Shares/Member Unit Structure

Founders should be moderately concerned about control. The only reason to have even a slightly complicated capitalization structure at the beginning of your startup’s life is to ensure that you can guarantee control early on before what you might consider the middle age of startup life (i.e. Series C and beyond).

Control

It is a good idea for a founder to guarantee some control at the beginning, but before delving into that we should put the whole concept of control into focus. Your investors are not investing in your company with the hopes of ousting you. Early on that would be insanely counter-productive. In the later stages, they still want to believe in you but it might be time to recognize you have limitations, such as being an engineer not a professional CEO.

With that being said protecting yourself early on by ensuring control might seem a bit counter-intuitive, however it is just to protect yourself from the chance of some crazy angel investor ousting you early on. This is on the off-chance you gave up too much of your company early on.

So the question becomes how do you achieve this, and what other considerations go into capital structure.

Stick comes in two basic varieties. Common stock and preferred stock. Preferred is for the professional investors such as professional angels and VC firms. Your family, friends, and rich acquaintances should convert to common stock.

“Common stock is ostensibly voting stock while preferred is not” would be all you need to know, but its only really true of public companies. In private companies preferred stock can get a vote for most votes of substance or just generally. So at that point the real difference comes down to preferred stock taking precedence in liquidation or other exit than common stock. Put simply, preferred stock gets paid first at least until its liquidation preference with anything beyond determined by whether it is participating or not participating (you can Google everything you need to know about preferred stock, read Venture Deals, or join the full accelerator to learn more).

Share types like preferred or common can have different classes between them. Each class of stock can have different rights and priorities. These classes let you choose who gets certain privileges or benefits over others.

When you start your company you will issue common stock to yourself. How much is covered in another article. You might consider creating a class of common stock that has 3 times the voting power. Therefore every share of this class of shares has the vote of 3 shares of regular common stock. However, that one unit of triple voting stock is only worth 1 unit of ownership. So the economic power between the two share classes is even, but when it comes to control one is worth 3 times more.

Let’s call this class Founder’s shares and set them to 3x voting power. That means if you have 30% of the economic ownership of the company you’d probably still have control. Imagine there are 2M shares with 1 vote a piece and 1M shares with 3x the vote. The 1M shares would have 3/5th of the voting power assuming we were keeping things nice and rounded. The math makes it clear that you do not need overly powerful shares to keep control for quite a while.

The other early investors, i.e. not founders, go in on another class of common stock with 1x the vote. This is how founders keep control of their companies even when they only have 10% or less. A true co-founder would join in with your powerful shares but does not get as many shares. You can also provision the shares so that when the founders transfer their shares it converts to the class with 1x voting. That way if the original founders have ever divested themselves of ownership in the company there is no lop-sided cap table to inherit.

Preferred on Common

Other than carving out your founder shares, the next complexity comes from stacking the preferred shares. Each VC round comes with a new preferred stock series being issued. Normally the newest preferred shares have the best terms among the pack, or at least equal to (no worse) than the previous class’s terms. And there are clauses in preferred shares that have them convert to common stock under certain circumstances.

What about LLCs?

LLCs don’t have shares they have membership units. While it is possible to create some fancy classes of member units it is more uncommon, more restricted, and more complicated than it would be for C-Corps. A benefit for C-Corps is that they have greater control over their ownership structure. We do not recommend getting fancy with the LLCs. We would direct you to an attorney if you are looking to customize your LLC’s ownership table.

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