Anatomy of a Termsheet 5 — Voting Rights

Welcome back to the fifth installment of my series on the Anatomy of a Term Sheet. In this series, I am going through the model term sheet provided by the National Venture Capital Association, which you can find here.

In previous posts, I discussed provisions such as pre-money valuation, the option pool issue, dividend terms, and the liquidation preference. Today we are going to look at voting rights.    

Here is what the sample voting rights term looks like:

The Series A Preferred shall vote together with the Common Stock on an as-converted basis, and not as a separate class, except 

(i) [so long as [insert fixed number, or %, or “any”] shares of Series A Preferred are outstanding,] the Series A Preferred as a class shall be entitled to elect [_______] [(_)] members of the Board (the “Series A Directors”), and 

(ii) as required by law.  

The Company’s Certificate of Incorporation will provide that the number of authorized shares of Common Stock may be increased or decreased with the approval of a majority of the Preferred and Common Stock, voting together as a single class, and without a separate class vote by the Common Stock.

There are a few things going on with this term. First, it gives the Series A investors, which hold preferred stock, the ability to vote alongside common stockholders, as if their preferred shares had been converted to common stock. In addition, the Series A investors have the power to elect one or more directors, giving them an important voice in the management of the startup. Investors are naturally going to want control of the board, even if they don’t hold a majority of the stock on an as-converted basis, to protect their substantial investment. This is a negotiation point. It is still possible for the founders to maintain board control if other factors are at play, for example if the startup is particularly hot and there is more than one VC fund eager to invest. A possible fallback that might be acceptable for both sides is for the founders and investors to each select an equal number of board members, and for those existing board members to then choose an additional member. For example, if there is a five-person board, the founders and investors each choose two directors, and those four directors choose a fifth.

Finally, there is a provision that the number of authorized shares can be changed only by a majority vote of the preferred stockholders and the common stockholders voting together as a class. It takes away the right of the common stockholders to vote separately as a class on changing the authorized number of shares. Note that if the company is incorporated in California, it cannot opt out of the statutory requirement that the common stockholders vote separately as a class to authorize shares of common stock. If the company is incorporated in Delaware, on the other hand, it can opt out from the separate class vote requirement under Delaware General Corporation Law Section 242(b)(2), and this clause in the Term Sheet exercises that opt-out right.

Thanks for reading, and I hope this has been informative. Next time, we look at protective provisions.

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