Schitzophrenia

Same Person, Different Roles, Different Answers

By Frank Demmler

They should have known better. I sent in my check for Super Bowl tickets. I wasn’t selected for tickets in the lottery. You know what happened next. Talk about conflicting emotions.

I mention this because in the past week I’ve had discussions with several people with roles and responsibilities that were muddled, and the individuals needed some help in sorting through it all.

Founders

Founders are in a particularly precarious position. Consider the simultaneous roles that they play:

· Private citizen

· Founder

· Shareholder

· Director

· Officer

· Executive

· Employee

In the beginning, all of these roles are closely aligned, but overtime each takes on a specific character, often in conflict with one another. The differences are often magnified when an investor is brought on board.

Consider the founder-director-shareholder. The director has a responsibility to make decisions based upon what’s best for ALL shareholders. The shareholder is driven by self-interest.

What does he do if a company offers to acquire “his” company? It is clear that selling the company is in the best interests of ALL shareholders. The investor gets a chance to exit on attractive terms. The employees with options have an opportunity to realize the benefits of all their hard work.

But you, the shareholder, doesn’t want to sell. Maybe you think there’s an even bigger exit opportunity in the future. Maybe you don’t want to work for someone else. Maybe you don’t like the acquirer. Whatever the reason, you don’t want to do it.

How do you resolve this conundrum? Strictly speaking, it’s pretty straightforward. As a director, you have to vote, “Yes.” When it is submitted to the shareholders for approval, you will vote, “No.”

Is that the end of it? Not likely.

If you don’t own enough shares to block the acquisition, your vote will be counted, and the acquisition will proceed. In fact, if it’s inevitable, you may vote in favor of the deal just to avoid the appearance of dissension.

If you can block the acquisition, things will get very interesting. In all probability, you’re likely to sell the company anyway, but not before you go over a few bumps along the way.

As a practical matter, if discussions with the acquirer were to get to this point, everyone but you will be thinking about life after the acquisition. The investors are thinking of the distributions to their investors. The employees are daydreaming about the Harley, the boat, and the college fund.

You will come to the realization that even if you could stop the transaction, it would likely be a pyrrhic victory. Your company will never be able to return to what it was. Recognizing that, you’re likely to negotiate some form of consideration for voting your shares in support of the acquisition.

In the Beginning…

While I’m sure you haven’t committed this sin, many start-ups begin with great intentions, but naive expectations. For example, let’s say that you invented something, and you and a friend started a business based upon that invention. You may not have considered some of the issues associated with the ownership of the intellectual property. For the two of you, it’s not a problem, at least at the beginning. One for all, and all for one; that sort of thing.

After some time passes, your company attracts investment interest. As part of the due diligence, the ambiguity about the ownership of the intellectual property surfaces. The investors want you to assign all of your IP rights to the company. Now, what do you do?

It was “understood” that you were “contributing” your IP to the company way back when, but it was never reduced to a legal agreement. Things were simple then, but they’re getting complicated now. What did you really intend back then? …that the company would have complete rights to your technology? …that the company would have limited rights restricted to specific fields of use? Did you even think about these issues?

What are your legal obligations? …your moral obligations? As a director, you understand why the company wants the rights. As the inventor, you want to retain the rights. As a director, you understand the value to the company of bringing the investors on board. As the inventor, you resent being pressured to give up your rights.

This is another situation where you’re in the legal right, but are likely to have to give in. The reality is that investors are highly unlikely to invest without the company owning the IP, or at least having an exclusive license to it. You may be able to get consideration of some sort, but the disposition of the IP is pretty much preordained if you need growth capital from investors.

Talking about legal stuff and lawyers…

When you start your business, you and your company are pretty much synonymous. When you engage an attorney, your interests and those of the company are aligned. If you’ve selected the right attorney, she will become a trusted advisor. But, overtime, your interests and those of the company are likely to diverge [see above].

When a significant event occurs that requires legal input, “your” attorney is looking out for the company, not you. Let me say that again. Your attorney is looking out for the company, not you. In many cases, that may not be a big deal, but in others, you may be unknowingly vulnerable.

In one memorable case, a company with which I was involved had gotten its initial funding from local sources. The management, investors and board members were all well known to one another. We were all comfortable with one another and the fact that we could trust one another. We knew that one another’s word was his bond. [Perhaps naïve in today’s world, but that’s a whole other article.]

We had received an investment offer from some out-of-town institutional investors. I talked to the founder-CEO and cautioned him that when the new investors come on board, they will not be obligated to honor any “understandings” that the CEO had with the existing board. I also pointed out that he probably should get an attorney to represent him personally, for the reasons just stated.

As I knew it would, it created a flurry of activity, some of it unpleasant, but necessary. The CEO’s deal was put in place and he was legally protected as the company moved forward. At the exit, these actions had a material impact on what the founder received.

Conclusion

In an entrepreneurial setting, the individuals involved often wear many hats. Quite often the different roles will have different perspectives on the same issues. Not only are you likely to find yourself in legal quandaries on occasion, but also the moral and ethical considerations will be surprisingly complex.

If you’re going to be an entrepreneur, schizophrenia will be a way of life.

Frank Demmler is Associate Teaching Professor of Entrepreneurship at the Donald H. Jones Center for Entrepreneurship at the Tepper School of Business at Carnegie Mellon University. Previously he was president & CEO of the Future Fund, general partner of the Pittsburgh Seed Fund, co-founder & investment advisor to the Western Pennsylvania Adventure Capital Fund, as well as vice president, venture development, for The Enterprise Corporation of Pittsburgh. An archive of this series of articles can be found at my website.