I was chatting with a company who sold a large minority stake in their company to a well known private equity group (think 49%) with the explicit purpose of retaining control.
Soon after the transaction closed, the PE firm was able to covertly buy another 2% of voting shares from a pre-existing investor in the company, which resulted in the PE firm gaining full majority control over the company, kicked out the CEO, replaced the board of directors, the whole works.
The unfortunate part about these kinds of things is that 1) they happen all the time, and 2) founders rarely talk about it because doing so can so often destroy your ability to get funding for future endevors, etc.
I really wish there were an anonymous but vetted "yelp" type of site for people/firms who do bad business. So much business is done in bad faith and the people on the losing end rarely have the ability to warn others of their experience without killing their own reputation.
1. Giving another party 49% doesn't guarantee you will have retaining control. You having 51% shares does guarantee that. So, their strategy was flawed.
2. Not sure if regulations allow this, but to make it bullet proof they should have made a contract that the PR group will not go beyond 49%.
Without either of the above, the company just did not do good diligence.
I believe the usual path in this type of situation is to dual-class shares, so you can retain voting control while selling beneficial ownership to others. I suspect the PE group would have, you know, rejected this arrangement given their plan.
there are also “poison pill” provisions to prevent takeovers in various ways such as providing minority owners the ability to purchase stock at very steep discounts if a certain event is triggered
> "Having your cake and eating it" is a really bad attitude
Ray Dalio says the following in his book Principles:
“When faced with the choice between two things you need that are seemingly at odds, go slowly to figure out how you can have as much of both as possible. There is almost always a good path that you just haven't figured out yet, so look for it until you find it rather than settle for the choice that is then apparent to you.”
He credits this approach to helping his firm spearhead risk parity as well as other successes. Sometimes, trying to have your cake and eat it too leads to being able to do just that.
At an old job, I worked with an eng manager who believed software quality and time to market were mutually exclusive. You decide which one is important to you and you go for that one.
In his thinking, he then constantly failed to identify options that were both fast to build and good, usually due to significant simplification. He could never find these things because in his mind you couldn't have both.
Later on, I worked for Ray for a few years and would always think of this dude whenever I encountered this principle.
I don't know if you can still do it, but it's how Zuckerberg has retained control over Meta/Facebook. Zuckerberg and friends has 90% of the voting power, because the special class of shares has 10x voting power compared to regular shares.
Why? I don't see any problem with dual class shares:
1. It's not like anything is being hidden - people who buy shares without (or with less) voting share rights know what they're getting, and can adjust the amount they're willing to pay for those shares accordingly.
2. Dual share is a double edged sword: if you believe and want a visionary founder to stay in control, you're good. At the same time, you should be clear that if the visionary founder goes off his rocker, there is not much people will be able to do to oust him.
Zuckerberg pretty much shows these pros and cons perfectly. People were wringing their hands at the end of last year when Meta stock was in the toilet that there was nothing anyone could do to replace Zuckerberg. Now, though, Meta is up over 150% over the past year, and the fact that Zuckerberg could play a longer game and wasn't just ousted due to the share dip was probably ultimately good for investors.
What's wrong with it? If people want to be allowed to buy/sell second-class shares that don't have voting rights, then I don't see the problem with there being a market for that.
It’s not a free market. Your options are buy the class of stocks that the company wishes to sell, or not participate at all. Therefore it can be aggressively abused to disenfranchise public shareholders who have no say in the creation of share classes in the first place.
One important role of government is to set and maintain standards for listing on markets, so that customers are protected. An example of such a rule would be that all publicly traded companies have equal voting rights across all share classes: one share, one vote.
> Therefore it can be aggressively abused to disenfranchise public shareholders who have no say in the creation of share classes in the first place.
Elaborate on this, because I think I'm misreading it.
It seems to me like shareholders, generally already have a vote. Converting those shares, from voting to non-voting, would be quite illegal (at the very least breach of contract) without shareholder sign-off. Which they probably wouldn't do... y'know... because they're the shareholders.
