Pitfalls of Giving Up Equity in a Business Venture (Part 1)

Pitfalls of Giving Up Equity in a Business VentureFrom entrepreneurs to trusted advisors, financing a new business venture can be extraordinarily challenging. When you are considering your options, however, be very cautious about giving up ownership. Such a strategy can help get your business started in the short run, but it also can be a complete headache in the long run.

An Ounce Now, A Pound Later…

  • Imagine that you are an entrepreneur with a great idea and superb business model, but no start-up capital, or at least not enough to take flight with your business. You go to your parents, spouse, brothers, sisters, friends, and your spouse’s brothers, sisters, and friends (you get the picture).
  • They spare you some change, and in return, you offer them something as a symbol of your gratitude, something that will pay huge dividends later when your idea takes off and the big-money suitors come knocking: ownership in your business
  • A few years later, guess what? Congratulations! A large publicly traded company wants to acquire your business. Your hard work has paid off. Your potential acquirer wants to write you a check for several million dollars. All you have to do is cross your “t”s and dot your “i”s and the deal is done. In order to do so, however, your attorney tells you to have a meeting, take a vote, and make sure all of the other owners are on board.

Uh-Oh, I Didn’t Forsee This…

From the initial start-up capital to the equity you granted key employees, your business now has 10 other co-owners, all of whom are entitled to vote on the proposal. By the way, as part of the acquisition, the acquirer wants to move your operations to Ohio. Plus, in the years since you started the business, you and your spouse went through a messy divorce, but your ex-father-in-law and ex-brother-in-law are still owners. (Trust us; we’ve seen this and much worse …)

With all of these variables, do you think getting a consensus vote from all the co-owners will be easy? Not a chance! Some people are not so keen on the idea of moving to Ohio. Others (your ex-in-laws) see the dollar signs and know that they can make life very difficult for you if they refuse to go along with the acquisition.

What’s the Solution?

Perhaps you take a drastic measure and re-acquire ownership from everyone. But this can be extremely expensive and risky, especially if the acquirer backs out at the 11th hour. Or maybe you try to get everyone to agree. But that takes several hours of excruciatingly painful negotiations and discussions, with you making numerous concessions just to get the deal done.

In almost all cases, your opinions for a favorable outcome are few and far between.

Please stay tuned in the next couple weeks for more information on how to avoid this nightmare. In the meantime, if you have any more specific questions about your venture, you can contact our business lawyer in Woodland Hills.

 

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