The Corporate Structure - The Company Foundation
A company's corporate structure is like a building's foundation. If the foundation is flawed, it may not be immediately apparent. But as the structure grows, there is an increasing likelihood that the structural flaws will lead to a complete collapse.
This happens much more often with companies than with buildings.
A good example is share and option vesting. Often young entrepreneurs will create vesting formulas that are fatal, genetic flaws in their newborn companies.
The failure mechanism for a flawed vesting formula usually goes something like this:
- An entrepreneurial team forms and pledges eternal loyalty to the new venture.
- They work shoulder to shoulder for long hours for low pay building the value of their equity.
- One day, one of them gets an offer to join "ReallyNewCo" with the promise of new equity and a cool new idea to get obsessed with.
- He or she leaves the original team to join the new enterprise -- and it's everything they dreamed it would be... the long hours and low pay are no worse, but the idea and the people are new.
- The rest of the first team continues to grind it out doing all the hard stuff that young companies need.
- Then the members of the original team get together with their old colleague who regales them with stories about how much fun it is at ReallyNewCo.
- Then a second member of the team starts to think: "These hours are arduous and the pay really sucks. This isn't as exciting anymore. My partners are doing a good job of building the value of my equity... they don't really need my help that much. My old partner sure is having fun at ReallyNewCo..."
- And they get seduced by the next new thing.
- At this stage, the other members of the team realize they are chumps for working really long hours for low pay for the same equity that their old partners have.
- And an exodus begins, leaving almost nobody with the critically important experience to work the long hours for low pay that the original company really needs at the stage its at.
- And the value of everyone's equity plummets...
This happens all the time. But what happens even more often is that the original structure, including a fundamentally fair and equitable equity allocation and vesting formula prevents that type of thinking from reaching critical mass. People inevitably come and go. What's important is treating both the people that leave and the people that stay fairly and equitably.
Alignment on exit strategy is another element of structure that most entrepreneurs rarely think about until its too late. It can be the single biggest factor in determining whether entrepreneurs can actually realize on the value in their founders shares.
Even though the exit comes last, the exit strategy should be built into the structure of the company from its earliest days. The exit strategy is one of the most important considerations in determining the financing strategy and choice of investors.