What's being discussed is issuing different shares (with approval of the voting shareholders). And if you don't like that, you can... just not invest in that company. There are several other companies you can invest in if that's what you want.
And if the companies that offer only non-voting shares dominate (probably being driven by the founders)... most investors would probably want that. Most investors are looking for a return first and foremost.
> An example of such a rule would be that all publicly traded companies have equal voting rights across all share classes: one share, one vote.
I agree that it's an example of such a rule. Do you have an argument for why it's a good rule?
>Your options are buy the class of stocks that the company wishes to sell, or not participate at all.
Respectfully, I think you're confused about what a "free market" is. What you're describing, where market participants can compel the sale of a firm's assets, is antithetical to a free market.
Free market: “voluntary exchange and the laws of supply and demand provide the sole basis for the economic system.”
It’s voluntary exchange, yes, but it is not a driven by supply and demand. In the same way that the 1970’s oil market driven by the OPEC cartel was not a free market either. If you don’t like the control that Zuck has, can you express that dislike by buying shares of Meta that don’t include unequal voting rights? You can’t, because this is an issuer controlled market.
It is a free market though? Sellers in a free market are free to sell what they choose, which includes not selling things they don't want to sell. If the government were to step in and _force_ public companies to sell stock they don't want to sell, that would be the opposite of a free market, by every definition I've heard of.
> One important role of government is to set and maintain standards for listing on markets, so that customers are protected. An example of such a rule would be that all publicly traded companies have equal voting rights across all share classes: one share, one vote.
That is exactly what you argued for. Your rule would force public companies to offer up for sale shares with equal voting rights, whereas today many do not want to do so.
I'm not saying it's bad. Perhaps it's a good rule. It's just that you said you want a free market, and then proposed rules that in fact detract from a free market.
The extreme case of this would be Poison Pills, so if that's allowed then I suspect you can contract for this as well.
Having said that this is the type of thing that is likely to get dragged in front of a judge, so the more foolproof way would be to retain 51% control or dual-class shares. Once you give up majority control to third parties, you can't really prevent everyone else ganging up on you and outvoting you.
> Can this ever work? The PR group can control the 2% without nominally owning it.
Yes. In tight-control transactions, there are a number of mechanisms.
Off the top of my head: specifying Board seats in the charter and requiring a supermajority or unanimity to change that. Voting rights agreements that delegate 51% of votes to one party. Turning all shares but two into non-voting shares, the two having 51% and 49% of the votes. Making transferred shares convert to non-voting. Transfer approvals.
I think Beneficial Ownership bans this now and make it a criminal thing if you have control over an entity (regardless of ownership) and you don't declare that.
You can write all kinds of things in the articles of association/incorporation of a company. There's certain legal requirements but you can set up how the control of it works in many different ways to suit the purposes of the company or the desires of the founder/board. It's just a case of whether any investors will be happy to go along with what you're offering them inside those rules, since usually some degree of formal influence is expected (but not always, see how the tech giants are all generally quite immune from hostile takeover).
In this case wouldn't the individual with > 50% shares need to be diluted to < 50% for another party to acquire > 50% stake?
And surely at the point of dilution the individual would realise they have < 50% shares and this was a risk?
I guess what I'm confuse at is if you own 51% of the shares, unless you sell some of that or dilute your holding there will only ever be 49% stake that can be purchased by another party.
I think you are missing that there may be one or more third parties who also own a stake. A quick example (figures plucked from the air, not a real world case) might make it clear:
Starting point:
Founder 75%, Other(s) 25%
--
New investor buys 49% from founder:
Founder 26%, Other(s) 25%, New Investor 49%
Founder no longer has overall control, but nor does the new investor
Founder+Others can block the new investor if they all agree
--
New investor buys 2% from elsewhere:
Founder 26%, Other(s) 23%, New Investor 51%
New investor now has overall control and can do pretty much what they like
It should be obvious that this is a risk, so my sympathy is low. If the new investor promised that sort of thing wouldn't happen then it is a crappy thing to do, but the founder should know that in business very little which isn't written & signed is worth as much as the paper it isn't written on. This sort of thing happens all the time.
