The Illusion of Control - Slicing Pie

The Illusion of Control

I hear this all the time from founders: “I need to have 51% of the equity so I can ‘maintain control!’” Yes, if you own 51% you will probably technically have control, but I cringe when I hear this because it ignores the real issue: do you deserve control? This is a more complicated issue than whether a person can legally impose a 1% voting advantage over other participants.

The Slicing Pie model is primarily focused on the potential financial benefits of a startup—profits or capital gains—rather than the operations of the organization. However, when the Pie bakes, the person who has the most at risk will have the most equity, and, therefore, the most votes. There may not be anyone with a single majority ownership, which means the team will have to continue to cooperate to make key decisions. This is probably a good thing. After all, if you’re one of the few startups to make it far enough to bake the Pie, something is clearly working! In my experience, cooperative teams are better than a single person calling all the shots.

So, the Slicing Pie logic generally puts the right people in control. But some founders still think they need 51%. The big warning here is that a person’s desire to maintain control should not take precedence over being fair. If consolidating control is, for some reason, more important than logical control, there are ways to do it.

The specifics will vary from country to country and I’m not a lawyer, but I can give you a high-level overview. In the US, there are two common forms of corporate structure. An LLC or a Corporation (either a C-Corp or an S-Corp).

In an LLC, there is a concept called “manager-managed” in which an appointed manager has decision-making rights regardless of his or her membership interests. Blocking a manager’s decision or removing a manager generally requires a “super majority” of voters, which is usually two-thirds, but can be whatever you agree to in the operating agreement.

In an S or C-Corp you can consolidate control through the number of shares each person has. So, issuing 51% to one person would give them control, but this number will still have to be adjusted when the Pie bakes. The final outstanding share count should align allocations to the final Slicing Pie split. If your company issues new shares, it may trigger an income tax event. Buying down shares will help you avoid unnecessary income taxes.

Alternatively, you can issue restricted shares to each participant and use Slicing Pie to determine vesting when the Pie bakes. Always be sure to file an 83(b) election with the IRS within 30-days (talk to a lawyer or accountant for more information). Unvested shares, however, still have voting rights so you will need to create a new class of shares that have the exact same financial benefits as the common shares, but limit voting. In an S-Corp this is the only way you can create a new class of share.

On a side note, when considering creating multiple classes of shares, proceed carefully! People can and do pull all sorts of shenanigans with classes of shares and doing so will never, ever make your split fairer. Each class of share introduces changes to the owners’ rights which means someone thinks he or she is magical or special and somehow deserves to benefit at the expense of others. If an investor asks for a special class of share keep in mind that he or she is taking advantage of your desperation. It’s not going to be fair, but it may be unavoidable. Just make sure your core Pie participants are all experiencing the same consequences of the deal.

One of the first questions you should ask before consolidating control is: why? This may seem obvious, but when you really think about the answer you may be surprised at the answer. Control is simply the right to make unilateral decisions. It does not ensure good decisions. If your decisions are so unpopular with your team that you have to force them, you may not be making very good decisions. Slicing Pie always allocates the most control to the people who have the most to lose if things go wrong. This ensures that the decision-makers’ incentives are aligned with the non-decision makers.

The best way to keep control is to put the most at risk. If you’re not willing to do this, you have to be willing to let someone else help make decisions.

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