Swimming with Asian Sharks - Business Secrets from the Pacific Rim

The Shares Indicate the Intent

Mr. Princeton taught me that the way you set up the shares tells you the intent of the partners.  In general, the larger the number of shares one partner wants, the more responsibility he is going to have to accept.  If partners have equal shares, accountability will be harder to manage.  In short, deciding shares is a difficult thing that will depend greatly on the people with whom you are working.  If you are working with super dedicated and accountable people, then you can afford to have more equality in the shares.  In all my start-ups, I have yet to see a team that has every member accountable and dedicated, but it could be possible.

On the receiving end, when the percent is too low, say fewer than 5%, there may be initial enthusiasm, but as the venture drags along, with little skin in the game, there is little loyalty, especially if as a company you are unable to show any progress.

If you have a bit more of the pie, but still under about 30%, this is a sizable amount of the entire company. However, if you are on the receiving end of this share, you will likely come to rely on the leadership of those with more shares. Those holding more shares actually have elected themselves as the leadership of the company. If as the leadership you are unable to maintain the intensity, the shareholders with fewer than 30% people will begin to question why they are doing the project.  In some cases they may elect to remove you from the company if they can gather the support of the other members.  This is best illustrated with an example: when the company shares are split 20/40/40, basically a new member is added into an existing 50/50 partnership, you can run into this takeover situation.

The 20/40/40 situation can actually be used as a trick to underhandedly remove a partner.  Starting off with a 50/50 partnership, one of the 50% partners, let's call them partner A, claims they need someone with a certain talent. Both partners agree to dilute their shares a bit to make room for the new member. The pool becomes now 20/40/40, 20% for the new member, and reduced 10% for the previous founders.  Now partner A likely will bring in someone he can influence and lead. Once the shares are divided, partner A with the new member have a combined 60% say in the company.  They now have a combined say over what happens. This includes voting out the other 40% partner, or diluting their shares completely. 

This challenge to the old guard can happen from either partner A or the new member who was added.  A friend of mine had joined a company coming in at 20%, but over time, he noticed that one of the larger share partners was not carrying their weight.  He managed to negotiate a further dilution of the shares to 30/35/35.  Then, after some time, he teamed up with one of the 35% partners to remove the partner he believed was not performing.

If you are not careful when adding members to your company, you may wake up one morning and find that your company has been taken over.

If the company is more than two people, with roughly equal shares, for example in the case of three people, it would be 34/33/33. We would still have the issue of two or more partners ganging up to remove a partner.  This obviously could be very unfair, but is often for the best of the company. To be clear, removal from the company means that they can stop the partner or partners from participating in the company.  This can be accomplished either by voting them off the board or voting to issue more shares to themselves until the other partner is diluted.

In the scenario where you are the majority-owning partner with 51%, you must deal with the fact that you are the leader on paper.  This doesn't mean that you are the leader in reality.  Leadership is a different topic, but in short it is about influence, the influence that allows you to get things done.  A leader without influence is like a chef without ingredients.  In addition to taking on the full responsibility of the future success of the company, you must deal with the scenarios above.  Members are unlikely to be as motivated as you for long if they are smaller shareholders.

If you are hovering at 51% ownership, it is easy for you to lose control of the company when the need to raise additional capital arises.  You can find yourself at under 50% ownership if the need for outside investment dilutes the shares of the founders.  The new investors can then team up with existing members to remove you.

In the case where you as the shareholder have massive amounts of shares, 60-90%, you are still vulnerable to loss of control.  If you get married, or are married, management of your relationship is key.  If you find yourself in divorce, suddenly you may find yourself with half the number of shares in your company.  This sudden halving of your shares can lead you to all the above lower share scenarios.

Another potential disadvantage of having a large portion of shares is that you will have no true partners.  Most people who you will work with are either employees or advisers, both of whom will have a combined insignificant portion of the company.  This can be a problem because you likely will be the only one who is pushing the company forward at all times.  Most employees will not work overtime nor will they usually go the extra mile to ensure the success of the company.  In addition to this, investment into your company will be hard; if you ever find yourself in need of capital; it will be very hard to find an investor willing to enter into a passive relationship, unless he really believes in your product or the company.

Finally, being a one-man band, you have 100% of the company stock.  No employee shares, no advisor shares.  You will be the only one who pushes the company, and the only one who really cares if it succeeds or fails.  Employees will unlikely do anything outside of their job description.  If you get hit by a bus, unless you have a very clear succession plan, the company will end.

The advantage of being a majority shareholder is control.  You are in the driver seat; you steer where the company goes.  Even if someone challenges you, you can veto them and do it your way.  You are your own boss to some extent.  The problem is even if you own 100% of your company; you are still on the hook to your customers.  Your customers provide the money in the form of buying your product or paying for your services.  As a result, you are not truly free to do what you wish.

In summary, share structure is a system.  Systems are better than human will power because will power easily can fail.  A system such as shares can govern how we as individuals play together for a common goal:  the goal of making a successful company that makes all the participants wealthy.