Blog: Ownership Beware, Danger Ahead
When a company starts drifting to a self -styled business, stock options can become useless.
Minority ownership, in a self-style business or with a company that will never get to an equity transaction, can be worse than kissing your brother or sister. This is something an early minority owner like the team members should be careful of.
I can attest to this with my drawer filled with company stock certificates with no value, and the many failed promises of going public or a major equity transaction.
Stock will have no real value unless someone wants to buy it. In my experience as an Angel Investor, a payout in a startup can take several years, if ever, as the vast majority never have an ROI payout. Recently, one of the companies that I made an investment in 2001, went public in 2018.
At long as the minority stock owners believe the situation still has a potential for success it still should require, as the company ages, have some kind of agreement. If not, the only payout will happen if the company is successful, and does an equity event.
The failure rate for new company startups is four out of five. Failure for the company means there has not been a payback for the investors. I have made investments in two companies that still exist over ten years, the founders are still in control and apparently making an acceptable living for themselves. Investors have become smarter over the years and those type of situations have been reduced significantly.
There is hope when outside investors put money in as the term sheet may define changes in control of the company if the founder does not meet the performance committed. I have seen some term sheets with a clause that says, if a CEO does not live up to the forecasts, the company must buy back the stock of the investors. There is another one that requires the investors to have an equal number of directors as the company and then an outside director is added to be a tie breaker. This can help prevent the company of becoming a self-styled business for the founder.
A problem can arise when a majority owner really has no goal for an equity event – going public or selling the company. This can be a judgment call but the minority owner employees should make sure there is an agreement up front if they plan to stay.
At the other extreme, a company that has had an equal partnership in control is doomed for failure. I’ve been there many times. The majority partners will slip on their agreement, like requiring, when new capital is needed. Both parties need to put up an equal amount, and it is likely one partner will balk at this. I also encountered an often reason, that was one partner wants to grow and the other wants as to take cash out for personal reasons.
One example, where I helped resolve a serious situation. The engineering manager, who was the key employee in a company beside the founder, worked for him for 10 years and decided after 10 years to leave. I helped the founder, and we worked out an agreement together. We used the net worth of the company as a value. Tie together with this, the founder was able to take out $500,000 a year for salary and perks. Then the engineering manager had an agreement for getting a certain percentage of the company as the net worth increased, as a value of his service. The key point was, if he left the company, then at that point in time, he would get paid for the defined value gained.