We Rarely "Control" Our Startups

Welcome back to the episode of the Startup Therapy Podcast. This is Ryan Rutan, joined as always by my friend, the founder, and CEO of startups.com. Will, Schroeder will, we talked to lots and lots of founders and it's a secret to anybody and uh, most founders seem to think that control is a cap table problem. It isn't. You can own 90% of the company and still wake up one day realizing you need permission to do anything meaningful. Well, like. You have an experience like this?

Yeah, I like a lot of 'em.

I remember the first time this, this happened, well, not the first time. Remember one of the first times this happened, I was running a company and I owned like, I think like 80% of it, right? Uh, you know, the, the majority. And an investor comes to me, an early stage investor and says to me, Hey, unless you do X, Y, and Z, we're not gonna fund the company. Ergo, the company's not gonna make payroll. And I remember thinking, what the hell? Yeah. Like I own 80% of this company.

Yeah. How can this guy tell me this? I'm in charge around here. Yeah. Yeah. What I realized was control had very little to do with, with how much you owned and had a lot to do with how the company is set up and what the provisions are. Yeah. And when we talked to founders like, like Ryan, how many founders do you talk to that are like, I gotta worry about the valuation. 'cause if the valuation's not high enough, I'm gonna lose control of the company. A lot of them.

Well, we just had, we had that question pop up last week, right when you and I were doing the, the live workshop on funding and somebody asked something along those lines and you know, I think we answered it then, but it's pretty constant. I think a lot of founders really get this wrong and so like today, I think good that we talk about what control actually is and, and probably why equity is. Maybe the worst proxy for it. I mean, there's probably worst things, right?

Like, which way were the crows flying this morning? That's how much the company I control. Probably not, but you know, equity is not a good proxy for it, but it's the one that we most often see applied. Yeah. And, and so like, so here's the theory. This is what most people think. And if you're in the audience and you're listening to this right now, please like lean in on this one because I'm telling you we're gonna change everything.

You think about what control is in a company, the TLDR is, we're gonna tell you have very little of it. The longer version is we're gonna try to tell you how to focus on what matters. But here, here's the The short version. The short version is the idea of control.

Something along these lines that if I own the majority of the business, like the, the old school version, like I always picture of the Monopoly man version is that I own 51% of the business, and if I own 51%, then I control the company and that's, and everybody has to do what I say and blah, blah, blah. It's like, dude, it doesn't work like that. Nope. At all. I'm sure there are some companies where the literal 51% strikes some sort of decision making capability.

Sure. But like at that point, I'm thinking like public companies or something, like something way different. Not at all how startups work, not a startup raising money on, on a problem statement written on a napkin from their friends and family.

Yeah, and and I think what's also missing when, when I say to people, okay, you're afraid of losing control, what specifically. Are you afraid of losing? Yeah. And they'll have like kind of amorphous answers. They're like, well, you know, I wanna make sure that, you know, I can control any decisions, et cetera. I'm like, which decisions specifically do you mean? Right.

Yeah. And, and when you start to get specific, the fidelity and what they want to control drops off quickly because they don't really know. Yeah. They just know they don't want someone else making a decision, whatever that might be. I talked to a founder about this specifically about two, three weeks ago now, and we went through that same matrix and I was like, what is it you're afraid of actually losing control over? Yeah. And they didn't really know.

And so ran through some examples and I said like, look, typically when you're saying control, I, I think you mean like kind of one of three. Major things. Strategy, right? Like what are we building? Who are we serving? Okay, cool right pace, what's our growth rate, what's our burn rate, what's our risk tolerance? And then things around people, right? Hiring, firing, comp, and how we build culture.

Yeah. And they're all different levels and as we'll explore, they have different protections to make sure that you maintain some level of control should you want it, right, right around those three things. But I think it generally falls into those three buckets for me. You know when I never hear this, this is what blows my mind.

I never hear the lose control when people are having co-founder discussions. Now when they do, it looks like this, I wanna take on, uh, A CTO, let's say. Yeah. And that person's gonna build my app. By the way. Isn't it funny that all that's gonna go away? Yes. Like the lever of the CTO being able to take half the company or whatever. Hang on, let me check. Will, it's Tuesday, March 31st, 7 34 my time. I'm pretty sure it went away. I think it's gone to get left.

I just, I, there was, there was always the genesis of this conversation anyway, the idea is, hey, I'm gonna take on this co-founder. I wanna make sure they have 30%. I have 70%. Yeah. So I control the company. That is the, the understanding, again, when you press that person to say, how do you know that that will allow you to control the company? Like, well, I own majority. I was like, well, do you understand how the rest of this works?

Yeah. Like how owning a majority rarely has anything to do with controlling decisions, and most people have no idea whatsoever. Hence this episode. No. And why would you, why would you understand, like, like the intrinsic parts? Well, don't you remember back in kindergarten when we all started, uh, taking on co-founders for our companies and they, they taught us how, right? Like, we have no proxy for this stuff. I think, look, I think there's, there's an easy thing to remember here in my book.

It's like the moment you're not the only owner. Whether that comes in the form of a co-founder, whether that comes in the form of an investor, when you're not the only owner, your absolute freedom disappears, right? You're correct. Absolute freedom. Until then, you are absolutely free. Right? Your absolute freedom disappears and, and look, that's not evil, right? That's not necessarily even a problem. That is just the very nature of shared ownership of. Anything.

