How Small Business Owners Can Avoid Losing Ownership of Their Business

Every entrepreneur starts their business journey with a dream: to see their small business grow into a mega business someday. While the road from small business to medium-sized business is hard enough, taking it to the next step of becoming a big corporate brand is another ball game altogether.

The biggest hurdle in this is securing more capital. For many business owners, more capital equals going public by issuing shares or other securities in a significant seed round. Their thought process is understandable, because only with big money can big goals be achieved and big visions be realized, right?

But what they probably don’t realize, or gauge the gravity of, is that it’s not just shares they’re giving away – it’s also control over the business.

Where Is Business Control?

Control in a business goes beyond just shareholding percentages and ownership rights. True control is all about who has the power to make and break decisions, evoke and revoke rights, and play, sway, or delay future business plans.

Your business is your child. You’ve cared for it, guided it through its toughest days, and spent sleepless nights worrying over its future. A slight oversight or ignoring a seemingly minor detail in how your company’s structural and operational framework is composed can pose a threat to your position in your own business. It is therefore imperative to make any decisions that could change the ownership structure of your business with the utmost care, clarity, and foresight.

How Small Business Owners Lose Business Ownership

Control can be sneaky, often escaping unnoticed until a major company decision has to be made, and your opinion is drowned out by the voices of newly instated shareholders or “owners”. In all fairness, they, too, have the company’s best interests at heart. After all, their money is also at stake. However, all said and done, you know your company the best. And sometimes, their motivation to safeguard their investment could be at odds with your dream for your business.

Hence, what seem like little concessions to such investors, such as a seat on the board, veto rights, or the right to block business decisions, could eventually turn sour for you and your vision for the company if not thought through carefully. Some demands look so inconsequential that you agree to them readily enough, only to realize their seriousness when a problem arises. Other demands, such as exemptions on protective terms of the shareholders’ agreement, are obvious red flags that need to be addressed immediately and in detail.

Most importantly, such misaligned approaches and internal power plays ultimately affect the business itself, further aggravating existing tensions and leading to more errors in critical business decisions and growth activities.

So how do you recognize the danger areas and prevent control from slipping out of your hands?

How Can Entrepreneurs Preserve Ownership of Business

Fortunately, there are various ways to protect and control the destiny of your business, even as it scales to new heights and you bring on new stakeholders.

Avoid Raising External Capital Unless Needed: The first way is to avoid external capital investment for as long as possible, seeking to fund the company through business cash flow or founder investment. Rather than investing a single tranche of capital at the start, the founders can invest successive tranches to grow their business further.

Many founders believe that to grow, they need to raise capital, which requires giving up more than just equity in the transaction, such as a board seat or advisory position. While many later-stage financing rounds, especially from Series A onwards, require founders to give up a board seat, there is one easy way to avoid this: avoid raising venture capital. Control can’t be preserved through optimism or improvisation. It has to be built intentionally.

Board Provisions: If you cannot avoid raising external capital, ensure you know how much upper hand you have in negotiations. A lucrative business opportunity can help you get better negotiation terms, and you do not have to give up board control and board member nominations.

Shareholders’ Agreement: You may not always win the negotiations. The external investor may ask for equity, and that is where a carefully drafted shareholder agreement can protect your ownership. You can draft the agreement to preserve the business’s vision and to put guardrails around decision-making thresholds, transfer restrictions, and dispute resolution.

Articles of Incorporation: Apart from the shareholders’ agreement, your next line of defence will be the Articles of Incorporation. There are standard forms that a founder might adopt. However, the standard format may not reflect your company’s strategic and operational goals, including future fundraising or planned exits. Consider revising the Articles of Incorporation to protect your ownership.

Share Class Structure: Many startups issue only one class of common shares to all shareholders. You can have different classes of shares that give different rights to their owners. For instance, you can have class A shares that only have the right to dividends, class B shares that have special voting rights, and so on. Talk to a business consultant to design a share class structure that can protect you from losing control of your company in fundraising rounds.

Convertible Notes or Staged Investment: Instead of issuing equity, which dilutes ownership and profits, you could consider issuing convertible notes that will work as debt initially and delay the dilution by inferring a right to receive equity shares later. Such investment options give you time to buy back the notes if your business becomes profitable, thereby reducing the risk of losing ownership.

This article is not to discourage capital raising, but to protect you from losing control. Investors want to preserve their interest. Good investors bring experience, capital, networks, and credibility to the table and lend startups market credibility.

An expert business consultant and legal advisor can help you place clauses, agreements, and several lines of defence in your company’s structure that will help you give options to the investor at the negotiation table. You need not give the investor outright equity and a board seat at the early stage of investing. However, you can gradually issue convertible bonds, dividend-only shares, and other such securities that protect investors’ interests and your control over the company.

Remember, saying yes to investors’ demands is easy, but saying no to them requires a strong structure.

Contact DNTW Toronto LLP in North York to Help You with the Company’s Ownership Structure

Talk to a professional business consultant to help advise you on how to raise capital without giving up too much ownership of your company. To learn more about how DNTW Toronto LLP can provide you with the best business consulting, reach out to us here.