Demystifying the VC term sheet: Board control

(Editor’s note: Scott Edward Walker is the founder and CEO of Walker Corporate Law Group, PLLC, a law firm specializing in the representation of entrepreneurs. He submitted this column to VentureBeat.)

As I’ve explored some of the more confusing terminology of VC term sheets, I have received a number of questions regarding the composition of the Board of Directors – specifically who should control the Board following a Series A financing.

Controling the board, of course, means controling the corporation. Thus, the composition of the Board is an important and sensitive issue to founders.  Sadly, we’ve all heard the horror stories of founders being “fired” from the company they founded.

It has traditionally been rare for the founders to control the Board following a Series A financing (despite the fact that Series A investors do not generally acquire a majority stake in the venture).  Sometimes the investors push to control the Board, but this is relatively uncommon as well.  Instead, there is typically a “compromise” in which neither the investors nor the founders technically control the Board.

Thus, in a five-member Board, two directors would be appointed by the investors, two would be appointed by the founders and one director would be independent (jointly appointed by the other directors).  Similarly, in a three-member Board (which is more common these days), one director would be appointed by the investors, one would be appointed by the founders and there one be one independent.

However, the pendulum has recently swung dramatically in the founders’ favor (particularly in the Bay area), giving the founders extraordinary negotiating leverage with investors if they have a “hot” startup.  One area where founders have exercised such leverage is in connection with Board composition.

As Paul Graham, co-founder of Y Combinator, recently wrote: “Founders retaining control after a series A is clearly heard-of. And barring financial catastrophe, I think in the coming year it will become the norm.”

Accordingly, if you have the leverage, push hard to maintain control of your Board post-closing.  The entrepreneur-friendly VCs know what’s happening in the marketplace and are likely to capitulate and agree to a provision in the term sheet akin to the following:

“Immediately following the Closing, the Board shall consist of three members.  Holders of a majority of the Series A Preferred shall be entitled to elect one member, which member shall be designated by [Investor A], [who initially shall be __________].   Holders of a majority of the Common Stock shall be entitled to elect one member, which member shall initially be __________ [the Company’s Founder].  Holders of the Preferred Stock and Common Stock, voting as a single class on an as-converted basis, shall elect the remaining director.”

It would also be prudent for the founders to require the investors to actually name their representative on the Board – to avoid a situation where some unknown junior staffer takes the seat (as opposed to the heavyweight partner who can clearly add value).

As I’ve said many times: all terms are negotiable – no matter what anyone tells you.

(Miss previous installments in this ongoing series? Click to learn more about the following issues:)

• dividends
• price-based anti-dilution provisions
• exploding term sheets and no shop provisions
• valuation
• liquidation preferences
• stock options

Startup owners: Got a legal question about your business? Submit it in the comments below or email Scott directly. It could end up in an upcoming “Ask the Attorney” column.

Disclaimer: This “Ask the Attorney” post discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  VentureBeat, the author and the author’s firm expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.