Funding and Controlling Your Startup's Destiny

By Pedro Hernandez | Posted August 31, 2012

Imagine losing control of your company. Apart from flaming out spectacularly, it's every entrepreneur's greatest fear, and for good reason.

A founder getting pushed out of a company is a terrible and real possibility. Take, for instance, Sean Parker (of Napster fame), who was iced out of Plaxo in 2004, or most famously, Apple's Steve Jobs during the 1980's. Although Jobs later staged a storied and triumphant return, Apple teetered on the brink of bankruptcy during his absence.

And they're not the only entrepreneur to face the wrath of venture capitalists and boards of directors that don't see eye-to-eye with a founder's vision for their companies.

How can it happen?


The short answer is that entrepreneurs are sometimes outsmarted. Somewhere along the line, typically during multiple rounds of financing, a founder's stake in a company can end up diluted to a point where the controlling interest now lies in the hands of investors and/or other board members. It's nothing illegal; just a shrewd VC tactic.

Luckily, entrepreneurs can employ tactics of their own to prevent such a scene from playing out. And it starts with asking yourself a very important question: Can I go it alone?

Bootstrapping Your Startup

A tried-and-true way of starting your own business is to self-fund it, or bootstrapping as it's commonly called.

Not all types of businesses lend themselves to this self-starter approach. But many, Web companies in particular, have low barriers to entry that makes bootstrapping an attractive option.

The allure is obvious. As your company's one-and-only investor -- investors, plural, if it's a small, trusted group -- you are in full control of the direction of your company. The downside is that it's all on you.

When it comes to bootstrapping your startup, you're in for a lot of pressure. It may mean staying in that day job you hate until your startup has enough cash flow to make it self-sustaining. Bootstrapping a startup also takes thorough planning, financial discipline, a solid business plan and a lot of hard work.

This all translates into a lot of time spent keeping your company afloat, so don't expect a 9-to-5 workday. And if your idea doesn't pan out, you may end up with a depleted savings account and a stack of credit card bills.

Maybe your idea for a business is a little more ambitious than your finances can handle alone. In that case, it's time to go the venture capital route.

Due Diligence is a Two-Way Street

If a VC expresses an interest in your company, put them under the same microscope that you'll be under.

Today, researching a VC firm is as simple as entering its name in a Google search box. Enhance your research by getting the word on the street. Call up contacts, former colleagues and industry peers for the unvarnished truth -- good old fashioned networking as it's called.

And don't just stop at the firm, look at its people. Get a handle on the reputations of its principals and prominent partners. How they conduct business is a good indicator of how they'll treat you.

While you may never end up with a perfect, Cinderella-style fit, you can at least avoid a getting locked into in a contentious business relationship that can last for years. Even so, it helps to get good legal advice.

Hire an Attorney

Always good advice. In addition to all of the legalities in starting and running your own startup, the picture becomes even more complex when you throw venture capital into the mix.

An experienced attorney will not only have your back during negotiations, she will make certain that you're aware of where you stand before you sign any binding contracts. This is particularly important when a VC hands over a term sheet.

A term sheet, as its name implies, is a document that outlines major terms and provisions of a proposed deal. Generally, a term sheet will tackle key details like the level of investment, overall valuation and each party's stake in the company when the funds are released, to name a few.

Although considered non-binding in most cases, a term sheet signals that a VC is fairly serious about investing in your company. It's now that the details get hammered out, and therefore your attorney should help you avoid onerous terms and make sure that your interests are well-represented in the final agreement.

Don't have an attorney or don't know where to start? Check out the Small Business Computing guide to Affordable Legal Help for Startups.

Pedro Hernandez is a contributing editor at InternetNews.com, the news service of the IT Business Edge Network, the network for technology professionals. Follow him on Twitter @ecoINSITE.

Do you have a comment or question about this article or other small business topics in general? Speak out in the SmallBusinessComputing.com Forums. Join the discussion today!

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