Series A — Investor Stops & Controls
The term sheet not only contains confusing business terms but also contains certain mechanism that give investor “stop” rights in the startup.
Investors usually take a board seat in a series A company. A board seat allows for control and protection of the Series A investment. For example, terms that are negotiated by the parties is the scope of approval rights of the Series A director. The term sheet may give the board director the right to approve hiring and firing of key staff, approve budgets or stock option plan grants or creation of additional debts. This might be importance to VCs that are operational and want to review and approve key business decisions.
Protective provisions give effective veto rights to investors as shareholders for certain actions. For example, issuance of new securities, adoption of compensation, charter amendments and board structure. These are standard provisions although they can vary from a short laundry list to an extensive litany of “NOs”. Again, founders should not negotiate these provisions, because these are standards.
Employment and Vesting
Term sheets will require that all founders and employees be on vesting and execute standard Silicon Valley employment agreements. Vesting is a mechanism that reduces percentage of ownership in the company if the founder stops working or behave badly. Vesting aligns interest of founder and investors. A standard venture capital employment agreement contains restrictions on co-sale, ip assignment and non-compete provisions (if outside of California) and non-solicit clauses. These clauses are negotiated by founders and series A investors within certain logical parameters.
Series A investors not only get “stop” rights, but also information rights to effectively control the company. Information rights are usually given to lead investors. Typical information rights require information about sales, revenue, break evens, P&L, operations, sales and marketing. The scope of information rights is negotiable and savvy investors and founders find a common ground.