This post is the nineteenth in a series giving practical advice to startups with respect to understanding and negotiating a venture capital term sheet.
In the prior eighteen posts, we provided an introduction to negotiation of the term sheet and discussed binding and non-binding provisions and discussed valuation, cap tables, and the price per share, dividends on preferred stock, liquidation preferences, the conversion rights and features of preferred stock, voting rights and investor protection provisions, anti-dilution provisions, anti-dilution carve-outs and “pay to play” provisions, redemption rights, registration rights, management and information rights, preemptive rights, drag-along rights, representations and warranties, rights of first refusal and co-sale, closing conditions and expenses, non-competition and non-solicitation agreements, and non-disclosure and developments agreements. In this post, we will discuss board matters.
The NVCA model term sheet (available here) groups a number of terms under the umbrella of the “Investor’s Rights Agreement,” the title of which is fairly self-explanatory. This is an agreement between the company, the venture capital investor, and perhaps certain key stockholders that sets forth certain rights the venture capital investor expects to accompany its investment in the company, including registration rights, management and information rights, the right to participate in future rounds to maintain its percentage ownership, and the right to have the investor-appointed director approve certain matters. Another minor set of investor rights this agreement generally includes is categorized in the model term sheet as “board matters.”
The first term under this category is an optional one: each committee of the board of directors of the company must include at least one director appointed by the venture capital investor. Companies generally don’t institute board committees until the board expands to more than a few directors, but if the size of the board justifies committees, such as audit and compensation committees, a venture capital investor will want to have the management rights afforded by appointing a director to each.
The second term in the category provides that the board will meet at least monthly or quarterly unless a majority of directors otherwise agree by vote. Early stage companies often overlook conducting these meetings on a regular basis, at which certain corporate actions should be approved, such as the appointment of officers. A venture capital investor will want to ensure that these meetings take place regularly.
The third term provides that the company will procure directors and officers liability insurance (called “D&O insurance”) with a carrier and in an amount satisfactory to the board. D&O insurance covers directors’ and officers’ legal fees, settlements, and other costs if they are personally sued by stockholders, employees, competitors, suppliers, customers, or others. Even before a venture capital investment is contemplated, the company’s directors and officers may have demanded this coverage as a condition to serving in those roles, to protect their personal assets. If this coverage is not in place, the venture capital investor will demand it.
Finally, the term sheet provides that the company will enter into an indemnification agreement with each director appointed by the venture capital investor that is acceptable to the director. Some venture capital investors will request that the venture capital fund itself also be party to the agreement in addition to the director appointed by it, for additional protection. While the corporate statutes that govern a company permit indemnification of directors, they do not require it, so directors want companies to provide for mandatory indemnification in certain circumstances and perhaps more favorable terms than those outlined in the relevant statute. The company’s certificate of incorporation or bylaws can include mandatory and permissive director indemnification, but directors prefer a separate indemnification agreement because it cannot be amended without the approval of the directors being indemnified.
All of these terms are typical and would not be negotiated at the term sheet stage. The venture capital investor will see these as essential to protecting its investment, and none should be objectionable to the company or its founders, as long as any D&O insurance and director indemnification applies equally to the directors not appointed by the venture capital investor.
In the next post, we’ll discuss founder’s stock.
© 2015 Casey W. Riggs — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.