Investor voting rights

Hi startup nation!

This is officially our last newsletter before summer. While we do hope you’ll get some well-deserved rest, we’re also here to give you some light food for thought to pair nicely with drinks on a beach. Today, we’re going to talk about POWER - voting power, to be specific. Read on to see how a typical term sheet deals with investor voting rights.

What are voting rights provisions?

We already know that investors typically own preferred shares while founders own common shares. When it comes to voting, investors generally vote on an “as-converted basis” - which simply means that their preferred shares count as common shares. It also means that on most matters, investors don’t have more power than founders.

But there are certain decisions that investors insist on approving because they are so essential to the value of their investments. In practice, a term sheet includes a list of these decisions under “reserved matters” and says (typically) that a majority of preferred shareholders (i.e. investors) has to approve these.

In the US, reserved matters include things like:

• changing the terms of the preferred stock,
• changing the authorized number of shares,
• authorizing a new series of preferred stock with the same or better rights,
• stock buy backs,
• dividend payouts,
• changing the board size,
• company liquidation, dissolution or change of control, or
• changing the company bylaws.

Important note for all the Czech or Slovak founders out there: the list of reserved matters local investors require tends to be more extensive. That’s why it’s double worth it to read that section in detail.

Why does this matter?

The distribution of voting rights between founders and investors is crucial. While it’s absolutely justified for investors to ask for approval rights over decisions that could negatively impact the value of their investments, the founders should make sure they keep control of the strategic direction of the company. In the end, it’s all a balancing exercise that requires looking at the voting rights provision in detail and assessing its impact on the company’s future.

Dos & dont’s

So, what are the dos & dont’s here:

Dos:

• assess the impact of reserved matters on your ability to run the company
• make sure reserved matters don’t block future fundraising
• exclude standard business operations from reserved matters

Don'ts:

• extend the scope of reserved matter beyond what directly impacts the value of investment
• give investors too much say over compensation structure (yes to general framework, no to individual amounts)
• let investors decide on strategic direction of the company

In a nutshell

The voting rights provision may not be the most glorious, but it’s definitely one of the most impactful. Once again, it’s about striking a balance. Investors will want to ensure their investment is not adversely affected by company decisions. Founders will need to protect their ability to steer the company in the direction they want.

Want to chat about voting rights or other investment-related topics??Reach out to our team?for personalized advice and stay connected with us on?LinkedIn?for more insights.

Bye for now!