Introduction to Funding Structures in Tech Start-ups

As technology start-ups rapidly evolve and seek funding, one of the central themes in corporate structuring lies in the A/B stock structure. This article delves into the common practice of founders having voting preference on their shares and the VCs' perspectives on these structures.

The Concept and Commonality of A/B Stock Structure in Tech Start-ups

One of the key trends in modern tech start-ups is the adoption of the A/B stock structure. This mechanism ensures that founders and early investors maintain significant voting control over their shares despite later rounds of funding diluting their equity stakes.

Looking at the major IPOs over the last decade, it is clear that A/B stock structures have become increasingly common. Companies like Slack, Zynga, and Dolby have all utilized this structure. However, the critical factor is to implement A/B stock structures before investors inject capital. Once a company has received funding, it may be challenging to introduce a new equity class that provides voting preferences.

The Perceptions and Motivations of VCs Regarding A/B Stock Structures

Many Venture Capitalists (VCs) understand the advantages of A/B stock structures. Despite their potential challenges, VCs often agree to these structures because they know that lead VCs in major financing rounds generally seek board seats.

By obtaining a seat on the board, VCs gain substantial influence over company decisions through board deliberations. In practice, this board representation may be more impactful than direct voting control. Assuming that the board functions collaboratively and aligns with company objectives, having a say through board representation can be far more beneficial than pure voting rights, especially if the board is not adversarial or dysfunctional.

Optimal Voting Share Structure for Founders

For founders, the ideal corporate structure might include the following elements:

Role of CEO: The founder should be listed as the CEO. Role of Chairman: The founder should also serve as the Chairman of the Board. Voting Shares: Founders should possess B-class 10:1 voting shares. This ratio significantly amplifies the voting power of the founders and provides substantial leverage during board and shareholder meetings. Board Composition: The Board at the Series A stage should consist of three members, including two co-founders or key leadership figures and one Series A VC investor. This balanced composition prevents any potential deadlock situations.

Power Dynamics in Corporate Governance

Understanding power dynamics and the distribution of control is crucial for founders. In corporate governance, there are several aspects to consider:

Board Votes: Committees or sub-committees may handle matters that require board-level approval, such as company strategy, major acquisitions, and alliance agreements. Shareholder Votes: Certain decisions, such as the sale or liquidation of the company, may require direct shareholder approval, which founders with voting preferences can control. CEO Control: The CEO often wields the power to make operational decisions and has the ability to manage the daily operations of the company. Chairman Influence: As the Chairman, the founder has significant sway over board meetings and strategic direction,which can be leveraged for long-term company success. CFO Authority: The CFO oversees financial matters and can influence company policies related to finance and budgeting.

By carefully analyzing these power dynamics, founders can ensure that decision-making processes align with the company's goals and the best interests of all stakeholders, rather than solely the founder's personal gain.