I know a guy who had 51% in the family company. His retired dad had, in exchange for money, deprived the 51% shares of their voting power.
His dad then sold the shares on the local stock exchange.
A couple months later, his CEO/son was fighting a hostile takeover of the family-run, but publicly traded company.
So his son bought the 51% from the local stock exchange, thinking he had a majority.
The guy who owned the actual voting shares showed up at the annual shareholder meeting with attorneys and accountants , a small number of shares, and walked out with the keys to the company.
> I know a guy who had 51% in the family company. His retired dad had, in exchange for money, deprived the 51% shares of their voting power.
You are either leaving out some important details or this is just not accurate. When people say you need to have "51% of shares" to control a company it means that you need to control 51% of voting rights of shares (sometimes different share classes have different voting rights).
It would simply have been impossible for "his retired dad to have deprived the 51% shares of their voting power" if his dad didn't have voting control. So something just doesn't add up in this story.
Both legitimate mistakes and arrogant hubris are common enough, as are those who feel good about finding loophole, mistakes, and blind spots, and exploiting them.
Musk, for example, seems to me from what he says to enjoy exploiting the blind spots of other businesses; but he was counter-exploited into buying Twitter for way too much.
Small story on these kind of takeovers, but on a MUCH, MUCH smaller scale:
Back home we have this small newspaper that's been going on for 25 years. It's just a small 3 man operation, and it's just a weekly paper that covers local stuff in our small county. Most of their customers are expats and older folks.
When they started out 25 years ago, they raised funds by selling private stocks. All in all, there are maybe 100 owners, many whom probably don't even remember that they own the stock (but you can easily find them, as we have pretty transparent laws when it comes to company ownership).
But here comes the fun part: A couple of years ago some of the leading media companies in our country (Norway) started consolidating "power" by acquiring small local newspapers all over the country. Eventually they came to our local newspaper, and they started cold-calling all the listed owners, asking if they could purchase their stocks - warning that the newspaper was on the brink of bankruptcy, and that they would buy it and restructure it into a profitable paper. Some owners, thinking the stock was going to be worthless anyway, sold them their shares.
They, of course, never told the majority owners any of this. The majority owner (the workers of the newspaper) started getting worried calls from senior/old readers if the newspaper was going to close, because some investors had been calling them with bad news about an impeding bankruptcy?
The paper printed a story about this attempted takeover and the fake news regarding any potential bankruptcy, and people stopped selling their stocks.
> A couple of years ago some of the leading media companies in our country (Norway) started consolidating "power" by acquiring small local newspapers all over the country.
This sounds like it should be a pretty big story. "Extremely dangerous to our democracy." On the other hand, it also sounds like it wouldn't be.
Stories like this are bizarre. There are a million ways to ensure rights for a founder-owner that do not depend on 51% ownership, such as requiring supermajority votes for replacing the CEO, or right of first refusals granted to the founder-owner for share transfers. If they throw a fit about those terms, then don't do the deal!
If you are selling shares to a PE firm with the explicit goal of retaining control, and you have less than 50% of shares, why would you make it so easy for them to get control?
A successful founder will sell 1 (maybe 2) companies in their lifetime, while PE/VC firms do these deals every day of the week.
It's like entering the ring with a pro MMA fighter and expecting to have a fair fight. You have a massive disadvantage that can't be overcome. The best you can do is take precautions and "do your best" but "your best" and "precautions" still isn't good enough if your opponent really wants to screw you over. Unfortunately this happens all the time in VC, and especially in PE.