Companies in particular have some very specific things that happen, but that's the nature of shared ownership. Let's talk about this before we get to investors. I know the investors part is what everybody's stressed out about. Yeah. We got a lot to talk about there, but let's talk about it even before we get there. When we take on a co-founder.

Because what throws me off is I rarely see people like have nearly as much consternation about control when it comes to taking on a co-founder or early employees, et cetera, as they do with an investor who's gonna take geometrically less of the company. Yes. In the early stages. So let's go back to our, our CTO. That's gonna build my mobile app type thing. Yeah, yeah. Which you hear all the time.

CTO wants 30% of the company, which is okay because I still own 70% of the company, so I'm still controlling it. And I'm like, pause right there. Right? Like, why is that okay? And when I say that, I'm saying, why 30%? Why do you need, uh, hey, as long as I'm over 51%, I'm good. That means nothing, right? And let me tell you, having learned it from the other side of the, the equation, early in my career, I wound up in a situation where I own 40% of a company.

My business partner owns 60% of the company, and I assumed, mind you, I was like 22. I assumed that that meant I am totally subservient. I am his absolute, uh, vassal. Vassel. Yes. I, I, I'm in this, this Vassel position and he actually told me, he is like, that's not the way any of this works. He is like, there are there, first off, we have an operating agreement that you clearly did not read. That's it, that states exactly how this supposed to work. And second, I have a fiduciary duty, right?

Yes. Like, even though I own the majority, there's a lot of stuff legally I can't do without getting in all kinds of hot water. And Ryan, I had no idea. I had no, I, I just thought that he has a hundred percent rights. I have no rights. Like he was the monopoly man. You weren't gonna question him. He had a monocle. Yeah. What can you say to that? But think about that for a second. Like, our lack of understanding of this Yeah. Is so significant.

But the amount of work we put into protecting something that we understand very little of is a lot. It is. It blows

my mind. Lemme draw some boxes around this stuff. So let's put some definition on it. Equity is how you split money. Control is how you split decisions. Great, great way to put it, right? Yep. Yep. The cap table, you brought that up. The cap table tells us who gets paid. You brought up something else that's even more important. The operating agreement tells us who gets to decide, right?

I think if we can keep those things in mind as we go through, as you're sitting on the other side of this podcast listening to Will and I go through this, those are a couple of important things that I think will help. Keep you aligned with how this actually works. Let's play it out. So let's do a simple scenario. Ryan, you and I are starting a company together and we're gonna go take on investment. So let's, let's play through an investment. We have to. Yeah. Do we have to?

Yes. And so day one, you and I decide to, to drop an operating agreement. Okay? Okay. Now for folks that don't understand, like they've heard of an operating agreement, they got one for free on legal zoom, like a template or something like that, right? Which a lot of people get. The operating agreement is like the constitution. Of the company.

Yeah. It basically says, and yours might, yours being folks listening, yours might be a total template that doesn't say much of anything, but it's designed very specifically to say, based on certain conditions of the company, here's how those decisions air go control. We'll get made. Okay. Now categorically there's an unlimited number of decisions that we can put as these provisions, right?

Yeah. Here's one that I got early on when it, when I was getting my first VC investment, a provision said in order to make a decision on a higher, over a hundred thousand dollars in annual comp. You have to get board approval, which makes total sense, by the way. Yeah. But Ryan, I was blown away by it. Yeah. I was like, what are you talking about? I have 80% of this company, and they're like, you don't have 80% of its money, dude. Yeah. That's where we come in. Right?

And so I don't think people understand how there's lots and lots of unique provisions that actually drive control, and some of those are really important and some of those you probably don't even care about. Yeah. When you think about the stuff that founders care about, like when they think about control, what comes to mind? You know, it's funny, I, I think it comes down to some of this just is like, they don't wanna be told what to do.

It's, and which isn't really how control works in the sense. It's not really that people are gonna tell you what to go do. It's more they're gonna tell you how it's gonna happen or sometimes what you can't go do there. There certainly are times where they, they may actually tell you what to do, but I think that most times what the founders actually care about. Doesn't really align with how companies are controlled.

Right. So I, I think maybe let's dig into a little bit more about how control actually works, where it lives. Yeah. What are voting rights, what's board composition have to do with this? Not ownership percentages. Right. And so I think because at the end of the day, I think really what founders are concerned with is that they don't want to be railroaded into doing something they don't want to do.

And I think you and I would both take the view that no one else wants to railroad you into something you don't wanna do either. Unless you're doing something that's so absolutely insane that they have to do that to save their investment, save the company, save the team, right? All those things. So let's stick with that.

Typically all these control provisions actually are the other way around. Yep. They're designed so you don't screw somebody else. Yes. As the founder founding team, you know, executive team, they're, those control provisions are put in place, particularly by investors, but even in co-founder agreements, like long before we get investors. Again, going back to a situation, Ryan, where you and I set up a co-founder agreement.

The co-founder agreement is designed not to say, I get to tell you what to do, or you get to tell me what to do. It's not that. It's dude, if stuff goes sideways, here's what you cannot do without both of us consenting. Right. There we go. You can't sell the company unless we both agree. Yeah. Now, when people think about control, you said it a moment ago, they think about being told what to do. Yes. Right.

But the control provisions, and this is, this is how you need to frame it, is what do I wanna be able to do that could potentially harm someone else that I wanna be able to do, regardless of how they feel about it. Yeah. Now most people will look at that and say. Well, nothing. I don't wanna 'em wanna do anything to harm people that, okay. Yeah. But what's harmed to, you know, to them may be the right decision for you. It's a really slippery slope. Stick on this for a second.

