because most startups do at that stage.

~~~
jedc
Two dozen is only about 10% of the 208 YC startups to date. I'm surprised that
that few have done a Series A. I would have thought it would be a much higher
percentage.

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gcheong
Minor typo: resort of compulsion --> resort to compulsion

~~~
pg
thanks; fixed

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Scott_MacGregor
With an equal number of founder elected Directors and VC elected Directors, if
your outside tiebreaker director is brought in by the VC's you will be in
danger of losing control because you cannot control the situation.

Especially if the tie breaker is planning on doing some additional business
with the VC in the future, you may not have a truly neutral person casting the
vote.

So, how is founder control typically structured?

For instance, do founder Stockholders get 2 votes per share to elect Directors
with, and VC's get 1 vote per share with a guaranteed VC director seat on the
board? Or are Directors elected by founders getting 2 votes on a particular
decision item A and 1 vote on decision item B, and VC Directors get 1 vote on
A and B?

Does anyone know what is currently going on with this?

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jaekwon
2 Questions:

Are there cases where a non-CEO founder controls the board?

What are the mechanics whereby the minority stake founder(s) control the
board? Some sort of skewed voting system? If so, what sort of legal entities
allow this structure?

~~~
faramarz
Yes, there is precedent. I mentioned Frank Stronach in the comments, See
<http://news.ycombinator.com/item?id=1976711>

I'm not sure if this is universal, but Stronach (a non-executive chairman of
Magna Int.) had control over the board because of his Class B share structure.
Every 1 of his B share converted to 100 Common Stock (and he had over 700
Class B shares, before he decided to give up control and convert)

That's quite remarkable, considering Magna is a publicly traded company.

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nlavezzo
I think one of the main factors pushing the trend in the direction of more
founders retaining control is the increased availability of angel money.

If it came down to my cofounders and I having to give up control to raise a
Series A (or any series for that matter) I'm sure we'd turn to Angel List to
raise a similar amount from well connected and useful investors, without
having to give up control - if that were a viable option.

Increasingly it seems like raising a large angel round is an option, which is
great for entrepreneurs.

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iamwil
"VCs will still be able to convince; they just won't be able to compel. And
the startups where they have to resort of compulsion are not the ones that
matter anyway. "

I excepted some sort of footnote for this one. It's not immediately obvious to
me this is true.

Hypothetically, the founders are the ones that know their business the best,
and hence tend to have a longer term vision. Given that the founder executes
on the long term vision, those are the companies that matter. Is that the line
of thinking?

~~~
shimon
If an investor disagrees with a founder so much that they are willing to take
actions that force that founder to act against his/her own will, then things
must be in pretty bad shape. When a company is doing great, nobody picks
fights with its leaders.

On the other hand, there may be cases where a generally positive opportunity,
such as a possible sale, is valued very differently by a founder and VCs. I'm
not sure how common these cases are, or whether there are existing rules about
the board's obligations to shareholders that reduce the likelihood of
conflict.

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EGreg
I definitely would like to control my own company.

That said, my philosophy is simple: Your first company should SUCCEED. You
should be prepare to give up control, equity, etc. as long as it succeeds.

That gives you a track record AND money. Think about it. If you had $10
million dollars 2 years from now, and a 5% stake in your first venture,
contacts lots of happy people and a reputation for succeeding with your first
venture, don't you think you could own the shit out of your next company? Like
100% ownership in pretty much anything you want, with $5 million of your own
money in it. You could try 30 different ideas or set up a nice lab.

Wanting to own your first venture is kind of like saying this will be your
only idea, ever.

It might sound unproductive, but my advice to fellow entrepreneurs would be:
listen to what investors want, and then give it to them. Put together a great
team. Find VC firms who like to invest in your kind of thing. Develop just
enough to get them interested. Set up appointments. Get funded. Exit with $10m
or more in the bank. Do your own thing. Your first business can be all about
the $$ exit.

It seems I myself am going a different route, though.

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pama
"Founders retaining control after a series A is clearly heard-of. And barring
financial catastrophe, I think in the coming year it will become the norm."

Would a financial catastrophe simply stop new series A rounds, or would it
rather change their terms? Are there any examples of changes related to the
adventures in 2007--2008?

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samd
_The switch to the new norm may be surprisingly fast, because the startups
that can retain control tend to be the best ones. They're the ones that set
the trends, both for other startups and for VCs._

Are they the best ones because they can retain control or can they retain
control because they are the best ones?

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JVerstry
Good insight information, thanks !

