Screwing up a startup Monday, February 26, 2007
Rik Segal has a fascinating post about how poor forethought on the part of the founders killed a deal - note, this is my interpretation of his post rather than what he necessarily wanted to convey.
The true story described how a startup had issued equity to a series of people during its early stages as a "barter" for services with the result that they had 42 shareholders that owned 22% of the company. A VC likes the company, but asks that the shareholders all agree to the deal proposed. Ooops. Many of the shareholders are scattered across the globe and can't be traced. So the deal withers and the company runs out of cash. Rik highlights the importance of the provisions such as a voting trust that allows small shareholdings to voted as a block so as not to bog a company down.
Two deals we recently looked at hit exactly these issues but with different outcomes.
In the first, the founder had distributed shares to customers via a loyalty programme and as a consequence, there were over 10,000 shareholders who owned almost nothing individually. Aside from being a costly overhead, it was just plain messy. No problem for the founder though, he was happy for us to do an asset transfer in exchange for shares in a new company, thereby leaving the existing shareholders behind in a company holding an investment in a new "slim" company.
In the second, the founder had allocated a total of 20% out to several people that had given early advice but contributed nothing for some time. Being his first venture, the founder was very loyal to these shareholders and had somehow agreed that these shareholders both had a "veto" over future deals, so as not to be diluted, and had to be consulted on major commercial arrangements. Guess what? It was just to hard to make any progress on the deal since the other stakeholders didn't fancy being diluted on principle, regardless of owning 20% of something approaching zip rather than a smaller percentage of a growing business. Even worse though was that the company couldn't progress commercial arrangements since the decision making process was simply too slow - setting aside the timidity of the founder in approaching them and dealing with possible conflict, these people had jobs etc and this business didn't rank high on their priorities any longer.
Whatever you do as a startup founder, make sure that you get a shareholders agreement in place and that it is ensure the company is not hamstrung by small minority shareholders, especially if you're "free" with your favours in the early days.