Welcome back to the episode of the Startup Therapy Podcast.
This is Ryan Rutan, joined as always by my
friend, the founder, and CEO of startups.com.
Will, Schroeder will, we talked to lots and lots of founders and
it's a secret to anybody and uh, most founders seem to think that
control is a cap table problem.
It isn't.
You can own 90% of the company and still wake up one day
realizing you need permission to do anything meaningful.
Well, like.
You have an experience like this?
Yeah, I like a lot of 'em.
I remember the first time this, this happened,
well, not the first time.
Remember one of the first times this happened, I was running
a company and I owned like, I think like 80% of it, right?
Uh, you know, the, the majority.
And an investor comes to me, an early stage investor
and says to me, Hey, unless you do X, Y, and Z, we're
not gonna fund the company.
Ergo, the company's not gonna make payroll.
And I remember thinking, what the hell?
Yeah.
Like I own 80% of this company.
Yeah.
How can this guy tell me this?
I'm in
charge around here.
Yeah.
What I realized was control had very little to do with, with how
much you owned and had a lot to do with how the company is set
up and what the provisions are.
Yeah.
And when we talked to founders like, like Ryan,
how many founders do you talk to that are like, I gotta
worry about the valuation.
'cause if the valuation's not high enough, I'm gonna
lose control of the company.
A lot of them.
Well, we just had, we had that question pop up last week, right
when you and I were doing the, the live workshop on funding
and somebody asked something along those lines and you
know, I think we answered it then, but it's pretty constant.
I think a lot of founders really get this wrong and so like
today, I think good that we talk about what control actually is
and, and probably why equity is.
Maybe the worst proxy for it.
I mean, there's probably worst things, right?
Like, which way were the crows flying this morning?
That's how much the company I control.
Probably not, but you know, equity is not a good proxy
for it, but it's the one that we most often see applied.
Yeah.
And, and so like, so here's the theory.
This is what most people think.
And if you're in the audience and you're listening to
this right now, please like lean in on this one because
I'm telling you we're gonna change everything.
You think about what control is in a company, the TLDR
is, we're gonna tell you have very little of it.
The longer version is we're gonna try to tell you how
to focus on what matters.
But here, here's the The short version.
The short version is the idea of control.
Something along these lines that if I own the majority of
the business, like the, the old school version, like I always
picture of the Monopoly man version is that I own 51% of
the business, and if I own 51%, then I control the company and
that's, and everybody has to do what I say and blah, blah, blah.
It's like, dude, it doesn't work like that.
Nope.
At all.
I'm sure there are some companies where the literal
51% strikes some sort of decision making capability.
Sure.
But like at that point, I'm thinking like public
companies or something, like something way different.
Not at all how startups work,
not a startup raising money on, on a problem statement
written on a napkin from their friends and family.
Yeah,
and and I think what's also missing when, when
I say to people, okay, you're afraid of losing
control, what specifically.
Are you afraid of losing?
Yeah.
And they'll have like kind of amorphous answers.
They're like, well, you know, I wanna make sure
that, you know, I can control any decisions, et cetera.
I'm like, which decisions specifically do you mean?
Right.
Yeah.
And, and when you start to get specific, the fidelity
and what they want to control drops off quickly because
they don't really know.
Yeah.
They just know they don't want someone else making a decision,
whatever that might be.
I talked to a founder about this specifically about
two, three weeks ago now, and we went through that
same matrix and I was like, what is it you're afraid of
actually losing control over?
Yeah.
And they didn't really know.
And so ran through some examples and I said like, look,
typically when you're saying control, I, I think you mean
like kind of one of three.
Major things.
Strategy, right?
Like what are we building?
Who are we serving?
Okay, cool right pace, what's our growth rate, what's our burn
rate, what's our risk tolerance?
And then things around people, right?
Hiring, firing, comp, and how we build culture.
Yeah.
And they're all different levels and as we'll
explore, they have different protections to make sure that
you maintain some level of control should you want it,
right, right
around those three things.
But I think it generally falls into those three buckets for me.
You know when I never hear this, this is what blows my mind.
I never hear the lose control when people are having
co-founder discussions.
Now when they do, it looks like this, I wanna take
on, uh, A CTO, let's say.
Yeah.
And that person's gonna build my app.
By the way.
Isn't it funny that all that's gonna go away?
Yes.
Like the lever of the CTO being able to take half
the company or whatever.
Hang
on, let me check.
Will, it's Tuesday, March 31st, 7 34 my time.
I'm pretty sure it went away.
I think it's gone to get left.
I just, I, there was, there was always the genesis of
this conversation anyway, the idea is, hey, I'm gonna
take on this co-founder.
I wanna make sure they have 30%.
I have 70%.
Yeah.
So I control the company.
That is the, the understanding, again, when you press that
person to say, how do you know that that will allow
you to control the company?
Like, well, I own majority.
I was like, well, do you understand how the
rest of this works?
Yeah.
Like how owning a majority rarely has anything to do with
controlling decisions, and most people have no idea whatsoever.
Hence this episode.
No.
And why would you, why would you understand, like,
like the intrinsic parts?
Well, don't you remember back in kindergarten when
we all started, uh, taking on co-founders for our
companies and they, they taught us how, right?
Like, we have no proxy for this stuff.
I think, look, I think there's, there's an easy thing to
remember here in my book.
It's like the moment you're not the only owner.
Whether that comes in the form of a co-founder, whether
that comes in the form of an investor, when you're not
the only owner, your absolute freedom disappears, right?
You're correct.
Absolute freedom.
Until then, you are absolutely free.
Right?
Your absolute freedom disappears and, and look,
that's not evil, right?
That's not necessarily even a problem.
That is just the very nature of shared ownership of.
Anything.
Companies in particular have some very specific things
that happen, but that's the nature of shared ownership.
