An Invitation to Investors Risks Losing Control of Your Business

Gray Reed
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Cleve and I recently discussed how a business owner’s divorce might result in losing control of the business. While loss of business control by marital divorce is a real threat, many business owners lose their companies through “business divorces” after squabbling with their investors.

Some new businesses are overnight successes, like Ben Distiller’s Texas Whiskey Distillery in San Marcos, Texas. Ben’s craft whiskeys caught on with connoisseurs around the world, gaining Ben a great reputation and huge orders for his whiskey – but without the inventory to fill the demand. Although Ben was rich in ideas, he was cash-poor – so to raise money for expansion he sold a controlling interest in his distillery to venture capitalists from California. Ben’s management style clashed with his investors – Ben wanted to maintain the same high quality product he built his reputation on, but his investors wanted to ramp up production to generate cash flow. Ben’s complaints resulted in the investors locking him out of the company he founded.

What can Ben do?

Not much. By selling a controlling interest in his company, Ben has ceded control of the company to his investors – all too common a tale. So what should Ben have done?

Tilting the Scales in Your Favor – Dealing With Investors.

Before jumping on the cash wagon, Ben should have consulted a lawyer before dealing with the venture capitalists. David Earhart, a Gray Reed corporate and M&A attorney, notes that VC’s will almost always demand control of a company, but a clever attorney can help a business owner retain as advantageous a position as possible. For example, when setting up the company Ben could have retained ownership of the intellectual property – i.e., the whiskey recipes – and licensed the IP to the company for a set period of time, thus giving him negotiating leverage with the VC’s. Other things to consider are to:

  1. Stay Capitalized: Too many business owners get into trouble when they realize – too late – that they are undercapitalized. Plan ahead and start negotiations with investors before you need their money – and are desperate enough for it to fully cede control of the company.
  2. Consult an attorney. A good corporate attorney can negotiate with investors and draw up corporate documents that give you the best possible terms for retaining some control over your company.
  3. Structure the Company and Shareholder Agreements: Set up the Company and Shareholder Agreements on the best possible terms on the front end, giving the most leverage possible.
  4. Choose Board Members and employees wisely: Make sure your board members and employees are experienced and capable, to prevent VC’s from demanding a wholesale replacement of your loyalists with members loyal to them.
  5. Get an employment contract: Ben could have secured an employment contract minimizing the grounds to fire him and maximizing his benefits if he is removed.
  6. Get a business divorce: If all else fails, negotiate an exit and a buy-out from the company. You will need an attorney involved to advise you on the best terms and navigate the shoals of possible non-competition and trade secret agreements.

A Real Life Example

Our example above was based on the real-life case of Balcones Distilling in Waco, Texas. After a bitter fight, Balcones’ founder and master distiller was just bought out of the business he started by the investors who bought a controlling stake in the business. For those wise souls interested in good whiskey, more information is available here.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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