united-states, equity, founder, investorsSay someone were to have a holding company, we’ll call it Holding Labs, that owned a startup company called Startup Inc. Holding Labs is a software company whose business model is to hire web development talent and acquire server assets, and start many separate web companies using that same talent and resource pool. This company would be the one paying the employees and owning the assets.
If the founder of Holding Labs wanted to start a particularly exciting web company, let’s call it Startup Inc, and wanted to open it to outside investment, would venture capital groups or other investors be deterred by that ownership scheme?
If investment money originally coming from Startup Inc was used to grow the talent and resource pool of Holding Labs, would that be illegal? Or frowned upon?
If Holding Labs’ founder owned 80% of Holding Labs, and Holding Labs owned 60% of Startup Inc, would that effectively mean the founder couldn’t exercise majority control of Startup Inc?
What are the consequences of an arrangement like this?
Interesting and complicate question.
In the eyes of investors, particularly Angel Investors, the Team is probably the most important part of any startup. In your configuration, the Startup Inc. would have no team, it would be merely a project in the Holding Labs portfolio. A project that, depending on Holding Labs’ other projects, will receive attention and resources from Holding Labs, or not.
Also, the person of the Founder holds great importance in every startup. A Founder is someone with the passion and the view to make things happen. A startup with no clear Founder figure might just fall into the complicated aspects of “ownerless” projects so common in big companies. Maybe will even turn out to work as a department, with all the down sides of internal politics and else. Eric Ries in his “Lean Startup” (the current Tech StartUp Bible IMHO) addresses internal structure issues, and clearly states that hierarchy is an energy and resources drain that should be avoided at all costs in a startup, which, almost by definition, does not have resources to spare.
Even worse would be to use resources invested in Startup Inc. as resources for Holding Labs. That would be a huge red flag for investors. Not illegal, but most investment contracts will clearly state that all the money invested must be used to grow the company they invested in. Growing another company, especially the owner is a definitive no-no. There is a huge conflict of interest in this configuration, which will surely damage the investors.
I do not consider Startup Inc. to be a good investment target for investors, but Holding Labs might be! Holding Labs will have the team, and the team will be used 100% of the time to grow the best project that Holding Labs has at any particular time. As such, the conflict I described earlier won’t exist.
Now as for the control question. If Founder A controls Holding Labs and Holding Labs controls Startup Inc., as seems to be the case on your question, then Founder A has indirect control of Startup, Inc. He has control, nonetheless.
Think it like this: Founder A has control of Holding Labs. As such he can force Holdings Labs to do whatever he wishes (lets consider that there are no agreement, by-laws, legal or articles of incorporation restrictions). Then he can force Holding Labs to vote as he wishes. But given that Holding Labs’ vote controls Startup, Inc. (again considering no restrictions), then Founder A can define how Holding Labs will conduct Startup, Inc.’s businesses and, as such, holds control of Startup Inc. itself.
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