Seed Fundraising — Term Sheet Problems Part 2 — Boardroom Blues

Most term sheets have a section defining a new structure for your company’s Board. While the board can’t influence the day-to-day operations, they govern who does. It’s imperative you understand how the new board will work and most importantly, who has control.

Board Seats

What it is: This is the core structure of your company’s board. The ideal layout at the seed stage is 2 founders and 1 investor (usually the lead investor). However, some term sheets may define the board as 1 investor, 1 founder and 1 independent board member.

How it hurts: If the majority of board seats are not controlled by the founders, then you risk losing control of the company. In the example above of 1 founders, 1 independent and 1 investor, the board can fire you and your co-founders if the relationship breaks down.

Board Voting Rights

What it is: An investor with special voting rights has more weight to their vote than their equity stake. For example, “All board approvals require a yes vote by a majority of the Preferred Stockholders”, would allow your preferred stockholders (investors) to block decisions made by a majority of the board.

How it hurts: Very similar to the issue of board control, if a majority of the voting rights are not with the founders, you can lose control of the company or miss opportunities. A common example of this is investors blocking a favorable acquisition because they prefer you keep pushing for higher returns in the future.

Board Decisions

What it is: This is when the board is required to approve certain types of company decisions including strategic, fundraising, or vendor selection. For example, “All contracts over $10k/year must be approved by the Board”.

How it Hurts: Having to approve low-level decisions with the board can slow your progress significantly. For example, if you’re trying to select a new cloud server provider to cut costs but require the Board’s approval, the process could take months; reducing your options to save money at a critical time.

CEO Board Seat

What it is: In this case, the CEO of the company will always have a board seat, whether or not they’re a founder or have a significant equity stake. For example, “The board shall consist of the current CEO, 1 common stock, 2 preferred stock, and 1 independent appointee”.

How it Hurts: A CEO seat can cause the founders to lose control of the company. In the example above, if the founding CEO resigns or is fired, and the new incoming CEO is not a cofounder; then the founders will have just 1 seat on a board of 5. You can avoid this issue by insisting on 2 common stock appointees, rather than a named seat for the CEO. This ensures you get the ideal 5-person structure of 2 common stock, 2 preferred stock and 1 independent appointee.

Getting your board’s structure right can help avoid large headaches later. Understanding Board dynamics before signing an agreement will make it easier to focus on building the most successful business.

In Part 3 of Term Sheet Problems, we will discuss side letters.

This article is part of a series on Seed Fundraising.

1. When to Raise Money
2. How to Build a Deck
3. VCs vs. Seed Funds vs. Angels
4. How to Get a Meeting
5. How to Request an Introduction
6. How to Get Early Momentum
7. How to make a Good Pitch Great
8. The 5 Most Common Pitch Mistakes
9. Meeting Requirements
10. The Basics of Meetings
11. How to Handle an Angel Investor Meeting
12. Know these Numbers for your VC Meeting
13. 4 Investor Gotcha Questions
14. How to Follow-Up After an Investor Meeting
15. How to Close the Lead Investor
16. The 4 Stages of a VC Process
17. How to Raise a $2 Million Seed Round
18. Go from Investor YES to Cash in Hand
19. When Investors Say Yes but Mean No
20. When and When Not to Use an Investors Name
21. Stop Making These Common Fundraising Mistakes
22. How to Avoid Bad Terms that Kill Startups
23. What to do After Receiving a Term Sheet
24. Term Sheet Problems Part 1 — Money Talks
25. Term Sheet Problems Part 2 — Boardroom Blues
26. Term Sheet Problems Part 3 — Side Letters
27. 10 Traits of Successful Founders

Sterling Road invests in pre-seed B2B startups based in North America. Full process here: sterlingroad.com/process.

You can reach me here: ash@sterlingroad.com

Thanks to Kaego Rust, Alec Barrett-Wilsdon and David Smooke for their help on this article.
Photo by Benjamin Child