Let's go back to the example around the a hundred thousand dollars hire, right? Yeah. Because I think this is one that actually it's, this is a thing you may see. It does come up. This isn't them saying, we're gonna look at every hire you have, we're gonna scrutinize it. We're probably going to say no. That's actually not. One of the things I think is really important with these provisions is we look at where they came from.

Provisions like that came from people doing shit that was really wrong, like. We got investment and then I hired my mom and my dad and my cousin and my brother and my dog Steve, and they all got really big salaries and they don't do anything here. We're just sucking money outta the accounts. Right? And so because that happened once, yep. Now we have to have these provisions, right? I think that we have to look at it that way.

A lot of the stuff that happens on a, in a legal sense is there to protect these weird edge cases and they just have to be correct. There's not a problem. And they're there for a reason. They're there for a reason, and the reason isn't to stop you from doing what you want to do. Right. It's, it's not, again, it's not somebody trying to tell you what to do. They're just as a little bit of a control, and I can't tell you the last time I heard somebody say, yeah, we were trying to make this higher.

We love them, and then the board blocked it. Right. I've heard a lot of people complain about having that provision in. Yeah, but I've never heard anybody complain about having it exercised against them. Correct. This is where it starts to get really interesting. It's this specter of control versus the reality. Okay. Yeah. And again, I, I wanna go back to the control provisions we're generally concerned about, are there to actually protect the other party, usually a minority party.

Yep. Going back to, you know, when I learned what fiduciary duty was for the first time and I was the minority party and you know, my business partner was a great guy at the time, not he still is, but I'm saying he was business partner at the time. Your business partner at the time, who is a great guy. Yes. Yeah. I should phrase that differently, but was very cool about it. You know, he was, and again, he had way more tutelage than I did on this, this topic, and he said, look man.

My goal in this deal and the operating agreement and everything isn't to do things to harm you, if anything, as the minority. This is mostly set up to protect you. Protect you. Yep. And so my first learning about the control rights, et cetera, was based on being the minority and seeing it for why these things were being done. Okay. Yeah. And so going back to what I think you, you had a great setup, which was, you know, what are these categories of things that we want to control?

More specifically, why are other people putting these provisions, investors, et cetera. Yeah. Putting these provisions in this document. Well, number one, it's so that we can't go and do crazy shit. Yes. I mean if really like, like if it comes down to it, there's gotta be some protections where we can't just do crazy shit. Ryan, lemme throw one at you that I think is really interesting.

One of the, the most contentious control provisions that gets put into, like, particularly around when we take on investors, but it can't even be in an operating group, is that you are not legally entitled to a job. Mm-hmm. Right? Most people have no idea. I own 60% of the company, no one can fire me. Mm-hmm. No false. No one can take away your 60%. They can sure as hell fire you. Yeah. That's the kind of stuff that people don't even realize it exists.

Yeah. Yeah. That's, it's funny, they're out fighting about whether they can spend a hundred thousand dollars to hire somebody else and they, they've completely missed the provision that says, we might not continue to employ you. Founder. Like, wait, what? Right. And so just to pause on that, 'cause I think if anybody hears it goes, wait, what, what, what did you just say? Like, I get fired and, and own the majority. Yep. Yes. Just so you understand how much you own inequity.

And your employment status as an employee of the company, which are two totally separate things. Yep. Are not linked one for one. Now, you might have, you might wind up with voting control in the form of the board, the, the operating agreement, et cetera. That allows you to mostly prevent that. But generally speaking, this is the kind of stuff we're talking about. So for example, if you were to say, look man, I'm not doing anything.

Would jeopardize my opportunity to have a job at my own company. That's what I'm talking about. That's what we have to understand and say, okay, well if that's a primary concern, then we have to be able to address that in the operating agreement with the investors, et cetera. Yeah. Which they're not gonna love. However, they might not even accept. Then you might have to decide, I want to continue.

I want to be able to permanently employ myself, but I'm not gonna be able to do it with somebody else's money. Okay. Now think about this if you're the 30% CTO for a second, right? Yeah. So let's put a new scenario. Ryan, you're the 30% CTO and I'm 70% founder, right? And I'm, I'm presenting you this operating agreement. You're looking at this going, dude, I don't wanna put all this work and find that just guy decides one day just to fire me.

Yeah. Like you're concerned about being able to protect, now you're in the minority and you still have that concern. Yep. So everyone has that concern, but let me, let me flip it. If you decide to just stop showing up for work, and that sounds egregious, so, you know, I'm, I'm trying to deliberately make it egregious, but there's a lot of versions of not showing up for work. Yeah. Yeah. There's a version where you actually go somewhere else and you don't pay for work. Yeah. Go somewhere else.

Yeah. Company's not making money. I have to make bills. Right. I gotta, I go get a job. Yeah, man. And there's another version where you do show up. You just suck at your job. Yeah. Like you show up, you have no contribution. Oh man. We've done that in a couple other episodes where like that person who you brought on is co-founder and see whatever it gets eclipsed by some junior people later just because they happen to be the first ones to say yes. It happens a lot. Yeah, man.

