Venture Deals Part 4: Board Control, Protective Provisions, Drag-Along Rights

Hi, welcome to Part 4 in Dr.Miles Aron’s series on the book Venture Deals. Here we focus on the control-related terms in term sheets that investors send to founders.

This includes board seats, protective provisions, drag-along provisions, and a discussion about how you can structure your board and negotiate the control terms of venture deals for success.

It is the intention to provide zero-cost access to information about the art, the science, and the history of venture building.

Transcripts (the following transcripts are auto-generated and may have typos or inaccuracies):

all right producer Brian what do you uh

what do you think so far of all this

stuff we’ve been learning about VC deals

and everything yeah it’s it’s really

funny I I feel like I kind of know a lot

of these terms and different verbiage

from from the gaming World a lot of the

Nerds really or even terms like you know

cats and pay to play and and different

things that just kind of connect from

funny ways all right you hear that

Gamers it’s time to learn about Venture

deals let’s go arcanium

welcome to a production by Dr Miles

Aaron

[Music]

CEO and co-founder at Arcadian Ventures

what are you building

[Music]

please comment below

don’t forget to subscribe subscribe

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all right welcome back so we’re going to

conclude this series

um intro on to getting into Venture

deals

um with a conversation around the

control related terms on term sheets so

we talked about the economic terms now

let’s talk about control

oftentimes economics aren’t the only

thing that investors are interested in

they might try to get board seats they

may try to exert control over how you

run the company and it’s important when

you get into these deals to know what

you’re getting into well many things

you’ll see on the term sheet are dead

standard and don’t require any

negotiation the issue of control over

your company is so critical that you

really should consider negotiating some

of these terms if they’re not aligned

with what you want but first you have to

understand what they mean so it’s very

common for when you raise around for

there to be a lead investor and if

anything that’s become completely

standard nowadays so one investor is

going to take the lead that person is or

entity is going to invest the most and

then generally you’re going to have a

party of other smaller investors that

are saying hey miles or hey founder if

you can get this lead then we’ll hop in

and write a smaller check and get you up

to the full amount you want to raise so

you can close the round

um oftentimes that lead investor will be

the one who says I want a board seat now

typically your follow-on investors at

least in early stage are not all going

to get board seats the last thing you

want to do is be an extremely early

stage company with 15 people around the

table that you have to manage you’d

rather just have the founders and your

lead investor in there

it’s also common

um for there to be a negotiation around

what you might call outside directors

um or even advise a board of advisors

that may come in that have you know way

less Equity but might still have some

impact on the control of the company

um so you may want to consider who are

these outside directors is it someone

from the VC firm is it someone reputable

in the industry do you have a good

relationship with them because

um even if they don’t have a strong

voting control

around the board if they’re going to be

in those meetings they could sway the

conversation in a different direction

and affect the outcome for your company

so at the early stage you may have a

smaller board it might consider a be

composed of the founder

um and a second co-founder if they’re

both on the board and then you’ll

typically have that first lead investor

and maybe one outside board member that

could be another founder it could also

be someone from The Venture Capital firm

as the company grows you’ll expand that

that board and you’ll often have two VCS

or even three VCS on the board maybe

you’ll add a second outside board member

so you’re already starting to see more

people around the table at those Board

of director meetings the other way that

VCS will exert some control over your

company in these term sheet negotiations

is through what’s called protective

provisions and so those protective

Provisions

um basically

will exert some control or restrictions

on what you can do to change the

um the outcome for the investors and

require you to get

um permission from them so in other

words it gives those investors veto

rights over certain actions you would

take to manage your company

those actions may include things like

changing the number of stocks issuing

new stocks changing the size of the

board so adding a new board member it

could be borrowing money it could be

selling the company it could be buying

back common stock changing the terms of

the stock that the VCS received

declaring bankruptcy changing the

certificate of incorporations or the

corporate bylaws which are used to

dictate how the governance of that board

and the company Works licensing or

selling intellectual property or taking

on

um going into the crypto side doing an

initial coin offering or some other form

of crypto token that could impact what

happens in a liquidity event for that

company the other thing to be aware of

is drag along Provisions so sometimes

you might have a case where drag along

Provisions are not necessarily a bad

thing they just simplify what’s going on

other times they could be

um quite annoying so it’s good to be

aware of how they’re going to impact you

as a shareholder whether you’re a

founder or an investor so the drag along

right basically says that if a certain

investor is voting or a majority of

shareholders are voting in a certain

direction that they’re going to drag

along or basically force all the the

other investors to vote along with them

so that you don’t necessarily need to

get their consent to move forward with

that action

common example of drag along would be

for example if a Founder leaves the

company

you don’t really want to have to go back

to that founder and ask their permission

on every little thing you want to do

through the board so often you’ll just

say Okay this founder is leaving they

agree that all of their common shares

will vote along with the other founder

or along with the majority of the board

one case where the protective provisions

and the drag alongs can kind of play in

your favor is if

um

there’s a motion to sell the company

maybe some people do want to sell the

company some people don’t on the board

um and maybe the founder is being given

a price that they feel like is is not

ideal so as a negotiation tactic they

can actually lean on their investors and

if they’re all aligned that investor can

block the sale veto the sale and give

the founder another opportunity to go

back and say Hey you know my investors

aren’t willing to sell at this price we

have to come up so it can actually work

in the founders favor but of course

there are cases where maybe the founder

doesn’t want to sell because they

believe in the direction of the company

even if the price is maybe lower than it

is but the investors have more control

over your board and they’re able to go

ahead and push through a sale that maybe

you don’t want to have happen so even if

you get the economics you want out of

the the term sheet it’s important to

know who has control and in what cases

this is going to impact your outcome if

you find yourself in a negotiation

around the drag along rights one thing

you can do is push for the drag along

Provisions to to

go toward the common share so it gives

the founders a little more power instead

of saying that the drag along is going

to follow the preferred shares which is

um the shares that are owned by the

investors so if you’re going to have a

drag along you might as well have all

the founders on the same page since

these are the people who built the

company who are running the company who

probably do have a major majority

um

stake in the company and its future as

you get closer to IPO if you’re a later

Stage Company and you’re looking to go

public well first of all congrats to you

you’re probably about to make a lot of

money we can all hope and hopefully your

company has brought an incredible value

to the world and everyone’s excited to

see it

um Stock Exchange

um but there has been a history of IPOs

kind of failing because of these

protective Provisions where certain VCS

may look to block that IPO because they

don’t think it’s in their best interest

at the time so that would be a case

where

um you want to be careful about who has

control going in and you may consider

the different classes of shares involved

so you have your your common shares your

preferred shares at an IPO you’re

generally going to get everyone to

convert to Common and if an investor is

looking at that and saying actually you

know my preference is is better if I

don’t convert so I’d rather you not IPO

then that could be a problem for you in

getting to this Monumental liquidity

event in your journey as a Founder so if

you want to learn more about this

there’s so much more interesting

information and details in the Venture

deals book linked Below in the

description if you’ve had any run-ins

with these terms in your term sheets

please leave a comment let us know did

you have control taken for from you in a

way you didn’t like were you able to

negotiate better terms do you have

advice for better terms of course we’re

all here to learn and learn together and

learn in public so let’s get that

conversation going and I’m I’m curious

to see what you’ve all seen along your

journey all right tune in next time bye

all