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What is the primary reason for a VC to seek controlling voting shares in a start-up?

Answers

Topic Expert
Kent Thomas
Title: Founder
Company: Advanced CFO Solutions
(Founder, Advanced CFO Solutions) |

If it is the first financing round, then I can think of only two answers: 1) Greed or 2) the investors do not have faith in the founder's ability to execute and they are mitigating what they see as a serious risk that their money will be squandered. The only time I've witnessed a situation where I thought it was a good idea for an entrepreneur to give up control in the first round was when the founder did not want to be actively involved in the company - he wanted someone else to take his idea and make it successful. Remember that the "team" is the most important consideration for investors and usually if they don't have faith in the team, they simply will not invest.

Topic Expert
Randy Miller
Title: Partner
Company: CFO Edge
(Partner, CFO Edge) |

I would agree, and if you have a VC that wants a controlling position, then you can expect that the majority of the officers and board will be replaced as quickly as possible.

Topic Expert
Michael Bateman
Title: Principal
Company: The Bateman Company
(Principal, The Bateman Company) |

I think that Kent and Randy have answered this well though would modify Randy's comment by saying a VC with a controlling position won't necessarily make replacements as quickly as a possible. If giving up control (as a last resort) better to have at least two VC's participating, thus, if one goes insane/inane - been know to happen - hopefully you can reason with the other. Even better if the 2nd VC came in a year or two later. If the first wants to give up on the company too early, the 2nd may be more likely to stick with you having been invested for a shorter period. Always good to keep in mind that management and VC goals seldom align 100%, particularly if things aren't going as well as planned.

Topic Expert
Marc Faerber
Title: CFO
Company: Amarantus
(CFO, Amarantus) |

They have pretty much covered it. The VC world is also going through some changes and depending on the sector some VCs may not want to have other investors come in, which is rare. The over riding reason is still control and to have the ability to change board and management composition almost at will.

(Agent, JKS Solutions, Inc.) |

Everyone has a goal to achieve. The founder is looking for a high value exit, the early stage seed investors and Angels are looking for an exit at a descent rate of return and return of capital as soon as possible. When a VC decides to commit funds they are going to help the venture scale and transition fully to professional management and more times than not to IPO. The VC track has been traditionally 10 years to exit and they hope to get a return of 10 to 30 times their money. They're gamblers. For every 20 investments maybe only 1-3 pay off. There is a lot of pressure to meet the investment returns for their fund investors.

Today the time to exit is decreasing to say 2 to 3 years mainly due to the lower cost of development made possible by the availability of cloud architecture. Just about anyone can develop today without a $50 million investment. Today they need about $200,000 to get started, a minor amount compared to the past bricks and mortar model.

Fast starts fail when the team doesn't spend enough time to develop either the exit strategy or the revenue model. If a VC is getting in early, they've decided there is a compelling reason they need to be there and they will help to develop the revenue model. Eliminating earlier stage investors can annoy those Angels who wanted to wait it out until the big exit, but they don't always get that opportunity.

Recent examples of incorrect strategy based on greed are Zynga, Groupon, and Facebook. Groupon did not have a repeatable and well managed revenue strategy, neither does Facebook. And both companies have no plan to remove the founders. Founders can get in the way of professional management and keep the venture focused on things that do not allow it to get to scale successfully. Zynga was just silly excitement with no revenue strategy. But they did make cute cartoon people.

Reduced time to exit has been driven largely by Google acquiring cool tools quickly. The 2-3 year exit strategy is a recent phenom.

With the market the way it is IPOs are dead. They will rise from the grave when the economy gets back in gear and there is more investor confidence.

Recent 2012 comments from Ignition Partners on the topic of where is all the money for startups, indicated that VCs and Angels are being more picky about investing in ventures that have more strategy figured out by the time they pitch. There is lots of money but only if you have your strategy ready for investors to trust. The comments came from the MIT Enterprise Forum Venture Funding topic in January 2012 that I helped to sponsor.