Happens all the time. So now think about that. You come on, you've got a 30% share in the company and you're like, I wanna base, basically make sure I have job security, that in this operating agreement I cannot be fired. Think about what that means for me. Yeah, okay. Yeah. I'm like, well that sucks. Like if, if you stop showing up for work, you're saying you like you're guaranteed a job. Yeah. Like that's fucked up.

And so I, when we're talking about these control provisions, I'm specifically saying, here you are in the minority position. You have the same issue, right? I don't wanna be able to get fired. And even as the majority, I'm like, I wanna be able to fire people. If, if they're fucking off, guess what? That's what people wanna do to you. Yeah. Yeah. That's, that's exactly what people do thing for the same reason, right?

It's not that, it just like arbitrarily one day like, oh guys, guess it's international fire, A founder day, we. Right. And so again, we think of all these different conditions. Now, if some of this sounds overwhelming to folks listening, this is, this is why we still employ attorneys. These are the types of things that attorneys can walk you through.

A fun side note, last night I was talking to my, uh, father-in-law who's a contract attorney, and I was telling him, you know, we sold a company this week, and I was saying that we did it largely without attorney. And I was like, mostly because we had a lot of experience doing this. Yeah. But also because of ai and, and he was like, yeah, but I'm pretty partial to attorneys. It's, you don't say itt, of course you're, but it's guys like him. You know, folks in, in legal profession.

If, if you're not sure that can walk you through what you don't know. Yeah. Right. We're here to tell you that this is why you should start raising your hand and asking these questions, but they can tell you exactly what those questions and provisions are, but.

Let's fast forward a little bit and let's talk about how these provisions get in vote. Okay, so let's say we've got, we've got a provision that says, you know, we can be fired for cause, et cetera. Yeah. We've got a provision to get, to get this that says we cannot sell the company unless we get board approval. Board approval. Yep. Probably worth talking about how boards work.

Ryan, when you think of like a five to seven person board, can you explain to the folks that why that's there, why that board exists? I mean, it's there for governance, it's there for protection. It's there to act out and, and basically to interpret the operating agreement and make decisions based on, uh, their understanding of it and the, the agreements of the company. Yeah. Protective provisions that have been put into place.

Uh, you know, I think a lot of people think the board is there to advise them. There is such a thing as an advisory board when we're talking about a, it's, this is governance, right? This is, yeah, this is governance. How the company makes hard decisions. These are the people that can fire you right now. These are the people that can fire you. These are the people that can make, you know, they can, they can have control over some of those things we talked about.

And so that's why like when we get into. Things like, you know, the, the, the board seats. These aren't just receipts for giving people Right. It's, it's a steering wheel. We're handing somebody to the company. Right. And, and as you said before, they are, you know. Operating under the operating agreement, which is the company's constitution, which I find most, most founders to be woefully uneducated in their own, their own operating. So what does say in the operating agreement like?

Well, let me go dig it out. Right, but so like, there's a few things I think about when we're thinking through like the board itself and what's gonna happen is one who appoints board seats. How does that happen to begin with? Yep. Which decisions require board approval? Things like are there any things like do you have preferred shareholder approval? Are there any special provisions that, you know, bring out spec special provisions? The one we brought up before, can the board replace you?

Right under what condition? What's the threshold for selling the company? If we're saying it, it's board approval, do we want it to come to board approval or do we want to have some sort of a preset threshold, which we see a lot too? Will, I think there's, there's times where there are like board approval and then there's thresholds, which is that we're agreeing ahead of time. It's like under this amount, we're not selling.

Without approval over this amount, we're free to go right so that it doesn't mean that we have to always come to a decision. You know, something that's really funny about everything we talk about here is that none of it is new. Everything you're dealing with right now has been done a thousand times before you, which means the answer already exists. You may just not know it. But that's okay. That's kind of what we're here to do.

We talk about this stuff on the show, but we actually solve these problems all dayLong@groups.startups.com. So if any of this sounds familiar, stop guessing about what to do, let us just give you the answers to the test and be done with it.

Again. Let's go back to our situation. Two of us are starting a company. In this case, let's just, for easy mass, say it's 50 50. Right. You and I, you know, had our own probably really shallow, and I just mean like we didn't go too deep into it. Yeah. Uh, discussion over what should be in the operating agreement. Yeah. Neither of us were that experienced. You know, we did some chat GPT prompts to find out. We did some, some sleuthing online.

We asked a couple other founders and it's, it is usually a fairly loose document, but then we get to, to take on investors and we're both stressed out because we're like, Hey, um, these investors want 20% of the company. Which means you and I are gonna dilute down to, to 40% each. We're like, ah. But collectively, we still have control. Not really.

Okay. Here's what happens the moment you get a meaningful investment on, and meaningful sounds like a, a pretty broad term, but it's usually after your pre-seed run. I, I'm just going to spitball it and say it's usually over a million dollars. Yeah. You know, once you start taking over a million dollars that's right, under a million dollars, people can kind of let it ride. Once you get over a million dollars in investment, this, this stuff's tends to start to come up and, and even higher.

Here's what happens though. First thing that happens is the investors, and there's typically more than one. In this round, we'll say, look, as part of the operating agreement. We're gonna need to create a board of five to seven people. Typically, the board is always an odd number so that you obviously can't have a tie on votes. And the, the composition of the board almost always looks like this.

There's two members from the company, two members from the investors, and one independent that both of us kind of vie for. 'cause we want to have it to be our person. Yeah. At a small enough number. No one really cares. You can pick your buddy and think you, you've got control of everything at a big enough number that doesn't fly anymore. People see through it. That's where all of these decisions, this is where the control happens, like hard stop here.

