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Don't Give Away Ownership Easily

Unfortunately, you can't always retain full ownership of your company. If that's the case, here are some potential hazards to watch out for.

In a previous column , I suggested that you need to be realistic about getting outside investment for your new business. I'd like to take this column to deal with some of the basics of who owns a company, why they own it and how much they own. I'm scared by some of the questions that come through my e-mail on points related to this. So I'd like to dedicate this column to laying some foundations.

The best way to own a company is to own it fully. You started it, you own it, and you run it. You don't have to decide anything by majority rules.

You bring in others only for good reasons--and reluctantly. There are a few good reasons to expand ownership:

  • You are a team as you start. There are already two, three, four or even five of you. It's unusual to start with teams of more than two or three, but it does happen, although it's hard to make things work with several owners. I don't know if more companies start as single individuals than as teams, but I suspect the fact that there are more than 20 million companies in the U.S. without employees is a good indication.
  • You can't get the critical essential knowledge and experience you need without creating a team. In addition, you can't get a few, select others to join you without giving them ownership. This situation is quite common, but it's also about as safe and steady as a mine field. Go very carefully and expect a lot of problems.
  • You can't start your business without outside money. This is very common. If this is the case, create a good business plan and consider startup costs, initial cash flow and critical break-even points carefully. If you need outside investment, you're stuck with that reality. Outside investment almost always means you don't really own your company. There are exceptions, like very small investments, but they're so rare that I won't go into them here.

If your case doesn't fall into one of those three scenarios, you probably don't want to share your company. Don't let myth, manipulations or relationships get in the way of this cold truth. Let me make some specific recommendations based on a somewhat collective summary of e-mails and questions I get:

  • Don't give shares of your company to your friend who came up with the idea over drinks, while you were camping, after class or during lunch at work. Ideas have no value. If you build the company, it's yours. Don't apologize. Companies need their ownership as a strong foundation; they can't spread it around to people who had ideas. If they wanted to have a company, they should have done it, not just talked about it.
  • Don't give shares to friends, relatives, advisors, lawyers, accountants, consultants or people who have helped you. If they really helped you, reciprocate and help them in return. Buy from them. Recommend them. Invite them to lunch or dinner. And don't let professionals do professional services for you without specifying their billing rates ahead of time, and then pay your bills. Don't give away your company. Shares of a company are a serious business obligation, not to be confused with a thank you note.

If you have done either of these things, you're in dangerous territory. You should know that companies with more than one founder who aren't crystal clear from the very beginning about who owns what and how much are almost certain to end up with ugly and divisive fights over ownership. You must never assume that your partners and team members understand that you own the majority because you did something or paid a certain amount. That's deadly.

Write it down, early on, before there's real money involved, while you're still talking. I tend to think the idea is worth nothing; the money involved is worth a lot; and the work involved--so-called "sweat equity"--ought to be converted into money immediately. If you work for free to start a company, make sure your team members agree on how much your work is worth, by hour, day, week or month, and when it's going to be paid. Or, if it's to be converted to ownership, determine at what rate and when and according to what document. These things not only have to be talked about; they have to be written down and signed.

Don't think it's any better or easier with friends or family investment. In some ways it's harder because it's more difficult to stay at arms length about problems down the road, and often harder to get things written out clearly in the beginning.

Unfortunately, there's no formula for determining how much each founder of a small business owns. There's some mix of work, money, know-how, experience, equipment already owned and, maybe, the idea. You have to agree on what's fair or you're doomed.

In these cases, most companies end up managing this as shares, like shares of stock. When founding the legal entity, the lawyer formalizes how many total shares there will be and how many shares each founder owns. There's a lot of legal weight to that, so pay attention.

If you need serious outside investment, then all bets are off. Buckle your seat belts and get advisors you trust who have done it before. Expect to see a lot of shares going in a lot of different directions. Advisors, professionals, brain trust, investors--a lot of people can end up with shares in these companies. When you need to go back and get more investment, everybody's ownership gets diluted. Founders of companies that go public often end up having surprisingly small shares of the final company.

If you aren't in any of the first three categories I mentioned, use your savings or borrow the money. Be careful, plan well, but own it yourself. Leave Uncle Ralph and Cousin Millie out of the equation, please.

The author is an Entrepreneur contributor. The opinions expressed are those of the writer.

Tim Berry is the president of Palo Alto Software Inc., based in Eugene, Ore., which produces business planning software. He is also the author of 3 Weeks to Startup and The Plan-As-You-Go Business Plan, published by Entrepreneur Press.
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