As an example, when you sign a term sheet to sell a company, most founders assume the deal will go through at the price that was agreed. In reality, deals almost never close at the originally agreed upon price. The buyer usually waits until the very last minute, then drops the bomb on the seller "Btw, we can't do the deal anymore at this price, but we can sign tomorrow for 30% less". The sad part is it's such a common tactic and PE firms will do things like encourage founders to get their whole team excited about the transaction -before- dropping the bomb / new deal terms. At which point the founder is basically trapped with their whole team excited about an exit, which PE then exploits.
All of the lawyers in the world won't help if the PE/VC firm has the ability to spread the word "Don't do business with John Appleseed" effectively shadow-banning you from future funding from anyone. PE/VC world is very small and they have a lot of political leverage, which almost always trumps any legal leverage a founder might have.
The best defense is to have another VC/PE on your side.
That also puts bootsrapped companies at a severe disadvantage (no VC fighting on their side for the best outcome). There literally are PE firms who specialize in buying "family run bootstrapped businesses". Why? Because they're the easiest to screw over and exploit.
> The buyer usually waits until the very last minute, then drops the bomb on the seller "Btw, we can't do the deal anymore at this price, but we can sign tomorrow for 30% less". The sad part is it's such a common tactic and PE firms will do things like encourage founders to get their whole team excited about the transaction -before- dropping the bomb / new deal terms. At which point the founder is basically trapped with their whole team excited about an exit, which PE then exploits.
Eh, this was tried on a friend of mine selling his company. He simply said "the deal's off" and walked away. A couple weeks later, he got another call which said "ok" and he got the full price.
> That also puts bootsrapped companies at a severe disadvantage
It's very simple. Just say "no". It's an incredibly powerful tool. It's crucial to getting a proper deal on anything from selling/buying your house, your car, to your company. Be ready to walk away. Sometimes by the time you started your car and are backing out of the parking spot, they'll come running out and say "ok".
But you gotta mean it when you say "no" or you'll fail. They can smell weakness.
One other advantage of buying family run bootstrapped businesses is that they're too small to trip antitrust scrutiny. There are entire industries whose driving consolidation force is a handful of PE firms buying up old family businesses and running them into the ground. Things like funeral homes, dental offices, and the like.
Yes, I did learn about this from Cory Doctorow, why do you ask?
This sounds so easy but plenty lawyers sound great but have no clue either, or will believe that bad ideas aren’t, etc. And they’ll deal with the same VC much sooner than with you, so they’re not particularly incentivized to play super hardball.
If I were a first time founder I wouldn’t know where to find the right lawyer. In all honesty I still don’t and I’ve been at it for 8 years now.
I was tangentially involved in a deal where a Big Tech company acquired a VC-funded startup. The startup hired an investment bank as an advisor. The same investment bank that routinely underwrites debt offerings for the Big Tech company. Somehow they advised the startup to take the deal and not play hardball, even though there were public company comps at twice the valuation offered.
> You have a massive disadvantage that can't be overcome
If somebody can't understand that they need to retain a majority of the voting rights to retain control of a company, then you're certainly right about them being at a massive disadvantage.
I wonder how one would select a competent law firm that won't charge exorbitant fees, knows what they're doing and actually has your best interests at heart. It seems like a similar problem to the one you're trying to solve by finding a law firm, namely not having any experience in the area to make a good decision.
Lawyers have always known about this kind of stuff. Blows my mind that business owners are negotiating contracts like "I know what all these words mean, why would I need a lawyer to review this?".
As the sibling comment points out, it's not like you can hire any lawyer off Craigslist and expect to be bulletproof.
Lawyers can be an expensive rubber stamp on a deal that is absolutely not in your interest or be a chaos agent that makes you impossible to do business with. They can also make executing complex deals very simple (for you) or ward off sophisticated scammers. At least in my experience, it can be very hard to know which is which before it's too late.
