AngeBlog by Basil Peters

Shareholder Alignment

Alignment is critically important to entrepreneurial and investor success.

Alignment is still a relatively new concept. A full appreciation for alignment is a prerequisite for optimum corporate structuring. Alignment is all about human behavior and group psychology. It's often very difficult to describe to young entrepreneurs. Most angel investors agree that until you have been closely involved with a dozen or two early stage companies, the full impact of alignment is hard to appreciate.

Creating an optimum alignment among the stakeholders can dramatically improve organizational success. Failure to create alignment often leads directly to failure.

The effects of misalignment were more prevalent in the later 1990's as the full impact of VC Term Sheets and complex preferred shares structures became apparent. By the end of the decade, many entrepreneurs, angel investors and experts on governance came to believe that it was an irreconcilable conflict for a VC holding typical preferred shares to sit on a board.

It's very rare for an entrepreneur in their 30's or 40's to fully appreciate just how critical alignment is. It seems to take a couple of decades experience sitting on at least a dozen boards for the patterns to sink in. The light usually goes on when someone is sitting around a boardroom table, watching something negative happen, and realizes: "This is just like what happened to ABC Co in the early 1990's and XYZ Corp back in 1998."

Today, it is widely agreed that the goal for alignment, especially for an early stage company, should be that all of the stakeholders own the same type of equity. This should be common shares and possibly options, or warrants, on common shares.

When all of the company's stakeholders have the same type of ownership, everyone is automatically motivated to achieve the same result - the maximization of the value of those shares. Alternately, if a group of stakeholders has preferred shares, or a royalty interest, it's easy to imagine a situation where the value of their stake was maximized by events which did not maximize the value of the common shares.

This is not to say categorically that owning preferred shares, or a royalty interest, is wrong. But it does create a fundamental conflict which should preclude that person participating as a director.