A minority stake is simply a portion of equity less than 50% of the total amount of shares in a business. The benefits of selling a stake of this size in a secondary transaction is that you as the founder can liquidate part of your equity for a personal return while retaining a majority stake and thus maintaining control of the company.
Taking a few chips off the table is a common method for de-risking business ownership. Nobody knows what the future holds so in the event of a downturn in the business, at least you as the founder will not have all eggs in the same basket. Creating financial cushioning via a partial cash-out, you subsequently hedge your bet as a founder if you want to take your business all the way.
So how does it work? Here are a few examples of bootstrapped founders who sold minority stakes via secondary transactions.
Basecamp offers an all-in-one toolkit for working remotely. The product is delivered as a SaaS solution and has been bootstrapped and profitable from day one of launching in 2004. Two years later, the co-founders Jason Fried and David Heinemeier Hansson (DHH), decided to sell a minority no-control stake to a high net worth individual. This person was none other than Jeff Bezos. As DHH puts it in his 2017 blog post:
“It was an unusual deal for a number of reasons. First, Basecamp remained an LLC, which it still is. Not a corporation. Bezos’ personal investment shop simply took the role of a member in the LLC. This means that even to this day our paperwork and administrative overhead is laughably simple (Basecamp has no CFO, not even a full-time accountant!).”
The specifics of the deal in terms of the exact bits of equity sold by the two founders to Mr Bezos and the digits received in return is not public knowledge. What is known, however, is that each founder sold a chunk of ownership that when combined makes up less than 50% of the company’s shares, and in return each got a few million USD in cash.
The deal included a one-time provision for Jeff to sell his stake back to the founders after about 7 years but this was never triggered so he’s still a co-owner of Basecamp to this day. The reason for his inaction is probably because Jeff got the same terms as Jason and David had, which is to say a share of the annual profits.
Profit distributions can be achieved via a shared earnings agreement where the investor, in this case a high net worth individual, gets his share of the proceeds usually equal to the amount of equity owned. Some might ask why anyone would sell a piece of a profitable business but Jason and David’s reasons for doing so ticks all the boxes: risk mitigation, life-changing personal liquidity and with that, confidence to go the distance.
Jeff’s own regret-minimization framework actually applies well to the founders’ decision to sell a small, no-control stake to him. In the scenario where Basecamp fails, the founders obviously wouldn’t regret making the decision but nor would/did they when it turned out to succeed because selling a small piece only meant giving up a small slice of the upside.
The alternative options to a business angel’s limited involvement in the company would likely have resulted in regret from the normal investment-induced drawbacks. This includes a scenario where the founders sell part of the company to VCs and end up on their timeline, or one where they sell all of it to an incumbent corporation and wind up as employees.
In summarizing the choice to sell a minority stake in a deal with Jeff Bezos, DHH states:
”The big financial cliff for most entrepreneurs is the difference between no net worth and a few million. The difference between having a few million and a lot of millions is vanishingly small in comparison.”
Guillaume, Vianney and François founded lemlist back in 2018 with a mission to help fellow entrepreneurs build and grow a profitable business. With just a $1,000 initial investment they have grown the SaaS company’s annual recurring revenue to a whopping $10M fully bootstrapped! By 2021 the business reached a valuation of $150M when the founders received a partial buyout offer from an untraditional VC fund.
Up until this point, the founders had received many offers and had even turned down a $30M growth capital funding round. Instead, the offer they ultimately took was a partial buyout deal entailing each of the founders to part with a minority stake that collectively made up 20% of the company’s equity. In return for that and a board seat, the founders received a total sum of $30M split between the three of them. With $10M paid out to each founder they managed to get peace of mind knowing they would never need to worry about money again.
As an outsider it is easy to wonder what drives a founder to part with shares in a company so successful. Thankfully, Guillaume explains the decision in his 2021 blog post as coming down to pressure and risk:
“The bigger your company gets, the higher the valuation is and the more pressure you have as a founder. [...] On top of it, building and growing a company is always a risky process. As you grow, the risk of failure gets smaller (statistically), but on a personal level the risk level increases.”
This makes sense when you think about it. In the beginning of a company’s journey, the decisions of a founder will impact only a few customers whereas the weight of each decision will increase as the operation scales and the user base grows. Similarly, the bigger the valuation of a business has on paper and the founder has yet to see any of that money in their personal bank account, the bigger the wealth tied up in the business and is at risk of being lost by the founder.
What made this venture capital fund untraditional in offering the founders a large cash-out, is that most investors think of secondaries as a red flag. The traditional and frankly outdated school of thought is that if founders do not have enough ‘skin in the game’ then they will mentally ‘check out’ of the venture by being less involved because they ‘don’t have to’.
More modern investors like the investor that bought out the founders of lemlist for a minority stake will look for bootstrapped, profitable businesses operated by founders not only driven by money. Taking some of the weight off their shoulders via a partial sale will enable them to be more ambitious in their running of the company. And fortunately, the three founders still get to call the shots with full control over the business and three board seats.
This partial sale did not have any mention of a profit distribution arrangement between the investor and founders but does come with an expectation of capital gains from aggressive growth. It also entailed a more formal structure of the company with quarterly board meetings and the addition of a CFO to do monthly financial reporting which the founders view as a good thing now that the company has matured.
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