You’ve heard the pitch before, right? Be your own boss! Call you own shots! Wear the feathered hat. The topic this time is business ownership.
Assuming you’re answering this call to adventure, we’ll examine two main ways of approaching it, and which of them delivers best.
Everyone who has worked in a startup or considered founding one should have a basic understanding of what it entails. Feel free to skip this first section and go straight to the meat. For those less in-the-know, read the rest of this section.
First off, familiarize yourself with companies, the catch-all category for business organizations.
This article will concern itself with:
- Sole proprietorships and LLCs, which we’ll treat as being two stages on one track — sole proprietorships often become LLCs as they mature.
- Full-blown corporations. The most common type for our purposes is the C corporation.
More or less the whole point of creating a corporation is to issue stock. Stock is partial ownership of the corporation. In order to raise money, founders issue stock in exchange for funds. However, it’s not quite so simple.
Dilution occurs when new stock is issued. It is like monetary inflation: each individual stock unit is made less valuable by virtue of there existing more of them. In a funding round, this is acceptable because it is accompanied by the company gaining assets, which makes each stock unit more valuable to compensate.
The board of directors is the next piece of corporate anatomy. The board wields supreme power in the corporation, but its members’ votes decide its decrees.
The traditional track for entrepreneurship is to start a business as the sole owner or as partners. This approach remains common for small business, legal practices, and private medical practices. The founders foot the bills, do the work, and take home the profits.
The startup route differs in a way that makes it very alluring: rather than spending your own wealth to start the business, investors will pay your way in exchange for partial ownership. In exchange, they enjoy certain rights and privileges that ensure that you don’t cut and run with their money.
These two tracks share crucial benefits for the entrepreneur:
- You will be an executive. If your business is successful, you will either go on to start more businesses, or you will find employment in upper management. Whichever road you choose, you will have gifted yourself a major promotion that takes some time to mature.
- You will call the shots. For how long depends on the path you take, but you will call the shots for some period either way.
- You will own a company. Again, the difference is for how long, but you will own it. If your outcome is the sale of a successful business, then you will get paid for your slice of the pie.
The devil is in the details, and these details will show up in the differences.
The traditional track maintains your ownership. You pay employees with money, not equity in your company; you foot your own bills, so you never sell part of your company. You have no shareholders to answer to. You really are captain of your own ship.
Startups deliver their allure entirely through making a game of company ownership. A startup’s lifecycle includes many rounds of funding, each of which means you own less of the company. This is fair and reasonable; again, the devil is in the details. Adioma has a great infographic about startup equity that covers this aspect.
Now, investors aren’t trusting people. Blame the shitty people in the world, it’s ultimately their fault. Taking money from investors means making your company a hospitable environment for them; here’s how these changes will impact you and your business.
First, investors aren’t plebs like you or me. They don’t buy common stock, regular company ownership, from you. They buy preferred stock, which differs in a key way: it enjoys liquidation preference. That is, if your company goes bust, preferred stockholders get paid in the fire sale before you do. Often enough, this means you get nothing.
In every round of funding, the question of board seats will come up. Even angel investors are starting to ask for board seats now. The board has the ultimate say in what direction the company takes, so losing control of the board means you’re no longer the boss; you’re just an employee who gets to have a say.
Anti-dilution clauses are an extreme risk-mitigation measure for investors. These clauses kick in when you sell stock for less than your previous investors bought theirs for — if your company’s valuation drops and you need more money, anti-dilution will be a problem.
These clauses issue your previous stockholders more stock until their share of the company is worth the amount they originally paid. Your newest investors won’t be happy about this, as they get diluted right along with you.
In short, anti-dilution is you-dilution.
This is a forcible buy-back clause for the stock you own as the founder. If you ever quit, or the board decides to fire you, your stake will be bought out by the company at its present valuation.
This is a perfectly reasonable clause. The only reason I bring it up is that its entire purpose is to make you replaceable. Did you start your business so that you could be replaceable?
As a precondition to getting your startup funded, the company must own any new technology or other intellectual property (IP) your business is based on.
The effect of this requirement is that you only get to try once. If you fail, your company is liquidated, and the IP is sold to recover some of the investment capital. Recall the section above about preferred stock: in all likelihood, you won’t see a dime of what your invention was sold for.
Now, if you want to try again, your first roadblock is buying back the rights to your invention. If the buyer saw half the value in it that you did, it’s probably not for sale.
Once you lose board control, you are an employee. Nothing drives this home better than the reality that the board can now fire you. And, often enough, it will.
As a founder, you are a mere useful idiot to venture capitalists (VCs), the people you will get nearly all your investment capital from. They tolerate you as a mere cost in the transaction; as toxic as the measures described above looked to you, letting an often-inexperienced entrepreneur run their investment appears the same to them. The moment they have board control and the company is doing well enough to afford buying out your stake, your VCs will fire and replace you.
Cog in a Machine
If you’ve read this far, you understand how the startup route reneges on the promise of entrepreneurship by turning you into an employee. Indeed, to be replaceable is antithetical to the entrepreneurial pursuit; to be replaceable means you’re not impacting the world in the way that only you can.
So, then, the choice between the two tracks is a question of your motivation: do you want to be a replaceable cog in a machine, or do you want to be an individual with full power and responsibility over his property?
I hope that, by this point, there is no doubt left for the reader that the startup route is guilty of false advertising. It is a system for churning out original corporations ready to be run by their pocket executives.
For those among us who want to make an original impact upon this world, those of us who do business as a form of self-expression, there is only one track: ownership.