When Tesla founder and CEO Elon Musk tweeted the above statement early August, it kickstarted a series of things:
- Tesla stock jumped from about $363 to $379.
- The Securities and Exchange Commission launched a formal investigation into Musk — accusing him of making false and misleading statements to prop up Tesla’s value.
- The US Department of Justice opened a fraud investigation into Tesla.
- The SEC charged Musk with fraud, and Tesla and Musk reached a settlement with the SEC in which both Tesla and Musk will each pay a $20 million penalty and Musk will have to step down from his role as chairman at Tesla.
Musk apparently hasn’t learned from the experience and only recently went on Twitter to make a gibe at the SEC, referring to it as the Shortseller Enrichment Commission, and venting his frustration at short sellers and claiming that what they do should be illegal.
Regardless, it doesn’t seem as if Tesla’s woes will be ending anytime soon (not as long as Musk has access to Twitter), but what if we look at this whole fiasco from another angle:
While it is easy to single out Musk’s behavior, and to particularly direct an inordinate amount of criticism towards him because he is a billionaire celebrity, it is important to pay attention to a more subtle issue: founders’ struggles not to lose control of their startup.
While Musk has been able to keep such tight reins over Tesla, other founders are not so lucky: an example that quickly comes to mind is that of Lane Becker, the founder of Get Satisfaction who was not only ousted from his company but didn’t make a dime when his company sold for $50 million. Worse, he wasn’t even told that the company he founded was about to be sold.
For companies at the edge of innovation like Tesla, it can be a real challenge achieving real progress when you have to bother about having to disclose information that could potentially empower your competitors in quarterly reports, when you have to worry about how shareholders respond to every strategic move you make based on its short-term impact, and when you can easily be ousted due to shareholders’ perceived ineffectiveness of your approach. These seem to be some of the key reasons why Musk is contemplating taking Tesla private. He has repeatedly referred to and decried these “distractions.”
However, analysts have suggested that it would cost Tesla more than $70 billion to go private (a figure Musk himself says is a bit exaggerated), making the prospect more dim for Tesla. Startups, however, could take a cue and take measures to avoid losing control of their company.
Here are some ways startup founders can avoid losing control of their company.
1. Be careful when taking venture capital
With blazing passion for taking your company to the next level and reaching new heights of growth, it’s easy to be tempted to take venture capital and to keep taking new funds. After all, more money will surely make things easy. But think twice before taking that VC fund.
What type control of your company are you giving up for the funds you are taking? Do you really need the money? If you do, do you really need the exact amount you are about to take?
It’s easy to be blinded by the desire to get funds and lose your company in the process. Get Satisfaction’s ousted founder, Lane Becker, isn’t alone. Research by Harvard Business Review found that approximately one-fifth of founders in VC-backed companies are replaced — and some estimates show that up to 40 percent of founders are removed from their original role when their company takes VC funds
2. Consider insider buying
Not to be confused with insider trading, insider buying is when directors of a company purchase the stock of that company. It’s easy to want to aim for the luxurious life when your company is doing well. However, it is smarter to buyback your company’s shares.
According to an analysis by J.P. Morgan, S&P 500 companies are expected to buy back $800 billion of their own shares this year.
While Apple recently made news for having repurchased over $220 billion of its own stock, it’s not just Apple that is doing this. Startups are, too: it wasn’t long ago that Carlyle Group LP made news for buying back $200 million of its own stock (in a move that was widely criticized). More recently, CTXR has also been in the limelight with several key executives, including chairman Leonard L. Mazur and president Myron Z. Holubiak, buying back millions in the company‘s shares. Data from Nasdaq Private Market revealed that in 2016 alone, private startups bought back $940 million of employee stock through its platform — an increase of 40 percent from just two years prior.
Buying back your company shares actually does more than just increase your control of your company, but it also signals to investors that you are a strong believer in your company’s vision and what you have to offer — which can help prop up your company’s value.
3. Ramp up your negotiation skills
Sometimes you have no choice but to take investor capital. It’s delusional however to think that you can get funds from investors without having to relinquish any form of control. You need their money, and you only get it by giving them part of the control you have over your startup.
However, you can give yourself an edge by carefully negotiating the kind of control you give when you take VC funds. You also want to pay careful attention to how the agreements are drawn: you can protect yourself by avoiding a kind of arrangement in which VCs get special veto rights that prevents you from taking certain decisions unless they agree (regardless of the decision of other shareholders).
You might also want to issue special kinds of stock for founders — stocks like the Class F common for founders can give founders special voting rights (10x that of ordinary shares) and certain protective provisions.
4. Don’t wait until things get really bad to negotiate funding terms
The more desperate you are are funds, the much disadvantaged you will be when you get the funds. For example, if you’re a cash positive startup trying to raise funds to fuel growth, you will get a much favorable deal compared to if you are a struggling company that needs funds to serve as your lifeline.
Be honest in your assessment of the situation of things for your startup. Don’t wait for things to get really bad before you seek funding.