Let's talk about this before we get to investors.
I know the investors part is what everybody's
stressed out about.
Yeah.
We got a lot to talk about there, but let's talk about
it even before we get there.
When we take on a co-founder.
Because what throws me off is I rarely see people like have
nearly as much consternation about control when it comes
to taking on a co-founder or early employees, et cetera,
as they do with an investor who's gonna take geometrically
less of the company.
Yes.
In the early stages.
So let's go back to our, our CTO.
That's gonna build my mobile app type thing.
Yeah, yeah.
Which you hear all the time.
CTO wants 30% of the company, which is okay because I still
own 70% of the company, so I'm still controlling it.
And I'm like, pause right there.
Right?
Like, why is that okay?
And when I say that, I'm saying, why 30%?
Why do you need, uh, hey, as long as I'm over 51%, I'm good.
That means nothing,
right?
And let me tell you, having learned it from the other
side of the, the equation, early in my career, I wound
up in a situation where I own 40% of a company.
My business partner owns 60% of the company, and I assumed,
mind you, I was like 22.
I assumed that that meant I am totally subservient.
I am his absolute,
uh, vassal.
Vassel.
Yes.
I, I, I'm in this, this Vassel position and he actually told
me, he is like, that's not the way any of this works.
He is like, there are there, first off, we have
an operating agreement that you clearly did not read.
That's it,
that states exactly how this supposed to work.
And second, I have a fiduciary duty, right?
Yes.
Like, even though I own the majority, there's a
lot of stuff legally I can't do without getting
in all kinds of hot water.
And Ryan, I had no idea.
I had no, I, I just thought that he has a hundred percent rights.
I have no rights.
Like he was the monopoly
man.
You weren't gonna question him.
He had a monocle.
Yeah.
What can you say to that?
But think about that for a second.
Like, our lack of understanding of this Yeah.
Is so significant.
But the amount of work we put into protecting
something that we understand very little of is a lot.
It is.
It blows
my mind.
Lemme draw some boxes around this stuff.
So let's put some definition on it.
Equity is how you split money.
Control is how you split decisions.
Great, great way
to put it, right?
Yep.
The cap table, you brought that up.
The cap table tells us who gets paid.
You brought up something else that's even more important.
The operating agreement tells us who gets to decide, right?
I think if we can keep those things in mind as we go through,
as you're sitting on the other side of this podcast listening
to Will and I go through this, those are a couple of important
things that I think will help.
Keep you aligned with how this actually works.
Let's play it out.
So let's do a simple scenario.
Ryan, you and I are starting a company together and we're
gonna go take on investment.
So let's, let's play through an investment.
We
have to.
Yeah.
Do we have to?
Yes.
And so day one, you and I decide to, to drop
an operating agreement.
Okay?
Okay.
Now for folks that don't understand, like they've heard
of an operating agreement, they got one for free on
legal zoom, like a template or something like that, right?
Which a lot of people get.
The operating agreement is like the constitution.
Of the company.
Yeah.
It basically says, and yours might, yours being folks
listening, yours might be a total template that doesn't
say much of anything, but it's designed very specifically to
say, based on certain conditions of the company, here's how
those decisions air go control.
We'll get made.
Okay.
Now categorically there's an unlimited number of
decisions that we can put as these provisions, right?
Yeah.
Here's one that I got early on when it, when I was getting my
first VC investment, a provision said in order to make a decision
on a higher, over a hundred thousand dollars in annual comp.
You have to get board approval, which makes
total sense, by the way.
Yeah.
But Ryan, I was blown away by it.
Yeah.
I was like, what are you talking about?
I have 80% of this company, and they're like, you don't
have 80% of its money, dude.
Yeah.
That's where we come in.
Right?
And so I don't think people understand how there's lots
and lots of unique provisions that actually drive control,
and some of those are really important and some of those you
probably don't even care about.
Yeah.
When you think about the stuff that founders care about,
like when they think about control, what comes to mind?
You know, it's funny, I, I think it comes down to some
of this just is like, they don't wanna be told what to do.
It's, and which isn't really how control works in the sense.
It's not really that people are gonna tell you what to go do.
It's more they're gonna tell you how it's gonna
happen or sometimes what you can't go do there.
There certainly are times where they, they may actually
tell you what to do, but I think that most times what the
founders actually care about.
Doesn't really align with how companies are controlled.
Right.
So I, I think maybe let's dig into a little bit more
about how control actually works, where it lives.
Yeah.
What are voting rights, what's board composition
have to do with this?
Not ownership percentages.
Right.
And so I think because at the end of the day, I think really
what founders are concerned with is that they don't want
to be railroaded into doing something they don't want to do.
And I think you and I would both take the view
that no one else wants to railroad you into something
you don't wanna do either.
Unless you're doing something that's so absolutely insane
that they have to do that to save their investment, save the
company, save the team, right?
All those things.
So
let's stick with that.
Typically all these control provisions actually are
the other way around.
Yep.
They're designed so you don't screw somebody else.
Yes.
As the founder founding team, you know, executive
team, they're, those control provisions are put in place,
particularly by investors, but even in co-founder
agreements, like long before we get investors.
Again, going back to a situation, Ryan, where you and
I set up a co-founder agreement.
The co-founder agreement is designed not to say, I get to
tell you what to do, or you get to tell me what to do.
It's not that.
It's dude, if stuff goes sideways, here's what
you cannot do without both of us consenting.
Right.
There we go.
You can't sell the company unless we both agree.
Yeah.
Now, when people think about control, you said it
a moment ago, they think about being told what to do.
Yes.
Right.
But the control provisions, and this is, this is how you
need to frame it, is what do I wanna be able to do
that could potentially harm someone else that I wanna
be able to do, regardless of how they feel about it.
Yeah.
Now most people will look at that and say.
