Source | Strategist CEO

Corporate control is at the core of corporate governance, and it is the guarantee of a company's standardized operation.

The controlling stake is king. Who owns more equity in the business, who holds the control of the more solid, this is every experienced business operators are well versed in the common sense. A reasonable shareholding structure not only clarifies the rights and responsibilities of the management team, but also has an extremely favorable impact on enterprise refinancing. Investors judge whether a company is worth investing in, trustworthy, also depends on whether the shareholding structure is reasonable.

This article originated from my long-term service of a customer in a period of rapid development, the recent financing to carry out national expansion, to build the system, to achieve the company's strategic goals. One of the very powerful strategic investors, very optimistic about the business track, business model, management team and its technical level and service capabilities. However, the proposed condition is: under the premise of meeting the investment amount, it requires 50% of the company's equity. This means that the founders and strategic investors have formed a 50%:50% shareholding situation.

To accept or not to accept?

If accepted, can the founder still control the company?

How can the founders maintain control of the company?

In fact, a 50%:50% split between both shareholders is said to be the worst possible shareholding structure.

If such a company goes back to financing, investors will be very resistant. Once they see that it is such a shareholding structure, most of them will just give up.

Based on years of experience in corporate governance consulting and helping entrepreneurial CEOs raise capital, I know that companies with this kind of shareholding structure will almost always end up failing. The familiar Chinese restaurant "Zhenkongfu" shareholding dispute was a result of this kind of shareholding structure, which led it from glory to a stormy future.

This absolutely equal share of the equity set is what we call "game-type" equity structure, but also one of the most common forms of equity structure. This kind of equal distribution of equity, the proportion of equity held by shareholders is equivalent, mutual checks and balances, it is difficult to form the actual controller, it is also difficult to identify the actual controller. From the perspective of corporate governance, the main risk of this kind of shareholding structure is that it is easy to cause the company to be deadlocked, with no core shareholders, and it is also easy to cause conflicts among shareholders, thus affecting the company's operation and management and long-term development. Therefore, it is called the "worst" shareholding structure.

What is commonly referred to as corporate deadlock is that in the course of the company's existence, due to disagreements or disputes among the shareholders or directors, and their unwillingness to compromise and stalemate, resulting in the company not being able to make decisions in accordance with the legal procedures, the formation of a deadlock, an imbalance between the control of the company and the right to claim the benefits of the company, which will make the company fall into the inability to function normally or paralyzed state.

The two shareholders each hold 50% of the equity, indicating that they have equal rights to earnings and decision-making in the company. But they cannot be equally competent and contribute equally to the company, which creates inequity. There is nothing wrong with this in the start-up phase, but in the growth period or high speed development period, grievances or conflicts are inevitable.

Because everyone has different experiences, experiences, perceptions, motivations, or management styles, they will inevitably have different choices and orientations when facing problems in business management. Even if everyone is for the good of the enterprise, everyone will choose a different path, rhythm, and way. Enterprises have to make decisions, otherwise the operation cannot proceed. However, if two shareholders, both of whom own 50% of the shares, disagree and neither of them refuses to compromise, then no one's opinion will be passed. This level of conflict can be avoided if the founders or investors are both of a higher realm and the goal is to make the business bigger and stronger. But the dispute over decision-making power is absolutely unavoidable. At this time, the enterprise will naturally fall into the company deadlock.

In accordance with the provisions of the Companies Act, there are three basic lines of control of the company, 67%, 51%, 34%, which we call the absolute line of control, the relative line of control and security line of control.

67%, i.e., more than 2/3, for the company to increase or decrease the registered capital, amend the articles of association, merger, separation, dissolution, change of company form, usually called the company's major events.

51%, i.e., more than half, for situations other than those mentioned above, such as the company's management, investment decisions, etc., usually called the company's ordinary matters.

34%, i.e. more than 1/3, have the right to veto on important matters.

As you can see, owning 50% of the shares does not mean that you have control of the company.

In terms of these control rights, what needs special attention is the "one-vote veto power", i.e. 34%.

When a shareholder holds 34% of the shares, it means that he can veto major matters of the company, and by exercising his veto power, he has the effect of negatively controlling the company to a certain extent.

