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Pitfalls of FOAK Capital Stack

Writer: Emin AskerovEmin Askerov

🌊In the days of the Genoa Republic, a startup would not be about building cutting-edge tech in the comfort of your lab -  it was about buckling on a cutlass and setting sail into treacherous seas. Back then, the stakes were a bit different—storms, pirates, and illness meant the risk wasn’t just financial but often life-threatening. Yet, the Genoans were legendary seamen, known for their innovations and dominance on the waves. What’s fascinating is how they structured their ventures, particularly their capital stack.


💰Here’s how it worked: wealthy Genoans who didn’t fancy risking their lives at sea—let’s call them the investors—would fund the ships, crews, and cargo. The captains—the founders—had no money but were willing to brave the seas for a share of the profits. The deal? A 50/50 split of the profits between investors and the captain. This arrangement gave captains every incentive to make the voyage a success. With skin in the game and control over the journey, it’s no wonder Genoa ruled the seas for seven centuries, innovating everything from brutal fencing to denim.


👨🏼‍💻Fast forward to the 21st century, and you’ll find that raising money for your FOAK (First-of-a-Kind) project can feel like navigating those same stormy seas. But unlike the Genoan investors, many modern-day investors balk at the idea of a 50/50 split. In one case I witnessed with an electric car platform startup, an investor insisted on taking 100% ownership because the founding team wasn’t contributing capital—just their expertise and sweat equity. Spoiler: this story doesn’t have a happy ending. But we’ll come back to that. 


So, what should you watch out for when building your FOAK capital stack? Let’s break it down:


🚫 Don’t Dilute Too Much

Planet A’s "Building and Scaling Climate Hardware Playbook" offers sensible advice here: don’t dilute too much. But how much is too much? In episode 6 of my podcast, WattsUpWithStartups, I talked with Duke Oh, the founder of JR Energy Solution. Duke’s startup, a classic hardware cleantech, built a factory capable of producing 500 MWh of lithium-ion electrodes annually. But Duke couldn’t prevent his investors from diluting his share too much, leading to management challenges and a severe drop in motivation.


My take? Aim to keep a controlling stake of 50%+1 share. This is crucial if you have one or two major investors holding more than 25%, giving them a blocking stake. With a simple majority, you can push through key decisions. Remember, after your FOAK, you’re not done with equity funding—you’ll likely need to dilute further. If you drop to 25% or less post-FOAK, your share will dwindle even more when building NOAKs (Nth-of-a-Kind projects), leaving you with little control and motivation.


🚷 Watch Out for Non-Operating Founders

Non-operating founders—advisors, counselors, and other part-timers—can contribute to your success, but they shouldn’t hold too much equity. Planet A suggests keeping their stakes below 5%. If they already own more than that, implement buy-back or dilution clauses to regain control. 


👑 Concentrate Decision-Making Authority

A capital stack that’s too diffused among many small investors is just as dangerous as one dominated by a single large investor. Too many small investors lead to confusion, slow decisions, and muddy governance. On the flip side, if one investor holds a majority, their opinion will outweigh everyone else’s, effectively making them the sole owner.


To avoid these pitfalls:

- Keep any single investor’s share under 20%, especially in the early stages. Don’t let them accumulate a blocking stake of 25%+.

- Pool smaller investors’ decision-making rights to streamline processes. This is where a good lawyer can be invaluable.

- Beware of exclusive rights like vetoes, golden shares, or rights of first refusal. These can undermine your control—avoid them at all costs.


🚩 Worst-Case Scenario

Back to that electric car platform startup. The original inventor, eager to get the project off the ground, conceded to the investor’s demands, handing over 100% ownership. The founder is now just an employee, drawing a paycheck instead of sharing in the success. It’s like agreeing to navigate stormy, pirate-infested waters—not for half the profit, but for a meal.


🧭 Need Guidance?

If you’re navigating the tricky waters of building your FOAK capital stack, reach out. I can help you secure the necessary funds while ensuring you retain the decision-making power you need to steer your venture to success. 🌊🚀


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© Emin Askerov, 2023.

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