Well, nothing.
I don't wanna 'em wanna do anything to harm
people that, okay.
Yeah.
But what's harmed to, you know, to them may be the
right decision for you.
It's a really slippery slope.
Stick on this for a second.
Let's go back to the example around the a hundred
thousand dollars hire, right?
Yeah.
Because I think this is one that actually it's, this
is a thing you may see.
It does come up.
This isn't them saying, we're gonna look at every hire you
have, we're gonna scrutinize it.
We're probably going to say no.
That's actually not.
One of the things I think is really important with
these provisions is we look at where they came from.
Provisions like that came from people doing shit that
was really wrong, like.
We got investment and then I hired my mom and my dad and
my cousin and my brother and my dog Steve, and they all
got really big salaries and they don't do anything here.
We're just sucking money outta the accounts.
Right?
And so because that happened once, yep.
Now we have to have these provisions, right?
I think that we have to look at it that way.
A lot of the stuff that happens on a, in a legal
sense is there to protect these weird edge cases and
they just have to be correct.
There's not a problem.
And
they're there
for
a reason.
They're there for a reason, and the reason isn't to stop you
from doing what you want to do.
Right.
It's, it's not, again, it's not somebody trying
to tell you what to do.
They're just as a little bit of a control, and I can't
tell you the last time I heard somebody say, yeah, we were
trying to make this higher.
We love them, and then the board blocked it.
Right.
I've heard a lot of people complain about
having that provision in.
Yeah, but I've never heard anybody complain about having
it exercised against them.
Correct.
This is where it starts to get really interesting.
It's this specter of control versus the reality.
Okay.
Yeah.
And again, I, I wanna go back to the control provisions
we're generally concerned about, are there to actually
protect the other party, usually a minority party.
Yep.
Going back to, you know, when I learned what fiduciary duty
was for the first time and I was the minority party and you
know, my business partner was a great guy at the time, not he
still is, but I'm saying he was
business partner at the time.
Your business partner at the time, who is a great guy.
Yes.
Yeah.
I should phrase that differently, but was
very cool about it.
You know, he was, and again, he had way more tutelage
than I did on this, this topic, and he said, look man.
My goal in this deal and the operating agreement
and everything isn't to do things to harm you, if
anything, as the minority.
This is mostly set up to protect you.
Protect you.
Yep.
And so my first learning about the control rights, et
cetera, was based on being the minority and seeing it for why
these things were being done.
Okay.
Yeah.
And so going back to what I think you, you had a great
setup, which was, you know, what are these categories of
things that we want to control?
More specifically, why are other people putting these provisions,
investors, et cetera.
Yeah.
Putting these provisions in this document.
Well, number one, it's so that we can't go and do crazy shit.
Yes.
I mean if really like, like if it comes down to it, there's
gotta be some protections where we can't just do crazy shit.
Ryan, lemme throw one at you that I think
is really interesting.
One of the, the most contentious control provisions that gets put
into, like, particularly around when we take on investors,
but it can't even be in an operating group, is that you are
not legally entitled to a job.
Mm-hmm.
Right?
Most people have no idea.
I own 60% of the company, no one can fire me.
Mm-hmm.
No false.
No one can take away your 60%.
They can sure as hell fire you.
Yeah.
That's the kind of stuff that people don't
even realize it exists.
Yeah.
That's, it's funny, they're out fighting about whether they can
spend a hundred thousand dollars to hire somebody else and they,
they've completely missed the provision that says, we might
not continue to employ you.
Founder.
Like, wait, what?
Right.
And so just to pause on that, 'cause I think if anybody
hears it goes, wait, what, what, what did you just say?
Like, I get fired and, and own the majority.
Yep.
Yes.
Just so you understand how much you own inequity.
And your employment status as an employee of the company, which
are two totally separate things.
Yep.
Are not linked one for one.
Now, you might have, you might wind up with voting control in
the form of the board, the, the operating agreement, et cetera.
That allows you to mostly prevent that.
But generally speaking, this is the kind of stuff
we're talking about.
So for example, if you were to say, look man,
I'm not doing anything.
Would jeopardize my opportunity to have a job at my own company.
That's what I'm talking about.
That's what we have to understand and say, okay,
well if that's a primary concern, then we have to be
able to address that in the operating agreement with
the investors, et cetera.
Yeah.
Which they're not gonna love.
However,
they might not even accept.
Then you might have to decide, I want to continue.
I want to be able to permanently employ myself, but I'm
not gonna be able to do it with somebody else's money.
Okay.
Now think about this if you're the 30% CTO for a second, right?
Yeah.
So let's put a new scenario.
Ryan, you're the 30% CTO and I'm 70% founder, right?
And I'm, I'm presenting you this operating agreement.
You're looking at this going, dude, I don't wanna put all
this work and find that just guy decides one day just to fire me.
Yeah.
Like you're concerned about being able to protect, now
you're in the minority and you still have that concern.
Yep.
So everyone has that concern, but let me, let me flip it.
If you decide to just stop showing up for work, and
that sounds egregious, so, you know, I'm, I'm trying to
deliberately make it egregious, but there's a lot of versions
of not showing up for work.
Yeah.
There's a version where you actually go somewhere
else and you don't pay for
work.
Yeah.
Go somewhere else.
Yeah.
Company's not making money.
I have to make bills.
Right.
I gotta, I go get a job.
Yeah, man.
And there's another version where you do show up.
You just suck at your job.
Yeah.
Like you show up, you have no contribution.
Oh man.
We've done that in a couple other episodes where like
that person who you brought on is co-founder and see
whatever it gets eclipsed by some junior people later
just because they happen to be the first ones to say yes.
It happens a lot.
Yeah, man.
Happens all the time.
So now think about that.
You come on, you've got a 30% share in the company and
you're like, I wanna base, basically make sure I have job
security, that in this operating agreement I cannot be fired.
