4 Reasons Why It’s Better to Own a Big Chunk of a Small Company
Is it better to own a big chunk of a small business or a minority stake in a big company?
It’s one of the fundamental questions all owners must wrestle with. Owning a relatively small slice of a big pie has worked well for Elon Musk and Jeff Bezos, who recently traded places on the list of the world’s wealthiest people. Musk still owns around 20% of Tesla, and Bezos controls about 10% of Amazon, so they both have chosen to sell most of their company to fund their ambitions. The success of their bet has been amplified lately, given the stock market’s run over the last 12 months.
However, selling part of your business comes with some significant downsides. Let’s look at four reasons it’s better to own a big slice of a smaller pie.
Operational Freedom
The most obvious benefit of keeping all your shares is that you get to decide how to run your company. You need to know what products to launch or markets to enter. You are the king or queen of your kingdom and can decide the rules.
No Pressure to Exit
Tim Ferriss, the author of five books, including the wildly popular New York Times bestseller The 4-Hour Workweek, recently urged his Twitter followers to consider their endgame before investing in a business: “Before you get into an investment position, know-how and when you're going to get out, or at least how and when you will reevaluate. Getting in is the easy part….”
Once you accept outside investment in your business, you must try to earn a return for your shareholders. You must sell your company (or part of it) for your investors to realize a gain. Needing to sell so your investors can realize a return means you give up the option to run your business forever and need to start thinking about how your shareholders will get liquid. Some will pressure you, while others will wait patiently, but the exit clock starts ticking once you take an outside investment.
Nobody Ahead of You in Line
Sophisticated outside investors often demand preferred returns when they invest in your company, which can undermine your take from a sale.
For example, Ana Chaud started Garden Bar to offer fast-casual salads to Portland hipsters. The first store succeeded, but the restaurant industry’s thin margins inspired her to grow to get some economies of scale. She raised two rounds of outside capital, including one from a group of convertible noteholders. Chaud skimmed the term sheet but trusted her investors, so she didn’t think much about a clause that gave noteholders 2.5 times their money if she sold the business before the note expired.
Chaud had grown to nine locations, with a tenth on the way, when she attracted an exciting offer from Evergreens, Seattle’s fastest-growing salad restaurant. Things were going according to plan until Chaud’s lawyer pointed out the investors’ clause, which had the potential to wash out all her equity.
Chaud agreed to give the proceeds of her acquisition to investors. She negotiated an earn-out, which she hoped would allow her to earn a return on her years of sacrifice. Then COVID-19 hit, Portland restaurants closed, and Chaud ended up with nothing.
Avoid an $80 Million Mistake
The most obvious reason to hold on to your shares is to avoid dilution. When your company is not worth very much in the early days, it can be tempting to give away equity to attract a key team member, but being too generous could end up costing you dearly.
Look at the story of Greg Alexander, who started the Sales Benchmark Index (SBI). Alexander started the sales consultancy at his kitchen table and, early into his tenure, gave two employees a quarter share in his business. Ten years later, Alexander ended up selling SBI for $162 million, prompting him to refer to easily giving up half the company as an “$80 million mistake.”
Given the recent runaway success of some high-profile stocks, it can be tempting to consider raising money to fund your growth, but there are still several benefits to owning a big slice of a small pie.
Mark Hartmann is a three-time Inc 500|5000 CEO with a rich sales, operations, and leadership background in the insurance, financial services, and healthcare sectors. With extensive experience growing and selling his own businesses, Mark leverages his expertise to help owners grow and sell businesses valued at $1M —$25M. He’s earned a master’s degree in organizational change management from St. Elizabeth University and a graduate certificate in executive coaching from Columbia University. Mark’s professional certifications include Certified Mergers and Acquisitions Professional (CM&AP), Certified Business Intermediary (CBI), Certified Exit Planning Advisor (CEPA), and Certified Value Builder (CVB).