As startups scale, founders often face a harsh reality—losing control and ownership of the company they birthed to external factors like investors and funding endeavors. In some instances, the loss of control is so profound that founders are ousted from the very enterprises they helped build. Donald Valentine, the founder of Sequoia, a leading venture capital firm, noted that about half of the founding CEOs of their investments are fired within 18 months of their series A funding. Sam Altman, CEO and co-founder at OpenAI, recently joined the list of founding CEOs like Steve Jobs – Apple; Travis Kalanik – Uber; Jack Dorsey – Twitter, who were all sacked by the board of their respective companies, even though he was reinstated due to shareholder pressure and employee uproar,
Given the foregoing, this newsletter seeks to examine the legal mechanisms founders can leverage to maintain some semblance of control and power over their businesses as they scale to prevent or mitigate the risk of being ousted.
MECHANISMS TO MAINTAIN CONTROL
One of the many lessons from the sacking and reinstatement of Sam Altman is that making yourself indispensable to the company and its stakeholders might be the most effective strategy to prevent being ousted as a founder. Some other mechanisms to maintain control include:
1. BOARD COMPOSITION: The primary driver of founders being ousted from their companies is their board of directors. Thus, founders need to pay attention to the composition and dynamics of the board of the company at every point in the lifecycle of the company.
In the startup's early days, founders typically enjoy full control of the board. However, as the need for capital grows, fundraising from investors often means giving up board seats. This shift challenges the founders' initial control.
To avoid losing significant control in the company, founders should ensure that they do not give up board seats where it is avoidable. For example, they should only give up a board seat to a lead investor in a financing round while making other investors who demand board seat observers. Founders may also preemptively allocate common board seats at incorporation to help maintain a balance where board seats are taken by investors later. Additionally, founders may also ensure their seats on the board are for life so that they are perpetually involved in company matters. In Nigeria, under the Companies and Allied Matters Act (CAMA)1, a director may be appointed for life, which implies that such a director may continue to serve in perpetuity subject to removal under the Act.
2. EQUITY STRUCTURE: The share structure of the company should be such that it comprises various classes of shares as may be necessary to prevent loss of control on the part of the founders. In jurisdictions where it is permissible by law, founders may issue themselves weighted shares (shares with multiple voting rights) to maintain ownership and significant control over the affairs of the company. Please note that while weighted shares are prohibited under CAMA2, founders may issue other restrictive classes of shares to investors like redeemable preference shares, which allows for the redemption of issued shares by the company after a period of time.
3. INVESTMENT AND INVESTOR RELATIONS: To maintain control of their companies, founders should manage investments and investor relations strategically. Startups should steer clear of premature fundraising, raising excess funds, unnecessarily surrendering board seats and advisory roles, or accepting unfavorable investment terms out of desperation. A carefully crafted investment term sheet and agreements that protect the company and the interests of founders are also pivotal in preventing loss of control.
4. CONTRACTUAL ARRANGEMENTS:
The significance of having documented contractual arrangements such as founders' agreements, shareholder agreements, investment term sheets and agreements, and other related documents cannot be overemphasized. When drafted properly, these agreements help create a framework for the business as significant matters that may affect the control and ownership of the company, in the long run, are adequately addressed.
5. SEEK EXPERT ADVICE: Founders should engage experienced legal advisors who specialize in corporate law. These professionals can provide personalized guidance, review legal documents, and help founders navigate complex legal considerations in their bid to maintain control and prevent being ousted by their companies as they scale.
In conclusion, while the focus of this edition of our newsletter is on how Founders may protect themselves and maintain control over their Startups, we must emphasize the significance of good corporate governance in operating the business. We recommend that Founders ensure that they act ethically, responsibly and in the best interest of the company. Furthermore, Founders should ensure open communication and synergy with the board of directors in order to achieve company goals.
1. Section 281 of CAMA
2. Section 140 of CAMA
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.