Think about what that means for me.
Yeah,
okay.
Yeah.
I'm like, well that sucks.
Like if, if you stop showing up for work, you're saying you
like you're guaranteed a job.
Yeah.
Like that's fucked up.
And so I, when we're talking about these control
provisions, I'm specifically saying, here you are in
the minority position.
You have the same issue, right?
I don't wanna be able to get fired.
And even as the majority, I'm like, I wanna be
able to fire people.
If, if they're fucking off, guess what?
That's what people wanna do to you.
Yeah.
That's, that's exactly what
people do thing for the same reason, right?
It's not that, it just like arbitrarily one day like, oh
guys, guess it's international fire, A founder day,
we.
Right.
And so again, we think of all these different conditions.
Now, if some of this sounds overwhelming to folks
listening, this is, this is why we still employ attorneys.
These are the types of things that attorneys
can walk you through.
A fun side note, last night I was talking to my, uh,
father-in-law who's a contract attorney, and I was telling him,
you know, we sold a company this week, and I was saying that we
did it largely without attorney.
And I was like, mostly because we had a lot of
experience doing this.
Yeah.
But also because of ai and, and he was like, yeah, but I'm
pretty partial to attorneys.
It's, you don't
say
itt, of course you're, but it's guys like him.
You know, folks in, in legal profession.
If, if you're not sure that can walk you through
what you don't know.
Yeah.
Right.
We're here to tell you that this is why you should start raising
your hand and asking these questions, but they can tell
you exactly what those questions and provisions are, but.
Let's fast forward a little bit and let's talk about how
these provisions get in vote.
Okay, so let's say we've got, we've got a provision that
says, you know, we can be fired for cause, et cetera.
Yeah.
We've got a provision to get, to get this that says
we cannot sell the company unless we get board approval.
Board approval.
Yep.
Probably worth talking about how boards work.
Ryan, when you think of like a five to seven person
board, can you explain to the folks that why that's
there, why that board exists?
I mean, it's there for governance, it's
there for protection.
It's there to act out and, and basically to interpret the
operating agreement and make decisions based on, uh, their
understanding of it and the, the agreements of the company.
Yeah.
Protective provisions that have been put into place.
Uh, you know, I think a lot of people think the board
is there to advise them.
There is such a thing as an advisory board when we're
talking about a, it's, this is governance, right?
This is, yeah, this is governance.
How the company makes hard decisions.
These are the people that can fire you right
now.
These are the people that can fire you.
These are the people that can make, you know, they can, they
can have control over some of those things we talked about.
And so that's why like when we get into.
Things like, you know, the, the, the board seats.
These aren't just receipts for giving people Right.
It's, it's a steering wheel.
We're handing somebody to the company.
Right.
And, and as you said before, they are, you know.
Operating under the operating agreement, which is the
company's constitution, which I find most, most founders
to be woefully uneducated in their own, their own operating.
So what does say in the operating agreement like?
Well, let me go dig it out.
Right, but so like, there's a few things I think about
when we're thinking through like the board itself and
what's gonna happen is one who appoints board seats.
How does that happen to begin with?
Yep.
Which decisions require board approval?
Things like are there any things like do you have
preferred shareholder approval?
Are there any special provisions that, you know, bring out
spec special provisions?
The one we brought up before, can the board replace you?
Right under what condition?
What's the threshold for selling the company?
If we're saying it, it's board approval, do we want
it to come to board approval or do we want to have some
sort of a preset threshold, which we see a lot too?
Will, I think there's, there's times where there are like
board approval and then there's thresholds, which is that
we're agreeing ahead of time.
It's like under this amount, we're not selling.
Without approval over this amount, we're free to go
right so that it doesn't mean that we have to
always come to a decision.
You know, something that's really funny about everything
we talk about here is that none of it is new.
Everything you're dealing with right now has been done a
thousand times before you, which means the answer already exists.
You may just not know it.
But that's okay.
That's kind of what we're here to do.
We talk about this stuff on the show, but we actually
solve these problems all dayLong@groups.startups.com.
So if any of this sounds familiar, stop guessing
about what to do, let us just give you the answers to the
test and be done with it.
Again.
Let's go back to our situation.
Two of us are starting a company.
In this case, let's just, for easy mass, say it's 50 50.
Right.
You and I, you know, had our own probably really shallow,
and I just mean like we didn't go too deep into it.
Yeah.
Uh, discussion over what should be in the operating agreement.
Yeah.
Neither of us were that experienced.
You know, we did some chat GPT prompts to find out.
We did some, some sleuthing online.
We asked a couple other founders and it's, it is usually a
fairly loose document, but then we get to, to take on
investors and we're both stressed out because we're
like, Hey, um, these investors want 20% of the company.
Which means you and I are gonna dilute down to, to 40% each.
We're like, ah.
But collectively, we still have control.
Not really.
Okay.
Here's what happens the moment you get a meaningful investment
on, and meaningful sounds like a, a pretty broad term, but it's
usually after your pre-seed run.
I, I'm just going to spitball it and say it's usually
over a million dollars.
Yeah.
You know, once you start taking over a million dollars that's
right, under a million dollars, people can kind of let it ride.
Once you get over a million dollars in investment, this,
this stuff's tends to start to come up and, and even higher.
Here's what happens though.
First thing that happens is the investors, and there's
typically more than one.
In this round, we'll say, look, as part of
the operating agreement.
We're gonna need to create a board of five to seven people.
Typically, the board is always an odd number so
that you obviously can't have a tie on votes.
And the, the composition of the board almost
always looks like this.
There's two members from the company, two members from the
investors, and one independent that both of us kind of vie for.
'cause we want to have it to be our person.
Yeah.
At a small enough number.
No one really cares.
