Control . . .

is the ability to direct the actions of a company. It includes the power to determine company strategy and to select the people who will carry out that strategy. In a corporation, control resides with the shareholders, who elect the company’s board of directors, and with the board of directors, who set company strategy and elect company officers to carry out the company’s plan. The ability to elect or persuade a majority of a company’s board of directors is usually considered the deciding factor with respect to who controls a company.

Company control can be assured through ownership of enough shares of stock to elect more than half of the company's directors. In most cases, this means owning more than 50 percent of the company's voting stock. When more than one class of stock has been issued, control may, instead, be effected by owning sufficient shares of the different classes of stock to insure the ability to elect a majority of the board of directors.

Raising capital affects management's control in several ways. When enough stock to elect a majority of a company's board of directors is sold, management continues to direct the company only as long as the investors consent. Even when less stock is sold, contractual provisions required by an investor as a condition to funding can also change control by reducing management's unrestricted freedom to run the company. These provisions usually entitle the investor to participate in certain management decisions and to receive detailed and regular financial reports. Some contractual rights affect control by giving investors the right to manage the company if performance standards are not achieved.

As a rule, venture capitalists are more interested in obtaining a high rate of return on their investment than in obtaining control of a company. Most want control only to the extent that they believe is necessary to protect their investment. Few are interested in running the day-to-day affairs of a company.

Even when an investor acquires the ability to elect a majority of a company's board, there are ways management can retain operating control. A shareholders agreement requiring the investor to vote his stock for a slate of directors that is controlled by management is one example. Management contracts are another. These can be used to insure management of at least minimum representation on the company's board of directors or of the right to direct the company's activities as long as it does so within agreed-upon parameters.

Classes of common stock can also be created to insure that control stays with management. By issuing to investors a second class of common stock that only has the right to elect a minority of the company's directors, management can retain majority control of the company's board of directors even when it sells a majority of the company's outstanding capital. A combination of these devices can be used to keep control in management's hands.

Most investors insist on some influence over a company's affairs as a condition to funding and require a seat on the company's board of directors. Few will want to control the board unless they lack confidence in management's abilities. Most will expect to receive regular financial reports from company management.

Investors will say that they are not interested in control. They will say that as long as management runs the company successfully they will not interfere. Nonetheless, management's definition of success may differ significantly from that of its investors. And investors may develop independent reasons for moving a company in a direction that does not interest management. The only way for management to assure its control is through ownership of enough stock to elect a majority of the company's board of directors or through a binding written agreement with the investors. See: Affirmative Covenants, Board of Directors, Common Stock, Cumulative Voting, Management Agreements, Negative Covenants, Operating Covenants, Shareholders' Agreements, Take Away Provisions, Venture Capital Deal Structures, Voting Agreements, Voting Trusts.