When we sold Tatango, I controlled a majority of the voting shares of the company, and under our state's corporate law, the acquisition only needed approval from a majority of voting shares, so I was under the impression that I alone could approve the deal.
But approving a deal and closing a deal turned out to be two completely different things, and like many first time founders, I had no clue about the difference.
What I learned much later on in the process was that while I could approve the deal under our state's corporate law, the acquirer could put their own requirements on shareholder approvals, and this buyer wanted 90% of our shares to agree to the merger. Without that 90%, the buyer wasn't wiring a dollar.
So why would an acquirer demand shareholder approvals that go above and beyond what state law requires?
Put yourself in their shoes. They're about to spend millions of dollars acquiring a company. The shareholders who don't agree to the acquisition create two specific risks they don't want to inherit, rightfully so:
Dissenters' rights (also called appraisal rights). A shareholder holdout can't block the deal, but they can refuse the offered price and force a court to determine the "fair value" of their shares, which can be a huge headache for an acquirer.
Second, indemnification. The shareholders who sign aren't just approving the sale, they're agreeing to stand behind it. If something turns out to be wrong with the company post-close, shareholders who never approved the deal can't easily be bound to that. So every unsigned holder is equity the buyer can't fully protect itself against.
The 90% bar solves both at once. It locks in the overwhelming majority of the equity to the price, the escrow, and the indemnity, and shrinks the pool of holdouts who could cause problems later.
According to Wilson Sonsini, one of the top startup law firms in the country, it's "relatively common for a buyer to request that a company obtain the approval of holders of an even greater percentage of shares (often around 90 percent) for a merger in order to limit the number of stockholders that may exercise appraisal or dissenters' rights."
In other words: this is standard. I just didn't know it.
Drag-Along Rights
A few years ago our attorney recommended we implement drag-along rights into our corporate governance, and we did. In my naivety, I thought this would protect us from exactly this sort of thing. Wrong again.
What drag-along rights typically do is let the majority bring the minority along. If the majority of shares vote to approve a sale, the minority shareholders are contractually obligated to go along with it. They're dragged along with whatever the majority wants to do. That can help you approve a deal. But again, approving a deal and closing a deal are two very different things. In our case, even with drag-along rights securely in place, the acquirer still wanted 90% of shares to approve the transaction.
What this means for founders
Here's where it gets uncomfortable.
If the acquirer requires 90% approval, you, the founder with majority voting control, now have to go convince every single one of your shareholders to approve the deal. But Derek, everyone is gonna approve the deal, they're going to become rich, who wouldn't approve of that?
It's not that simple. Each shareholder has their own reasons for doing anything. That ex-employee shareholder you fired 10 years ago can now finally stick it to you. That one investor who put in $15,000 and you barely knew 18 years ago, do you even have a working email for them? That one investor who died, and you now have to figure out who controls those shares. That one investor who thinks you're crazy for selling at this valuation and wants you to keep building. The shareholders who are now divorced. The shareholder who wants their uncle, an attorney, to review the deal before they sign. The co-founder you thought you'd never have to deal with again. The extremely wealthy investor who is out of the country for the next month and tells you they'll review the docs when they get back to the USA.
Advice
I honestly don't know what I'd do differently about raising capital 18 years ago, since we were desperate for the money when we were starting out, and beggars can't be choosers.
The one thing I'd do differently is this: I wish I'd realized from the start that every investor we took a check from was someone whose approval I'd eventually need at the very end. We still would have raised money from everyone we did, but I think I would have done a much better job of investor relations over the last 18 years if I'd understood I'd need them to sell the company.
Keep your cap table tight. Every additional shareholder is one more person you'll need to get on board if you ever sell. The "small check from a friend" feels harmless when you're desperate for $15K. It's not harmless when it's the difference between hitting 90% and the deal collapsing.
Keep your cap table updated. The week before the acquisition is about to close is not the best time to realize that none of the contact information you have for an investor still works.
Stay in touch with all of your investors. A quick annual update keeps relationships warm, and I'd have a personal call or email with each investor every couple of years on top of that. When the day comes that you need their signature inside of two weeks, you don't want it to be the first time you've talked in five years.
Venture Capital Investors
We didn't raise from VCs, only friends, family, and traditional angels, and in our deal most everyone was fine with the outcome. VCs, on the other hand, can have completely different expectations than you or your other investors. Remember, VCs are looking for outsized returns. To be in the top quartile of VC performance, funds need ~25-30% IRR. Most funds end up with only 1 or 2 truly outsized winners, which means those winners need to return 700-1,400X of their investment. That means a company that raised at a $5M valuation might need to reach a $3.5-$7B valuation, and that's before factoring in dilution from future rounds.
Our investors made good returns, but nowhere near the kind of returns VCs are looking for, and I shudder to think what would have happened if we'd taken VC money. Most likely a VC would have rejected the acquisition and encouraged us to "go for it," because they need billion-dollar outcomes to offset all their losses and outperform the stock market. A 10X return is a home run for founders, employees, and non-VC investors, but it wouldn't have even moved the needle for a VC fund.
This is also where I get a little concerned when I ask first time founders about their VCs' expectations. Usually I get a response like: Don't worry, they only have 20%, so at the end of the day we're in control. It's very important to understand the expectations of all your investors, so you're not only building toward those expectations, but it's also not a surprise when an investor says a 10X return at the finish line of an acquisition is nowhere close to what they expected.
I went into my acquisition thinking I had the final say. I learned, very late in the process, that I'd have to sit down with everyone I'd ever taken money from and convince them this was the right deal, or watch it fall apart.
It worked out, thankfully. But it didn't have to.
Take it for what it's worth. This is one of those lessons you usually only learn once, and it's an expensive one.