You can pick your buddy and think you, you've got control
of everything at a big enough number that doesn't fly anymore.
People see through it.
That's where all of these decisions, this is where
the control happens, like hard stop here.
It has nothing to do with what you and I now have in equity.
Yeah.
If in the operating agreement it states that under this
provision, this provision, this provision that it requires
a board majority, which most of this will, it's just
kind of the simplest way to say it, then a whole bunch
of stuff starts to happen.
For example, I come in one day and all of a sudden it's like
an intervention and it's you, it's our independent and our,
our two, uh, our two investors.
You never want to be surprised by seeing your
board sitting into a room you walk into like that.
It's never happy birthday, right?
Yeah,
exactly.
You don't never
that.
We just feel like you, you're not getting paid enough.
Right?
Yeah.
So we just figured we'd get all together.
Right.
And at that point, you know, they're saying, Hey,
performance isn't what it is.
The company needs to raise money.
We don't think you're capable.
You know, whatever, name your excuse.
We think you're gonna need to step down.
And I'm using this as a, like a pretty egregious case.
And I'm like, I'm not going to step down.
Mm-hmm.
Me and Ryan are, are voting that I'm staying here.
Right, Ryan.
Exactly.
And all of a sudden Ryan gets real quiet.
Right.
I can't find my vote.
I don't remember where to put
it.
Yeah, right, right.
Yeah.
Oh, just vote like everybody else.
Votes, guys.
What do you think?
Right.
Yeah.
And now you realize how Inconsequentially
hopeless you are?
Yeah.
Okay.
Because like I own 40% of the company, but I only
own one fifth of the votes.
I only own 20% of the votes.
Right.
Yeah.
And let's say it's a simple majority, just means like
three outta the five people, you know, voted that way.
And even if you backed me up on this, Ryan, and you're like,
you know what I, I have no idea.
This is bullshit.
If the independent votes against us and the two investors,
yeah, man,
they win.
Done board math beats founder egos every time.
Right.
It's the way it goes.
Once the board exists, you're no longer supreme
leader or supreme leaders.
Yeah.
You're kind of employees with influence that point.
Correct.
And I don't think, I don't think the founders understand it.
Let me flip it the other way 'cause I think
this also interesting.
If, if for some reason we still had a five member board
and you and I were both, uh, on the board and you
know, again, e equal votes, we're not getting into like.
Way, way, way later we start to get into weights.
You mentioned preferred, et cetera, like, like some
votes are worth more than others, but let's just
keep it simple, right?
It's just five people.
Majority rules.
It goes the other direction too.
You and I might be down to 4% ownership in
the company, not 40%.
Yeah.
If we've somehow been able to maintain our voting right.
We have a disproportionate control.
Oh yeah.
In the company, you see this with public
companies all the time.
You know, you see people who have a lower amount,
but a lot of cases they have a different class of, of
voting shares, et cetera.
Yeah.
That gets way more complex than most people will ever deal with.
But the point is, since a lot of these board decisions are,
uh, happen at the majority level, and there's five votes
to be had, sometimes seven as the, the numbers, you
know, the dollars get bigger.
That's really what drives most of the big decisions.
The big decisions being like, does the company
sell things like that?
Right.
Or, you know, are we gonna take on more, more
funding, things like that.
One thing I think we might wanna touch on here Will,
which is the, the operating agreement itself, right?
I, I don't want founders the way we've told it so far.
It kind of sounds like there's this thing that we draft
in the beginning that then controls things forever.
Right.
And that's not quite how this for,
it's just full provisions that say we can never get fired.
Yeah.
We, we wrote it into the original operating room.
It's right here.
See, they're like uhha.
You mean the one that's been amended 90 times, uh,
since you started taking on investment dollars?
So you wanna talk about that just for a minute, just
so that people understand.
Yeah.
Good call win.
Where and how those things get beat up,
changed and, and amended.
The operating agreement to some degree kind of can get,
you know, restated re uh, amended, uh, rebuilt every
time there's a funding round.
That's, that's what's most typical.
Now, the reason for that is because the most recent
investor is going to have certain provisions that
are important to them.
That they won't jump in if that isn't dialed into
the operating agreement.
And there's all kinds of stuff in there that's important
to them because they're the last money in that may not
necessarily be to the best interest of other people that
are currently in there in almost every case, not to the
best interest of the founders.
And so even if you and I write the perfect operating like,
aha, we've got this figured out.
Yeah.
Brian, before we raise money, let's write an ironclad
operating agreement that says no one can ever fire us and no
one can ever make decisions.
Yeah.
We figured out, and only people named Ryan and Will are allowed
to make decisions that matter.
Right.
You know, you name it.
Right.
Better make sure that we write that in some kind of ink that is
impervious to redlining, right?
Yeah.
Right, right.
Might as well
can never be changed.
It'll be fine.
Doesn't make a lick of difference.
Every investor, when they come on board is gonna say,
yeah, but the operating agreement looks like this.
Right.
And that's a huge part of the closing process when
everybody's agreed to invest.
And then you turn it over to the attorneys and they fight
back and forth while they go through the closing process.
They're going through that to say, Hey, my client, most
recent investors have these terms, uh, that are very
important and we need to make sure they're properly amended
into the operating agreement.
Now, look, there's a lot of people that are, that are in
the room as well, like previous investors, et cetera, that
are like, Hey, screw you, like that's gonna work against me now
and I'm gonna fight with you.
Good luck with all that problem for another day.
But I think what's interesting here is that, again, our
illusion of control is that, but I thought, you know, if I just
own the majority, I don't have to deal with any of this stuff.
It's like, dude, as this is not where any this is coming from.
Yeah.
And there's, there's one other point I wanna make and I'm
curious your thoughts here.
I've been in a situation multiple times as a funded
founder, and you talked to lots of funded founders
about this stuff, where I have full control of the
company in whatever capacity.