It has nothing to do with what you and I now have in equity. Yeah. If in the operating agreement it states that under this provision, this provision, this provision that it requires a board majority, which most of this will, it's just kind of the simplest way to say it, then a whole bunch of stuff starts to happen. For example, I come in one day and all of a sudden it's like an intervention and it's you, it's our independent and our, our two, uh, our two investors.

You never want to be surprised by seeing your board sitting into a room you walk into like that. It's never happy birthday, right? Yeah, exactly. You don't never that. We just feel like you, you're not getting paid enough. Right? Yeah. So we just figured we'd get all together.

Right. And at that point, you know, they're saying, Hey, performance isn't what it is. The company needs to raise money. We don't think you're capable. You know, whatever, name your excuse. We think you're gonna need to step down. And I'm using this as a, like a pretty egregious case. And I'm like, I'm not going to step down. Mm-hmm. Me and Ryan are, are voting that I'm staying here. Right, Ryan. Exactly. And all of a sudden Ryan gets real quiet. Right. I can't find my vote.

I don't remember where to put it. Yeah, right, right. Yeah. Oh, just vote like everybody else. Votes, guys. What do you think? Right.

Yeah. And now you realize how Inconsequentially hopeless you are? Yeah. Okay. Because like I own 40% of the company, but I only own one fifth of the votes. I only own 20% of the votes. Right. Yeah. And let's say it's a simple majority, just means like three outta the five people, you know, voted that way. And even if you backed me up on this, Ryan, and you're like, you know what I, I have no idea. This is bullshit. If the independent votes against us and the two investors, yeah, man, they win.

Done board math beats founder egos every time. Right. It's the way it goes. Once the board exists, you're no longer supreme leader or supreme leaders. Yeah. You're kind of employees with influence that point. Correct. And I don't think, I don't think the founders understand it.

Let me flip it the other way 'cause I think this also interesting. If, if for some reason we still had a five member board and you and I were both, uh, on the board and you know, again, e equal votes, we're not getting into like. Way, way, way later we start to get into weights. You mentioned preferred, et cetera, like, like some votes are worth more than others, but let's just keep it simple, right? It's just five people. Majority rules. It goes the other direction too.

You and I might be down to 4% ownership in the company, not 40%. Yeah. If we've somehow been able to maintain our voting right. We have a disproportionate control. Oh yeah. In the company, you see this with public companies all the time. You know, you see people who have a lower amount, but a lot of cases they have a different class of, of voting shares, et cetera. Yeah. That gets way more complex than most people will ever deal with.

But the point is, since a lot of these board decisions are, uh, happen at the majority level, and there's five votes to be had, sometimes seven as the, the numbers, you know, the dollars get bigger. That's really what drives most of the big decisions. The big decisions being like, does the company sell things like that? Right. Or, you know, are we gonna take on more, more funding, things like that.

One thing I think we might wanna touch on here Will, which is the, the operating agreement itself, right? I, I don't want founders the way we've told it so far. It kind of sounds like there's this thing that we draft in the beginning that then controls things forever. Right. And that's not quite how this for, it's just full provisions that say we can never get fired. Yeah. We, we wrote it into the original operating room. It's right here. See, they're like uhha.

You mean the one that's been amended 90 times, uh, since you started taking on investment dollars? So you wanna talk about that just for a minute, just so that people understand. Yeah. Good call win. Where and how those things get beat up, changed and, and amended. The operating agreement to some degree kind of can get, you know, restated re uh, amended, uh, rebuilt every time there's a funding round. That's, that's what's most typical.

Now, the reason for that is because the most recent investor is going to have certain provisions that are important to them. That they won't jump in if that isn't dialed into the operating agreement. And there's all kinds of stuff in there that's important to them because they're the last money in that may not necessarily be to the best interest of other people that are currently in there in almost every case, not to the best interest of the founders.

And so even if you and I write the perfect operating like, aha, we've got this figured out. Yeah. Brian, before we raise money, let's write an ironclad operating agreement that says no one can ever fire us and no one can ever make decisions. Yeah. We figured out, and only people named Ryan and Will are allowed to make decisions that matter. Right. You know, you name it. Right. Better make sure that we write that in some kind of ink that is impervious to redlining, right? Yeah. Right, right.

Might as well can never be changed. It'll be fine. Doesn't make a lick of difference. Every investor, when they come on board is gonna say, yeah, but the operating agreement looks like this. Right. And that's a huge part of the closing process when everybody's agreed to invest. And then you turn it over to the attorneys and they fight back and forth while they go through the closing process.

They're going through that to say, Hey, my client, most recent investors have these terms, uh, that are very important and we need to make sure they're properly amended into the operating agreement. Now, look, there's a lot of people that are, that are in the room as well, like previous investors, et cetera, that are like, Hey, screw you, like that's gonna work against me now and I'm gonna fight with you. Good luck with all that problem for another day.

But I think what's interesting here is that, again, our illusion of control is that, but I thought, you know, if I just own the majority, I don't have to deal with any of this stuff. It's like, dude, as this is not where any this is coming from.

Yeah. And there's, there's one other point I wanna make and I'm curious your thoughts here. I've been in a situation multiple times as a funded founder, and you talked to lots of funded founders about this stuff, where I have full control of the company in whatever capacity. I think, like I've got voting rights, I've got, you know, whatever. Right? But I got no money and it looks something like this, it, it looks something like this. Once again, you and I both have our 40% shares.