Some web resources:

Where the money is going
https://www.pwcmoneytree.com/MTPublic/ns/index.jsp

Analysis of VC investments July 2012 - Investments are on the Rise
http://www.pwc.com/us/en/press-releases/2012/2012-q2-moneytree.jhtml

National Venture Capital Association
http://www.nvca.org/

Topic Expert
Ken Kaufman
Title: CFO
Company: Community Dental Partners
LinkedIn Profile
(CFO, Community Dental Partners) |

I agree with a lot of the comments so far, and I am just going to add that I think the main reason VCs would seek a controlling position in an early-stage or start-up company. It goes along with Kent's second point of the VC having a lack of faith in the founder(s), but it goes even deeper than that. The VC believes it is likely that they will add more to the strategic direction of the business. Part of that is the lack of faith in the founder, although they may humor him/her for a while to see if they can deliver. But the other part is that the VC sees itself as more capable, they are excited about the business opportunity, and they do not want the existing management team to slow them down if the existing founders and managers do not get onboard with where the VC thinks the company should go.

Remember, the controlling shares can drive the election of the board, and the board hires/fires the President/CEO. Then the President/CEO, who reports to the board, drives the hiring/firing of the rest of the Executive Team as well as a lot of the strategic and tactical initiatives and execution. Most board of directors do not try to have too much influence on any hires except the President/CEO. After all, hiring their day-to-day leader for the business should mean they trust him/her to hire the right people and plan and execute effectively.

Topic Expert
Wayne Spivak
Title: President & CFO
Company: SBAConsulting.com
LinkedIn Profile
(President & CFO, SBAConsulting.com) |

Can I be more cynical?

When you sell part of your business to a party that has access to much larger amounts of capital you are putting your investment at risk.

Need a bridge loan, oh, your partner will provide it. Need certain introductions, that well connected partner will help out. Slowly you have shifted control to that partner, and the partner didn't even have to actively force the issue.

Topic Expert
Keith Perry
Title: Consulting CFO and Business Operations A..
Company: Growth Accelerator
(Consulting CFO and Business Operations Advisor, Growth Accelerator) |

In my experience, this is not necessarily about wanting to change anything immediately. Instead it is about risk.

Premise: the VC doesn't really know you, the team, the market, the technology, etc. They really don't *want* to be the expert in the space. We might tease our VC colleagues about being the smartest people in the room (in their opinions) but that isn't what this is about. Further, finding a good VP Sales, CEO, etc is really, really expensive. They're not going to invest $Ms in a company just so their nephew Joe can have a job (allowing that I have actually seen this, so there are exceptions). Change is hard work, disruptive and expensive; they won't do it unless they have to.

Now about risk. When they come in, they don't know how you are going to do. If you hit your numbers, scale the business, work toward a favorable exit, etc....great! Why upset that by replacing the team? However, if you miss or if there are mis-matches, then as board members they have an obligation to fix the problem. As majority-control shareholders, they will have the ability to do so, and very likely will.

As a PS to Valerie Campbell's point, I agree...sort of. Zynga is in a hits business. The market figured this out...after the IPO. Oops! FB exited on historicals, and probably milked as much from the exit as possible. In both cases, they worked toward a successful exit, and in that light you wouldn't want to replace management. That they are walking-dead stocks now is really nobody's problem except perhaps managers who want to use stock as an incentive tool. If FB *hadn't* exited when they did, then you'd have a problem. There are plenty of companies who (I believe to Valerie's point) don't exit successfully, and investors want to be able to fix that if they can.

Derek Quackenbush
Title: CFO
Company: Rising Data Solutions
(CFO, Rising Data Solutions) |

Lots of good comments.

I would just call out the importance of picking the right partners, which includes investors. When you take someone else's money you are going to give up some control (and dilution, etc.). And expect for changes to be made/imposed if things are mismanaged. However, no VCs I know want to replace a founder if they can avoid it. It's costly and can damage an organization. Rather, they want to enable success. And if that means offering thoughts on a revenue model, then so be it. They are typically pretty well-educated and experienced. So it might make sense to listen to them. Yes, protect the downside in negotiations. But also look for the upside--find investors who can help you by providing information and guidance as well as dollars. I think it's both unrealistic and unreasonable to expect to get money from anyone and then not have them be involved.

Just my two cents. Good luck!

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