I think, like I've got voting rights, I've
got, you know, whatever.
Right?
But I got no money and it looks something like this, it,
it looks something like this.
Once again, you and I both have our 40% shares.
We've got 20% investors, but we're about to run outta money.
Yeah,
right.
We, we raised 2 million bucks.
We ripped through it all.
We set up payroll.
We got a bunch of people we gotta pay every, every
month and, and we're about to be outta cash.
And the investors come back and say, we're willing to
put in X amount of dollars.
Yeah.
However, here are our conditions.
That invokes the golden rule, which is be with the gold rules.
That's
it.
And the reason I, I wanna bring this up is because
this is part and parcel with running a funded startup.
This isn't like, oh, this happened one time.
It's like, it kind of happens every time.
It gets worse when you take on more money.
You know what I mean?
Pretty much every time.
Right?
Like, 'cause even if you won governance on paper.
Yeah.
Right.
Investors can still control outcomes through
financial leverage.
Yep.
Right.
And runway is kind of the only board seat
that can't be outvoted.
Correct?
Yeah.
It's
at that moment.
Great way to put it.
You could, right?
Technically I suppose you could.
And, and you're like, okay, so you choose to exercise
your vote into insolvency.
Like that's what are you gonna, what would the point be?
Right?
So.
Again, best voting right, is a positive bank balance.
You've got to be able to absolutely support the
decisions you wanna make because otherwise, like you
said, the financial leverage piece is, is always there.
You need money to move forward then, right?
If it's, that's where it comes from.
Cash is control.
When you're outta runway, rights become theoretical, right?
And that's the end of it.
Can you make payroll right there?
There's your right.
Right.
And, and, and we are all as startups perpetually
going out of business.
Yeah.
Like that's the nature of how this business works.
It's not a one-off.
It's not like, oh, there was that one startup
that ran outta money.
Right.
Yeah.
It's like every startup that's going to run outta money.
Yeah.
In a few survive.
Yeah.
So this is an incidental condition.
This is like the most common outcome.
For, for, again, for founders that are, for founders that
have been through this, we don't have to explain anything.
They're like, yep.
Yeah, that's pretty much, that's it.
That's exactly how it goes.
And it sucks for founders that haven't, but they're
getting into fundraising.
I wanna say what I wish somebody had told me.
When you raise money, it's the last time you have control.
Yeah.
Until you make money.
Okay.
And so when we raise money, you and I raised 2 million bucks.
We got money in the bank.
We've got a little bit of control at that point.
Yeah.
In as much as we have two voting seats out of five.
Right.
So we have a little bit of control and we don't have
to ask anybody for anything because we're doing okay.
We're making payroll, like everything's fine.
Now, fast forward 18 months and now we've got
six months of runway.
Right.
And now we still want to be able to say, but this
is our strategic direction, but this is our valuation,
but this is how much money we're gonna raise, et cetera.
Mm-hmm.
And the investors, both the current ones and the future
ones are like, I don't care about any of what you want.
Right.
Yeah.
Like, you're gonna do what I want, or You're
not gonna make payroll.
And we're like, yeah.
Huh?
Yeah.
We really don't have any control.
Yeah.
Like it doesn't matter what we own.
No, it doesn't.
When you're profitable, you can negotiate.
When you're broke, you comply.
Right?
Like that's, if you want to go play with more of
their money, you are going to play it by their rules.
You are.
It's interesting because you see this in public companies
now, there's all different conditions set in public
companies, but when public companies are doing well, read
Elon Musk on any given day.
Right.
Elon Musk can do whatever the hell he wants.
Now, in most cases, if you look at his companies, he owns a
tiny share of those companies.
Right?
Like he's, he's a big shareholder in Tesla.
Relative to Tesla.
Yeah.
But you know, small shareholder otherwise.
Um, but when Tesla's stock is doubling, and Elon Musk
put this theory to the test, you can do the craziest shit.
Imaginable and everyone's fine with it.
Okay.
He sure did put that to the test,
didn't he?
He sure put that to the test and in case you weren't
sure, but it's when things go the other direction.
Yeah,
right.
That you see what your control in your position really is.
If Tesla stock just plummets, now this is a bad example
'cause SpaceX is where he's gonna make all his money.
But if Tesla stock plummets Right, and that was the only
thing he owned his voting rights and everything else.
No one cares.
Yeah.
Right.
Because at that point he's lost sentiment.
He's lost trust.
And again, if the board or the activist shareholders, et
cetera, are actively conspiring against his performance,
almost no amount control is gonna say, save you from it
at that level of operation.
I would say the your control strategy is just stay funded
and stay credible, right?
That's right.
And so
that's all you need at that point.
Think about other, like, famous examples.
So back in the day, I was at late eighties, early nineties,
uh, Steve Jobs got fired from Apple by John Scully.
Right?
Uh, and that was, you know, a very famous moment.
Now, he didn't have the voting control to maintain his, his job
or, or even, you know, a stake, meaningful stake in the company.
And so he was able to be pushed out.
Now, a couple things.
This is Steve Jobs, right?
Uhhuh, like arguably one of the greatest
entrepreneurs of all time.
Yep.
He got pushed outta the company also.
Not a pushover by the way.
Yeah.
Also one of the biggest NAS of
all time.
Not just, he wasn't just like, oh, you want me to go?
Okay, cool.
Yeah.
See you.
Okay, here,
send me, have a box.
I can put my stuff in.
I can't think of a harder person to fire.
But again, even he lost the leverage.
Yeah.
So he gets pushed out now.
Now flip it around years later, he gets famously brought back
and you know, brings about one of the greatest, what
I'd argue to be turnarounds.
Apple is actually already a good company, but, uh, turnarounds
in corporate history.
Now that man can do no wrong.