My company has spent six figures with two different blue chip startup law firms. Our board specified the firms. Those in the VC scene would recognize them. The quality of the work has varied from "decent if eye wateringly expensive" to "subpar", seemingly dependent on the associate that worked on it and if there was any other industry-wide phenomena occupying the firm's attention.
I'd still suggest a lawyer for sure, but I wish I had counsel I liked.
There are lots of counterfeit motorcycle helmets. Sometimes it's hard to figure out what's a good helmet and a bad helmet.
Despite this, throwing up your hands and saying "I don't know how to find a good helmet, I don't want to waste my money on a bad one, I'm just gonna ride my motorcycle without one" is ill advised.
Be sure to use a startup lawyer not a general small business lawyer or you might end up incorporated in Florida with no founder vesting or shotgun clause.
You don't need to "know" anything to understand it was potentially possibly. And if you didn't, imo you're sorta braindead and that might explain why they wanted to out you in the first place.
Yeah, the way it's done in my country is the founder and his existing investors pool into a holding for the 51% which the founder controls. Then, they cannot sell around his back
There's also the story Richard Branson wrote about in his memoir where the co-founder of Virgin was pro unionizing and his workers were too.
Branson convinced (and lied to) his partner that no one in the company actually liked him and the union attempt would fail. Caused his co-founder to quietly quit and Branson to retain sole control.
I agree, I imagine shady shit like this is quite common just not discussed.
Oh wow, I misremembered it a bit. It was about a magazine Branson was running "Student" in his early days. The details of the story are accurate though.
The above situation seems like swimming with goldfish. If you have less than 50% yourself, why would you bank on someone else not being able to get more than 50%?
It was misplaced trust. That's a really easy mistake to make until you've been burned by it. I'll bet that person won't make that mistake a second time.
But better is to avoid swimming with the sharks at all. I have a wonderful horror story about a business deal I made where I was cheated out of about $5 mil. I didn't trust the party I was doing the deal with, so the contract negotiations took most of a year and the contract ended up being very thick as my attorney and I tried to anticipate and block every possible way that I could get screwed.
But we missed one rather obscure method.
That's what happens when you swim with sharks.
(Don't shed tears for me, though. I did very well through that deal -- just not as well as I should have.)
I feel like the story of the scorpion and the frog applies here. My solution is to try very, very hard not to engage with people I do not trust.
My mantra is "good people do good things, bad people do bad things". If you don't want bad things to happen to you, stay away from people you know to be bad regardless of how tempting it may be to associate with them.
Indeed. It was poor decisionmaking on my part. I was blinded by the $$. My attorney tried to warn me off of doing the deal at all. He had done his due diligence and looked into the company, and told me outright that the company was shady.
That was another thing I learned: if you respect someone's expertise enough to pay them for it, you should probably take what they have to say very seriously.
It was related to international distribution. I had negotiated royalties for international sales, but had neglected to cover the sale of the rights to sell internationally. So the company just sold the rights, of which I didn't get a piece, and the companies that bought the rights had no obligation to pay me anything.
This sounds like they sold something they never owned - i.e. "the right to sell without paying you royalty". Reminds me of the recent case where Disney tried to argue that in an acquisition, they bought only the rights, but not the obligations (royalty payments) that went with them [1]. Basically, writers were promised X% in royalty payments, but Disney argued they didn't buy that part of the contract, only the part where they now owned the works.
This is not something that should require, in any remotely sane legal system, an explicit contractual clause to prevent.
The larger context is that what they bought was my entire business, along with all rights to the intellectual property. What I got was a sale price and defined ongoing royalties for the product I formed the company to create.
They did sell something they owned. I neglected to attach a method by which I'd get compensated for them selling that particular thing.
In the mindset of cutthroat business, they legitimately won. They 100% adhered to the terms of the sale, and it's not their fault that I left a loophole they could leverage.
My attorney did say that if I wanted to, a case could be made for a lawsuit -- but it would have been expensive and wouldn't have had high odds of success. I just wanted to move on.