We've got 20% investors, but we're about to run outta money. Yeah, right. We, we raised 2 million bucks. We ripped through it all. We set up payroll. We got a bunch of people we gotta pay every, every month and, and we're about to be outta cash. And the investors come back and say, we're willing to put in X amount of dollars. Yeah. However, here are our conditions. That invokes the golden rule, which is be with the gold rules. That's it.

And the reason I, I wanna bring this up is because this is part and parcel with running a funded startup. This isn't like, oh, this happened one time. It's like, it kind of happens every time. It gets worse when you take on more money. You know what I mean? Pretty much every time. Right? Like, 'cause even if you won governance on paper. Yeah. Right. Investors can still control outcomes through financial leverage. Yep. Right. And runway is kind of the only board seat that can't be outvoted.

Correct? Yeah. It's at that moment. Great way to put it. You could, right? Technically I suppose you could. And, and you're like, okay, so you choose to exercise your vote into insolvency. Like that's what are you gonna, what would the point be? Right? So. Again, best voting right, is a positive bank balance. You've got to be able to absolutely support the decisions you wanna make because otherwise, like you said, the financial leverage piece is, is always there.

You need money to move forward then, right? If it's, that's where it comes from. Cash is control. When you're outta runway, rights become theoretical, right? And that's the end of it. Can you make payroll right there? There's your right. Right. Right. And, and, and we are all as startups perpetually going out of business. Yeah. Like that's the nature of how this business works. It's not a one-off. It's not like, oh, there was that one startup that ran outta money. Right.

Yeah. It's like every startup that's going to run outta money. Yeah. In a few survive. Yeah. So this is an incidental condition. This is like the most common outcome. For, for, again, for founders that are, for founders that have been through this, we don't have to explain anything. They're like, yep. Yeah, that's pretty much, that's it. That's exactly how it goes. And it sucks for founders that haven't, but they're getting into fundraising. I wanna say what I wish somebody had told me.

When you raise money, it's the last time you have control. Yeah. Until you make money. Okay. And so when we raise money, you and I raised 2 million bucks. We got money in the bank. We've got a little bit of control at that point. Yeah. In as much as we have two voting seats out of five. Right. So we have a little bit of control and we don't have to ask anybody for anything because we're doing okay. We're making payroll, like everything's fine.

Now, fast forward 18 months and now we've got six months of runway. Right. And now we still want to be able to say, but this is our strategic direction, but this is our valuation, but this is how much money we're gonna raise, et cetera. Mm-hmm. And the investors, both the current ones and the future ones are like, I don't care about any of what you want. Right. Yeah. Like, you're gonna do what I want, or You're not gonna make payroll. And we're like, yeah. Huh?

Yeah. Yeah. We really don't have any control. Yeah. Like it doesn't matter what we own. No, it doesn't. When you're profitable, you can negotiate. When you're broke, you comply. Right? Like that's, if you want to go play with more of their money, you are going to play it by their rules. You are.

It's interesting because you see this in public companies now, there's all different conditions set in public companies, but when public companies are doing well, read Elon Musk on any given day. Right. Elon Musk can do whatever the hell he wants. Now, in most cases, if you look at his companies, he owns a tiny share of those companies. Right? Like he's, he's a big shareholder in Tesla. Relative to Tesla. Yeah. But you know, small shareholder otherwise.

Um, but when Tesla's stock is doubling, and Elon Musk put this theory to the test, you can do the craziest shit. Imaginable and everyone's fine with it. Okay. He sure did put that to the test, didn't he? He sure put that to the test and in case you weren't sure, but it's when things go the other direction. Yeah, right. That you see what your control in your position really is. If Tesla stock just plummets, now this is a bad example 'cause SpaceX is where he's gonna make all his money.

But if Tesla stock plummets Right, and that was the only thing he owned his voting rights and everything else. No one cares. Yeah. Right. Because at that point he's lost sentiment. He's lost trust. And again, if the board or the activist shareholders, et cetera, are actively conspiring against his performance, almost no amount control is gonna say, save you from it at that level of operation. I would say the your control strategy is just stay funded and stay credible, right? That's right.

And so that's all you need at that point. Think about other, like, famous examples. So back in the day, I was at late eighties, early nineties, uh, Steve Jobs got fired from Apple by John Scully. Right? Uh, and that was, you know, a very famous moment. Now, he didn't have the voting control to maintain his, his job or, or even, you know, a stake, meaningful stake in the company. And so he was able to be pushed out. Now, a couple things. This is Steve Jobs, right?

Uhhuh, like arguably one of the greatest entrepreneurs of all time. Yep. He got pushed outta the company also. Not a pushover by the way. Yeah. Yeah. Also one of the biggest NAS of all time. Not just, he wasn't just like, oh, you want me to go? Okay, cool. Yeah. See you. Okay, here, send me, have a box. I can put my stuff in. I can't think of a harder person to fire. But again, even he lost the leverage. Yeah. So he gets pushed out now.

Now flip it around years later, he gets famously brought back and you know, brings about one of the greatest, what I'd argue to be turnarounds. Apple is actually already a good company, but, uh, turnarounds in corporate history. Now that man can do no wrong. Right? Right. This is at the time right When the company's doing well, you are god damned invincible. Yeah. When Tesla's doing well, Elon Musk is god damned invincible.