Right?
Right.
This is at the time right When the company's doing well, you
are god damned invincible.
Yeah.
When Tesla's doing well, Elon Musk is god damned invincible.
Yeah.
And the reason for that is because so long as you're making
them money control provisions just don't get invoked.
They don't, they don't get invoked.
That's kind of like the hiring thing.
If you're not making a really stupid hiring decision
over a hundred k, no one's gonna try to stop you.
Right.
They're not, they don't want to
stick with that.
The whole point of control provisions are
when things go wrong.
Yes.
Right.
Okay.
Things can be going right and people can
maybe not agree with you.
Like I can't fathom that any of the people that are
meaningfully invested in Tesla watch Elon's actions
on any given day and say to themselves, there's no other way
we could hope this was going.
Like the outcomes are incredible.
Like what?
What the guy can do is incredible, but the behavior
that gets you there yeah, is just batshit crazy.
And so again, as long as he's doing well.
Okay.
As soon as that changes, that's when control provisions come in.
Yep.
But that's also when people are trying to protect
themselves from crazy shit.
Let's talk about it from the founder's perspective.
Yeah.
What do we actually need to protect.
What is it we should be protecting?
Right?
What actually matters here?
Because I think that control is way too broad of a,
we can't have control.
We've already talked about that.
So yeah.
What are the specific things, specific rights,
the non-negotiables that we really want to have?
At least somewhat locked down before we're negotiating
under pressure right before we're at six months of runway
and only enough cash for the next, uh, five payrolls.
So let's dial that in a bit.
I think it's a great question.
Let's agree that we can't control the company, per se,
this amorphous thing that says I have supreme leadership, right?
But we can control particular provisions,
particular conditions that are important to us.
Okay?
And what I would also argue is, while these might be like
things that we'd love to have.
They also might just not be realistic, for example.
Any entrepreneur that gives us five seconds of
thought is gonna say, one provision I want more than
anything, I cannot be fired.
Mm-hmm.
I mean, 'cause you know, we think about that as as
very personal and secure.
Right.
And I would argue there's rarely going to be a case where
there's no way to fire you.
I mean, there's a hundred things that you could do wrong that
would be like straight up.
Of course we fired this person.
Yeah.
You know, what we consider to be for cause fraud, theft,
you know, things like that.
Yeah.
Like there's no co-founder or investor in the world
that wants to be joined at the hip with someone who can
do anything that they want and still not get fired.
Like
Right.
To me, that's a selfish clause.
So.
If you're willing to concede that and say,
okay, well, yeah, I get it.
I, I don't, I don't mean it that way, like, I do awful shit.
Of course I shouldn't be there.
Or people should have protections.
Then what you're really saying is, I don't want to take
on, not take on investors, so I don't wanna be fired.
I only wanna be able to get fired for these reasons.
Correct.
These are my non-negotiables.
Right.
Like, like if I hold up a bank, like I get it.
Anything short of that, you can't touch me.
If I deposited the company accounts though, like, I mean,
was the company really harmed?
Mm-hmm.
I had a case last Friday out to dinner with a founder
reached out to me and he said, my co-founder just cleared
out the bank account, cleared it out, and was like, yeah,
it's just not working out.
Can you imagine that?
I mean, like, you know what's crazy, right?
Is we get to see everything.
Yeah.
And this isn't the first time I've seen this, but to see the
look on his face when he was describing and that had just
gone down like a few days prior.
Emergency called me to come in and try to figure it out.
And I'm thinking to myself, you guys did this deal
together in good conscience.
You both thought you were gonna grow a great company, and
then one day your co-founder decided that you were no
longer going to be part of this company without your say.
Right?
Yeah.
Like.
How could you have ever predicted that?
Imagine that was coming.
Yep.
You don't,
and so what I said to him, I was like, have you read the
operating agreement or have they the other co-founder
read the operating agreement?
'cause I'm, if you have one, I guarantee this isn't okay.
Right.
And it turns out they had, they didn't, you know, dig in and I'm
guessing they didn't have a very like strong operating agreement.
But there's just, there's some fundamental protections
that say you can't just steal from the company and
get away from it scot free.
Like, like that.
That's almost 0% chance you're, you're gonna correct.
Hold that, that provision.
Yeah.
And, and why would you want to,
right?
Well, right, right.
Who would you expect to accept it if you did?
You're like, there is a, a non-litigation clause
against me absconding with funds to the Virgin Islands.
I, you guys are
okay with that, right?
Yeah.
I mean, so again, everyone says, well, no, if I do bad
things, I don't want to, I don't wanna protect myself,
so to speak against that.
But remember what you think are bad things.
Are different than what other people think are bad things.
Yeah.
Here's a good example.
Your lack of performance to someone else is a bad thing.
Yeah.
But you're like, I'm in every day killing it.
Yeah.
Right.
Like I'm, I'm working non Do what?
I can't
figure it out.
I'm getting there.
Little by little I'm making the progress.
Right?
Yeah, you
bet.
Like I
still not where we need it to be from a company standpoint.
Yeah.
I'm running as fast as I possibly can, but your
co-founder is looking at you going, yeah, but you're
still losing the race.
It does not matter.
Now think about how.
Giant, those perceptions are different.
Yep.
Right.
I'm working so hard or I'm contributing so much, and the
other person's like I, I'm about to clear out the entire bank
account because this person has such a liability and I'm willing
to go to quarter over it.
Yeah.
Think of how dramatically different those
expectations are.
So again, we go into and we're like, Hey, I wanna
make sure that, you know, I can't be fired or anything
else like that unless you do something really bad.
What I'm saying is, hey man, what you think is
really bad is one thing.
What other people are gonna think is really
bad is way different.
And so going back to, you know, protecting what matters,
we have to be able to say, I wanna be able to protect my,
my employment up until these provisions that I think any
reasonable person would agree.