This whole event was my first real business success, and the mistakes I made were legion. It taught me quite a lot -- including that I won't do business with anyone that I am nervous about doing business with. Contracts can only protect you so much.
Also, I feel the need to repeat... I did pretty well from this deal. I was angry when this happened, but with the passage of time, I see that even with this event, I came out of the deal better than I went into it. So I hesitate to even call it a "regret". It's more of a "learning experience".
> I really wish there were an anonymous but vetted "yelp" type of site for people/firms who do bad business. So much business is done in bad faith and the people on the losing end rarely have the ability to warn others of their experience without killing their own reputation.
If you credibly report your experience, they will know who did it, anonymous or not.
"The Funded" was an attempt to do this for VCs a decade ago. But it was astroturfed in practice.
From a control point of view, and maybe a salary or job viewpoint, this isn't too good.
But enlighten me how a 40% odd share distribution of a now PE-owned and operated company would be a bad thing? Surely they're going to try and increase the company's value for their own self interest?
PE and Founder interests are not as aligned as many would assume at face value.
Founders often care about doing good by their customers, vendors, employees... while the average PE firm will happily screw everyone over the moment there's a monetary incentive to do so.
If a founder has the same time horizon for an exit as the PE/VC and if the founder is emotionally detached from the business/product/customers/employees, then all incentives are aligned. But that's usually not the case which is why you often see CEO's ousted and replaced by a "professional CEO" to "take the company to the next level". In reality founder-CEOs are ousted most often because their passion for the business gets in the way of maximizing profit.
> In reality founder-CEOs are ousted most often because their passion for the business gets in the way of maximizing profit.
In this scenario then, it might be a kick to the ego, but if the original founder retained a large minority stake in the company, this profit-driven approach should result in an increased share price (over time) right?
I don’t know exactly how the CEO got kicked out but I know that Zuckerberg owns just about 13% of Meta and not only they cannot replace him but he still have superior power in decision making over the board of directors.
Zuckerberg (and a small group of other Meta shareholders) hold shares that have 10x as much voting power as normal shares. He has about 90% of those special shares, giving him a solid majority in most matters.
Some other companies like Lyft or Alphabet have similar structures, but it is very unusual.
I'm actually surprised it's not more common. If I buy meta stock I have zero expectation of being able to sway company decisions. I just care that if they make money I make money.
During periods when VCs have more leverage they'll lean on founders to not issue dual class stocks, since of course it reduces their power to fire CEOs when things aren't going well.
A bond is just a loan that is repayed with a fixed return. A stock is equity and can be worth a lot more. Stocks are riskier than bonds, but have a greater profit potential.
Which you prefer depends entirely on what your investment goal is.
> So much business is done in bad faith and the people on the losing end rarely have the ability to warn others of their experience without killing their own reputation.
The M&A world is much smaller than you think. These reputations get around and the story you're referring is an exception not the norm.
I'm not trying to be harsh but this seems like business 101? Is this really that common? If you can't retain control of your company are you truly fit to run it?
> with the explicit purpose of retaining control
Why wasn't the other party contractually prohibited from obtaining control?
What you described is not illegal. Capitalism is intended to be brutal like that. Companies are not owned by the founders, they are fundamentally owned by the shareholders, whether it seems fair or not.
What the article describes is a simple case of large fraud: deceiving someone for a personal gain. That is of course if the article is truthful.
Soon after the transaction closed, the PE firm was able to covertly buy another 2% of voting shares from a pre-existing investor in the company, which resulted in the PE firm gaining full majority control over the company, kicked out the CEO, replaced the board of directors, the whole works.
The unfortunate part about these kinds of things is that 1) they happen all the time, and 2) founders rarely talk about it because doing so can so often destroy your ability to get funding for future endevors, etc.
I really wish there were an anonymous but vetted "yelp" type of site for people/firms who do bad business. So much business is done in bad faith and the people on the losing end rarely have the ability to warn others of their experience without killing their own reputation.