Yeah. And the reason for that is because so long as you're making them money control provisions just don't get invoked. They don't, they don't get invoked. That's kind of like the hiring thing. If you're not making a really stupid hiring decision over a hundred k, no one's gonna try to stop you. Right. They're not, they don't want to stick with that. The whole point of control provisions are when things go wrong. Yes. Right.

Okay. Things can be going right and people can maybe not agree with you. Like I can't fathom that any of the people that are meaningfully invested in Tesla watch Elon's actions on any given day and say to themselves, there's no other way we could hope this was going. Like the outcomes are incredible. Like what? What the guy can do is incredible, but the behavior that gets you there yeah, is just batshit crazy. And so again, as long as he's doing well.

Okay. As soon as that changes, that's when control provisions come in. Yep. But that's also when people are trying to protect themselves from crazy shit.

Let's talk about it from the founder's perspective. Yeah. What do we actually need to protect. What is it we should be protecting? Right? What actually matters here? Because I think that control is way too broad of a, we can't have control. We've already talked about that. So yeah. What are the specific things, specific rights, the non-negotiables that we really want to have?

At least somewhat locked down before we're negotiating under pressure right before we're at six months of runway and only enough cash for the next, uh, five payrolls. So let's dial that in a bit. I think it's a great question. Let's agree that we can't control the company, per se, this amorphous thing that says I have supreme leadership, right? But we can control particular provisions, particular conditions that are important to us. Okay?

And what I would also argue is, while these might be like things that we'd love to have. They also might just not be realistic, for example. Any entrepreneur that gives us five seconds of thought is gonna say, one provision I want more than anything, I cannot be fired. Mm-hmm. I mean, 'cause you know, we think about that as as very personal and secure. Right. And I would argue there's rarely going to be a case where there's no way to fire you.

I mean, there's a hundred things that you could do wrong that would be like straight up. Of course we fired this person. Yeah. You know, what we consider to be for cause fraud, theft, you know, things like that. Yeah. Like there's no co-founder or investor in the world that wants to be joined at the hip with someone who can do anything that they want and still not get fired. Like Right. To me, that's a selfish clause. So. If you're willing to concede that and say, okay, well, yeah, I get it.

I, I don't, I don't mean it that way, like, I do awful shit. Of course I shouldn't be there. Or people should have protections. Then what you're really saying is, I don't want to take on, not take on investors, so I don't wanna be fired. I only wanna be able to get fired for these reasons. Correct. These are my non-negotiables. Right. Like, like if I hold up a bank, like I get it. Anything short of that, you can't touch me.

If I deposited the company accounts though, like, I mean, was the company really harmed? Mm-hmm. I had a case last Friday out to dinner with a founder reached out to me and he said, my co-founder just cleared out the bank account, cleared it out, and was like, yeah, it's just not working out. Can you imagine that? I mean, like, you know what's crazy, right? Is we get to see everything.

Yeah. And this isn't the first time I've seen this, but to see the look on his face when he was describing and that had just gone down like a few days prior. Emergency called me to come in and try to figure it out. And I'm thinking to myself, you guys did this deal together in good conscience. You both thought you were gonna grow a great company, and then one day your co-founder decided that you were no longer going to be part of this company without your say. Right?

Yeah. Like. How could you have ever predicted that? Imagine that was coming. Yep. You don't, and so what I said to him, I was like, have you read the operating agreement or have they the other co-founder read the operating agreement? 'cause I'm, if you have one, I guarantee this isn't okay. Right. And it turns out they had, they didn't, you know, dig in and I'm guessing they didn't have a very like strong operating agreement.

But there's just, there's some fundamental protections that say you can't just steal from the company and get away from it scot free. Like, like that. That's almost 0% chance you're, you're gonna correct. Hold that, that provision. Yeah. And, and why would you want to, right? Well, right, right. Who would you expect to accept it if you did? You're like, there is a, a non-litigation clause against me absconding with funds to the Virgin Islands. I, you guys are okay with that, right?

Yeah. I mean, so again, everyone says, well, no, if I do bad things, I don't want to, I don't wanna protect myself, so to speak against that. But remember what you think are bad things. Are different than what other people think are bad things. Yeah. Here's a good example. Your lack of performance to someone else is a bad thing. Yeah. But you're like, I'm in every day killing it. Yeah. Right. Like I'm, I'm working non Do what? I can't figure it out. I'm getting there.

Little by little I'm making the progress. Right? Yeah, you bet. Like I still not where we need it to be from a company standpoint. Yeah. I'm running as fast as I possibly can, but your co-founder is looking at you going, yeah, but you're still losing the race. It does not matter. Now think about how. Giant, those perceptions are different. Yep. Right.

I'm working so hard or I'm contributing so much, and the other person's like I, I'm about to clear out the entire bank account because this person has such a liability and I'm willing to go to quarter over it. Yeah. Think of how dramatically different those expectations are. So again, we go into and we're like, Hey, I wanna make sure that, you know, I can't be fired or anything else like that unless you do something really bad.

What I'm saying is, hey man, what you think is really bad is one thing. What other people are gonna think is really bad is way different. And so going back to, you know, protecting what matters, we have to be able to say, I wanna be able to protect my, my employment up until these provisions that I think any reasonable person would agree. And I have to know going in that those provisions can be invoked in ways I'm not expecting.

