If there is a lesson to be learned from the current economic recession, it is the value of running a well-capitalized company. Whereas debt has spelled disaster for too many highly leveraged businesses, equity offers a healthy measure of resilience. Of course, the downside of involving investors is equity dilution and the potential loss of creative control, but there are ways around that. Here are six strategies to help you get what you want most in business: maximum cash, comfort and control:
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Upgrade your board of directors now. Ideally, privately held businesses should upgrade their board of directors every four or five years to match advancing business goals. As entrepreneurs, it’s important for you to pick your team, preferably with targeted industry expertise. Skip friends and family members— “weak” boards always get overhauled by new investors. In subtle but meaningful ways, these new members will be more loyal to the financial investors than the business founder.
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Get an employment contract. How can business founders get fired from the companies they started? It’s easy: when they lose voting control of the company’s shares and theloyalty of the company’s board of directors. One way to minimize the risk of getting fired from your own company without cause or adequate compensation is to negotiate a “reasonable” employment contract with your company’s board of directors prior to raising capital. New investors typically receive one or more board of directors’ seats as part of their funding agreements, which can change the overall voting dynamic of a board. If a company’s sales and profits don’t meet projections, impatient new board members can push for management changes. Again, business owners are likely to get a better deal from the board members that they invite to the board, not investors.
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3. Hire qualified talent. Every time business owners put unproven staff in demanding positions, they jeopardize their equity stake. Here’s why: The longer it takes a company to meet product development schedules or bring in profitable sales, the more money founders may have to raise in order to cover added operating costs. More capital infusions mean an increased dilution for the founder. Don’t waste time or money on “so-so” employees.
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Set aside stock options. With the 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 their equity stake long after the company no longer needs investment capital.
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Explore “earn backs.” To the extent business owners accept what they perceive as a “low” valuation to secure expansion funding, founders can ask investors to escrow or set aside a certain number of shares to reward exceptional performance. If management doesn’t meet agreed targets, then the lower valuation holds. If management beats projections, then the founder earns back a slice of the company’s equity pie.
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Pay attention to preferences. Most business founders get hung up on negotiating their company’s current worth, or its “pre-money” valuation. I say, pay equal attention to preferred stock “liquidation preferences.” When a company grows to a lucrative sale, preferred shareholders get paid one or two times their original investment before common-stock-holding founders receive a penny. Investors can also add to their percentage equity stake with annual stock dividends that accumulate year after year until the company is sold. Again, founders have to wait in the wings until investors get their liquidation preference multiple, plus all of the accumulated stock dividends. Ouch!
These are just a few of the key steps entrepreneurs can take to ensure they get the kind of cash, comfort and control they seek in business. Ultimately, the best way to maintain controlof your company is to capitalize it well and not hide problems from investors or board members. If you collaborate as partners, not enemies, you’ll set yourself up for a successful—and profitable—future.