And I have to know going in that those provisions can be invoked
in ways I'm not expecting.
Okay, so that's one.
The second is anything these, again, the big ones, anything.
That would drive a change in control of the company.
Yeah, change in control could, could mean a litany of things.
It could mean, uh, we get bought by somebody else.
It could mean someone else Now has like the majority
control of the company and there's a lot of ways to, to
get to change in control when and if those things happen.
There have to be provisions that we care about that say
we can't get overridden.
Doesn't mean we're gonna get 'em, by the way.
Right?
Like we'd like them to be in there.
It doesn't mean everybody's gonna greet 'em.
Investors are gonna have a very strong say in that
one, but that's the shit you should be paying attention to.
Anything else come to mind?
Or like when you think about building a company,
what are the things you're most concerned about?
I, I think it does go back to a few little things,
but it's really just understanding kind of what
those non-negotiables are.
It's gonna depend on the type of company that
you're building, right?
If you're building something you intend to have, you know,
just a, a co-founder and team of AI agents at this point.
Like, do you really care about hiring protocols
or anything like that?
Maybe you're not gonna hire Yeah,
right.
Or not gonna be something that's.
Really meaningful.
So to me it's fairly nuanced.
What I would say is just make sure that you are
thinking through those things and that you are choosing
your trade-offs, right?
Understanding where you're being flexible, where you're not,
because if you don't choose your trade-offs, the term sheet's
going to choose them for you.
And I think that's where we see most founders get into trouble.
It's not that they failed to do anything, right?
They failed to plan at all.
They just didn't.
Yep.
Put anything into the term sheet, anything into the
operating agreement around controls like this, and then
later, uh, re regret it.
I also, Ryan, I think there's a lot of things that people you
can't maintain control over.
Like, you can't, like operating your agreement
way into, for example, you can't maintain control of the
product direction, unilateral.
Again, you could try to, like, I've never even
seen someone do this.
You could try to force a provision in your operating
agreement that says, you know, product direction will always be
made by this person, et cetera.
Or, you know, these co-founders, first off, no one would agree
to it, and second off, it's such a. Amorphous term that you'd
never be able to uphold it.
And by the way, if you're doing well, the company's doing well.
You get that anyway.
If you're doing poorly, no one's gonna wanna be able to
say, oh, I know we're doing poorly and losing a bunch
of money, but let's glad you got that provision that
says we can't change course.
By the way, like again, to go back and talk about the
reality of these situations.
We've talked to some other podcast episodes, but no
one wants to come in and do that either, right?
No.
There is no board member, no investor who's
like, you know what?
I really want is to have to take control over product
direction to save this sinking burning, about to
go down a whirlpool ship.
Right.
That's nobody's idea of a great time.
They're not coming in and trying to take away your control.
I, I think that's really like, for me, control and,
and the losing control, that's when it actually happens.
Yeah.
Investors don't generally take control.
You lose control of something and they're forced to step
in and assert control.
It's very different,
right?
They're trying to save the asset now.
You never see it that way.
Yeah, right.
You look at it like they're meddling.
Right?
They're telling me what to do, right?
Yeah.
Well, you're not doing it right, so someone has to.
Things going bad and meddling tend to go in
hand in hand, right.
It's kinda like when people think about the police, right?
Yeah.
Like, oh, the police are harassing me, not if you're
not breaking the law.
Yeah.
And not
to those two things is things tend to go hand in hand.
So when I think about putting a deal together, right, what I'm
actually most concerned about isn't the day-to-day operations.
It's how this ends.
In other words, like what are the requirements if I wanna
sell this thing, get liquidity, et cetera, because those are
the life changing things that if and when it comes to that,
I'm screwed if that provision doesn't, you know, work
in my favor or support me.
Most common example, and I can name 10 people off the top of my
head right now that are dealing with this, is we've got an offer
to sell the company or get some liquidity, et cetera, and the
investors don't want to take it because it doesn't benefit them.
We see this all the time.
You and I start this company, we raise 2 million bucks.
X amount of years later, we get an offer to sell
it for 5 million bucks.
And the investors were like, well, we'll
make no money on that.
Like, yeah, but Ryan, I'm, you know, make over a million
dollars a piece like that is life changing to us.
Yeah.
It's a at best of base hit.
Now, I'm not saying at all that the investors don't
deserve their return.
That's, that's why they do what they do.
But I'm saying it's moments like that where the delta.
Outcome is massive.
If I can't hire my buddy for 200 grand a year, okay,
it sucks, but I get it.
But if I can't fundamentally make a decision, that'll
change the trajectory in life.
Of me and my co-founder, that's a pretty big problem.
You know what I mean?
For sure.
And, and I think that's where these, these things tend
to go off the rails, right?
And I guess again, like we have to define these
things from the beginning.
And I think that's where if, if we don't fight for the right
things at the beginning, and I think that's a big part of why
you and I get so frustrated.
We're trying to find that, like we're trying to get them
to agree to this valuation because we want, and again,
fight for the valuation for the right reasons, right?
Fight for the valuation.
So you're getting the most money for the least equity
that you have to give up.
But it's not about control.
Right, and so I think this is what we so often see founders
spending energy on things that just don't really matter, right?
Founders don't lose control because they
diluted too much, right?
They lose control because they didn't define what mattered.
They didn't negotiate it clearly, and then
they ran outta cash.
Ergo, they ran outta leverage, right?
Equity is a scorecard.
Right.
Governance and runway are the steering wheel, so if you want
control, stop obsessing over percent ownership and start
obsessing over decision rights board math, staying funded
long enough to actually have your choice in this thing.
Overthinking your startup because you're going it alone.
You don't have to, and honestly, you shouldn't because instead,
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Connect with bootstrap founders and the advisors
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