Giving "veto power" is equivalent to ceding control of the enterprise. This is extremely risky behavior, and many company founders have paid a heavy price for it.

Controlling a company through shareholding is a better way. But in reality, it is unlikely that control can be achieved purely through percentage ownership, except in the case of a startup. The company's development process requires financing, equity incentives, and inevitably, the founder's equity will be diluted and diluted situation. Like Jack Ma, Ren Zhengfei, Liu Qiangdong, etc., their shares are very small, but still control the business, because through other ways, such as: through the holding company pyramid structure, limited partnership, articles of association, shareholders' agreement, etc. to control the right to effectively separate from the right to dividends to effectively solve the problem of control of the company.

So, as the founder of the enterprise, it makes little sense to want an absolute holding company, because this arrangement is not sustainable in the later capital operation process. What should be focused on is how to improve the business operation and create greater returns for shareholders, so that shareholders will willingly allow the founder to continue to retain control.

Of course, the following methods of corporate control can be designed to avoid the founder being kicked out.

1. Voting proxy: Some of the company's shareholders have agreed, by agreement, to delegate their voting rights to other specific shareholders to exercise.

2. Concert party agreement: By agreement, certain shareholders take concerted action on specific matters. In case of disagreement, certain shareholders follow the voting of the concert party.

3. Limited Partnership: This allows shareholders not to hold equity directly, but to place them all in a limited partnership (LP). Let this limited partnership to hold shares.

4. "AB Share Plan" in offshore structure:? If the company uses an offshore structure, it can use an AB share plan and implement the "different rights for the same share" system.

5. Founder's veto: This is a passive defense strategy. When the founder's shareholding is less than 50%, the shareholders' meeting will decide to give the founder some negative rights, mainly for some important matters, such as merger, separation, dissolution, financing or listing.

It's important to note that arrangements like AB shares can't be done by companies in China, limited partnerships, concerted actions, voting proxies, etc. can be done .

A lot of facts have proved that the equalization of equity is very unwise and even stupid. Because, it means "contribution matching contradiction" and "control" is missing.

If you have to use 50%:50% share, it is not impossible to solve the problem.

First, set up a good corporate governance structure in the company's articles of association. For example, if one party is the chairman of the board, the other party can send two directors; if one party is the executive director, the other party is the general manager, and it is clearly stipulated that the executive director can not replace the general manager; or both parties agree that the chairman of the board of directors will have the final say when there is a voting deadlock.

Second, the implementation of interested shareholders and directors voting recusal system. Shareholders or directors and the shareholders' meeting or the board of directors to discuss the resolution of the matter has a special interest, may lead to the occurrence of circumstances harmful to the interests of the company (such as related transactions, for shareholders, directors to provide security, etc.), the shareholders or directors and their proxies are not allowed to exercise voting rights, shareholders are not allowed to act on behalf of the other shareholders to exercise the right to vote.

Third, in the company's articles of association to design the exit clause. For example, the two sides agreed, such as several decision-making are unable to form a resolution, one party can apply for dissolution of the company or can apply to withdraw from the company, by another shareholder or major shareholder to fulfill the obligation of compulsory acquisition. As for how to withdraw, both parties can be agreed in the articles of association.

Fourth, the implementation of compulsory buyback system. If two consecutive shareholders' meetings or the board of directors have difficulty in reaching a resolution on a major matter, the shareholders or persons acting in concert who hold more than 50% of the company's equity have the right to acquire the equity of the shareholders who voted against the acquisition, and the price of the acquisition will be calculated on the basis of the equity price of the company in the previous fiscal year.

Finally, I believe that for an enterprise with rapid expansion potential, the entry of suitable investors is a strong impetus to accelerate the take-off of the enterprise, but after the investors enter the company as shareholders, how the founder balances the distribution of rights between the investor and the investor, and how to have a strong control of the company after the financing, sometimes depends on the founders of the enterprise at the beginning of the various decisions, but also depends on the negotiation process of financing. Sometimes it depends on the decisions made by the founders at the beginning of the company, and also on the agreements made with the investors during the negotiation process of financing. At the same time, the founders should also let the investors know that the loss of control over the company due to the entry of investors will actually harm the interests of both the founders and the investors. Because, the continued operation of the company is dependent on the founder to lead the operational management team to realize.