Okay, so that's one. The second is anything these, again, the big ones, anything. That would drive a change in control of the company. Yeah, change in control could, could mean a litany of things. It could mean, uh, we get bought by somebody else. It could mean someone else Now has like the majority control of the company and there's a lot of ways to, to get to change in control when and if those things happen. There have to be provisions that we care about that say we can't get overridden.

Doesn't mean we're gonna get 'em, by the way. Right? Like we'd like them to be in there. It doesn't mean everybody's gonna greet 'em. Investors are gonna have a very strong say in that one, but that's the shit you should be paying attention to. Anything else come to mind? Or like when you think about building a company, what are the things you're most concerned about? I, I think it does go back to a few little things, but it's really just understanding kind of what those non-negotiables are.

It's gonna depend on the type of company that you're building, right? If you're building something you intend to have, you know, just a, a co-founder and team of AI agents at this point. Like, do you really care about hiring protocols or anything like that? Maybe you're not gonna hire Yeah, right. Or not gonna be something that's. Really meaningful. So to me it's fairly nuanced.

What I would say is just make sure that you are thinking through those things and that you are choosing your trade-offs, right? Understanding where you're being flexible, where you're not, because if you don't choose your trade-offs, the term sheet's going to choose them for you. And I think that's where we see most founders get into trouble. It's not that they failed to do anything, right? They failed to plan at all. They just didn't.

Yep. Put anything into the term sheet, anything into the operating agreement around controls like this, and then later, uh, re regret it. I also, Ryan, I think there's a lot of things that people you can't maintain control over. Like, you can't, like operating your agreement way into, for example, you can't maintain control of the product direction, unilateral. Again, you could try to, like, I've never even seen someone do this.

You could try to force a provision in your operating agreement that says, you know, product direction will always be made by this person, et cetera. Or, you know, these co-founders, first off, no one would agree to it, and second off, it's such a. Amorphous term that you'd never be able to uphold it. And by the way, if you're doing well, the company's doing well. You get that anyway.

If you're doing poorly, no one's gonna wanna be able to say, oh, I know we're doing poorly and losing a bunch of money, but let's glad you got that provision that says we can't change course. By the way, like again, to go back and talk about the reality of these situations. We've talked to some other podcast episodes, but no one wants to come in and do that either, right? No. There is no board member, no investor who's like, you know what?

I really want is to have to take control over product direction to save this sinking burning, about to go down a whirlpool ship. Right. That's nobody's idea of a great time. They're not coming in and trying to take away your control. I, I think that's really like, for me, control and, and the losing control, that's when it actually happens. Yeah. Investors don't generally take control. You lose control of something and they're forced to step in and assert control. It's very different, right?

They're trying to save the asset now. You never see it that way. Yeah, right. You look at it like they're meddling. Right? They're telling me what to do, right? Yeah. Well, you're not doing it right, so someone has to. Things going bad and meddling tend to go in hand in hand, right. It's kinda like when people think about the police, right? Yeah. Like, oh, the police are harassing me, not if you're not breaking the law. Yeah. Yeah. And not to those two things is things tend to go hand in hand.

So when I think about putting a deal together, right, what I'm actually most concerned about isn't the day-to-day operations. It's how this ends. In other words, like what are the requirements if I wanna sell this thing, get liquidity, et cetera, because those are the life changing things that if and when it comes to that, I'm screwed if that provision doesn't, you know, work in my favor or support me.

Most common example, and I can name 10 people off the top of my head right now that are dealing with this, is we've got an offer to sell the company or get some liquidity, et cetera, and the investors don't want to take it because it doesn't benefit them. We see this all the time. You and I start this company, we raise 2 million bucks. X amount of years later, we get an offer to sell it for 5 million bucks. And the investors were like, well, we'll make no money on that.

Like, yeah, but Ryan, I'm, you know, make over a million dollars a piece like that is life changing to us. Yeah. It's a at best of base hit. Now, I'm not saying at all that the investors don't deserve their return. That's, that's why they do what they do. But I'm saying it's moments like that where the delta. Outcome is massive. If I can't hire my buddy for 200 grand a year, okay, it sucks, but I get it. But if I can't fundamentally make a decision, that'll change the trajectory in life.

Of me and my co-founder, that's a pretty big problem. You know what I mean? For sure. And, and I think that's where these, these things tend to go off the rails, right?

And I guess again, like we have to define these things from the beginning. And I think that's where if, if we don't fight for the right things at the beginning, and I think that's a big part of why you and I get so frustrated. We're trying to find that, like we're trying to get them to agree to this valuation because we want, and again, fight for the valuation for the right reasons, right? Fight for the valuation. So you're getting the most money for the least equity that you have to give up.

But it's not about control. Right, and so I think this is what we so often see founders spending energy on things that just don't really matter, right? Founders don't lose control because they diluted too much, right? They lose control because they didn't define what mattered. They didn't negotiate it clearly, and then they ran outta cash. Ergo, they ran outta leverage, right? Equity is a scorecard. Right.

Governance and runway are the steering wheel, so if you want control, stop obsessing over percent ownership and start obsessing over decision rights board math, staying funded long enough to actually have your choice in this thing. Overthinking your startup because you're going it alone. You don't have to, and honestly, you shouldn't because instead, you can learn directly from peers who've been in your shoes.

Connect with bootstrap founders and the advisors helping them win in the startups.com community. Check out the startups.com community@www.startups.com to see if it's for you. Could be just the thing you need. I hope to see you inside.