How Can I Raise Capital and Retain Control of My Company?

In Short

• Maintain the right to appoint directors, even if shareholding dilutes.

• Ensure board decisions require founder-majority approval to retain control.

• Utilise pre-emptive rights and right of first refusal to protect ownership.

Tips for Businesses

To retain control while raising capital, structure your board with an odd number of directors and include a casting vote for founders. Implement pre-emptive rights to purchase new shares and a right of first refusal on share sales. Consider convertible notes or SAFEs to delay dilution and maintain governance autonomy.

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Table of Contents

• Board Composition and Decision-Making  
• Pre-emptive Rights and ROFR
• Alternative Funding Types
• Convertible Notes
• Simple Agreement for Future Equity (SAFE)
• Key Takeaways
• Frequently Asked Questions

Companies often issue shares (equity) to investors in exchange for capital, which facilitates growth. As a result, the proportion of shares held by existing shareholders (including the company’s founders) will be diluted. Major investors may also receive certain rights with their shares, such as the right to appoint a director to the company’s board. These rights, along with the dilutionary effects of capital raising, can impact a founder’s ability to control business decisions. This article will explore certain strategies that founders should consider when raising capital.

Board Composition and Decision-Making  

Your company’s board (i.e., the directors of your Company) plays an important role in determining the day-to-day control of the Company. Therefore, as a founder, you want to try to retain control over your board for as long as possible.

Your shareholders’ agreement or constitution will outline who has the authority to appoint a director. Typically, you can expect that your co-founders or investors will require you to have a minimum shareholding to appoint a director.

It’s important to note that your ownership percentage will inevitably decrease when you raise capital. Therefore, you want to make this required shareholding as low as possible (e.g. 1 share). This ensures that you can appoint a director, even if your ownership percentage dilutes when you bring on new investors. 

Your board should contain an odd number of directors to avoid deadlocks in decision-making. Although relatively uncommon, you might also give yourself a ‘casting vote’. This allows you to break a deadlock should it arise and ensures a final say regarding whether a particular decision is approved. 

Ideally, your board should contain more founders than ‘external’ directors to ensure you can control the business’s overall strategy and direction. However, this may not be possible if your company has only one founder and it brings on new board members.

When considering appointing a director to your board, it is important to ensure that you have the same vision for your business. Otherwise, they might obstruct the decision-making and overall management of your company. 

Nature of Board Decisions 

Your company documents will outline who makes which decisions. Some decisions will be made by your board. Some decisions will be made by your shareholders. Ensure that your documents clearly state that most decisions should be made by the board. This facilitates efficient decision-making within the company. It also ensures that you can maintain primary control over the business’s direction, even if your ownership is diluted.  

Here are some decisions that you may want your board to have control over:

It is essential to note that certain decisions must be made by shareholders by law. For this reason, you should always consult a lawyer before selecting the matters that the board can determine.

Decision-making Thresholds 

A decision-making threshold refers to the percentage of votes required to pass a resolution or make a decision on a particular matter. You should consider whether the board composition (discussed above) will require votes from your other board members to approve matters. This may, in turn, influence the decision-making thresholds you set in your documents. 

Another strategy you can use to retain founder control is to ensure that any given matter obtains the approval of the founders. You may hear this referred to as a veto power because the founders can simply vote against a particular matter, and it will not be approved. 

Pre-emptive Rights and ROFR

A company’s governance documents likely grant you, along with all other shareholders, pre-emptive rights. These give you and the existing shareholders the first right to purchase your pro-rata proportion of new shares the company intends to issue before offering them to outside investors. This right provides a mechanism to ‘top-up’ your shareholding and avoid dilution when the company issues new shares to raise capital. 

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Alternative Funding Types

When seeking capital for your business, it’s crucial to explore options beyond traditional equity or debt financing. The following funding types can offer founders more control over their companies at the early stages of their life cycle, as they typically don’t come with governance rights or board seats, preserving founder autonomy in the early stages. 

Convertible Notes

Convertible notes are a form of short-term debt that converts into shares at a later date, typically upon the occurrence of a specific triggering event, such as a priced equity round. They allow you to postpone the valuation discussion with investors, which is beneficial if you’re not yet sure of your company’s value. The conversion terms, including valuation caps and discounts, are negotiated upfront, providing some predictability for both the investor and the company.

Simple Agreement for Future Equity (SAFE)

A Simple Agreement for Future Equity, or SAFE, is another increasingly popular funding instrument in the startup ecosystem. SAFEs are designed to streamline the early-stage investment process and provide much-needed capital to founders while delaying the complexities of a traditional equity raise. They operate in a similar manner to convertible notes, in that the company offers future equity (triggered by a conversion event) for upfront capital. However, SAFEs are not considered debt instruments and don’t accrue interest.

While these two examples of alternative finance postpone dilution, they don’t eliminate it entirely. Depending on the terms of the arrangement, it may be the case that the delayed dilutionary effects leave you in a worse long-term position from a control perspective.  

Key Takeaways

Founder and shareholder dilution is, to some extent, unavoidable as the company grows and undertakes capital raises. However, there are strategies that founders can implement to ensure that they maintain practical control of the company, for example, ensuring that:

• founders have entrenched rights to appoint directors; 
• the company’s governance documents provide for critical decisions to be made at the board level; 
• the decision-making thresholds can be achieved by the founding team without relying on approval from ‘independent directors’, taking into account the board composition; 
• founders have customary pre-emptive rights on new share issues and, where possible, a right of first refusal on share disposals. 

If you need advice on the strategies you can implement to maintain effective management control of the company while raising capital, our experienced capital-raising lawyers can assist. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today on 1300 544 755 or visit our membership page. 

Frequently Asked Questions