Ask the Wizard

I’ve had a few questions recently from folks who have received first round financing term sheets in which the proposed board makeup seems over the top, from my perspective. Here is a composite (sorry, “mashup”) of the kind of first round term sheet language for Board participation I recently heard from different founders:

One CEO seat (currently founder X), two Series A investor seats, and and independent nominated by the Series A and approved by the board.

This is silly. A more cynical wizard (who would look like me but say “hmm” a lot more) might interpret this as early investors trying to take control of the company immediately. Can you spot the three things we don’t like about this proposed board structure?

First, “one CEO seat (currently founder X)”. That’s nice, founder X gets a board seat. How long does founder X have a board seat? Only as long as (s)he is the CEO. New CEO, new board member and out with founder X. No more founder board seats. Let’s move on to the other troubles before we re-draft the entire proposal.

Problemo numero dos, “Two Series A seats”. Um, I don’t get why the first round investors should get two seats. If the Series A is all being done by one institution, then this is particularly annoying, but even in the case of a syndicate, the series A investors should have a single representative on the board. “But but but”, you say. “Wait wait wait”, you say. “What if you really appreciate the input of two particular members of a syndicated financing?” Excellent point; the proposed board structure might include a board seat for the lead investor on the round, and board observation rights for one or more members of the syndicate.

Finally, and particularly the way this proposed board is structured, watch out for the wording on “an independent seat nominated by the Series A and approved by the board.” In this case, the Series A investor obviously controls the independent seat completely. This entrepreneur’s post-A round board, if accepted, is going to have 3 people representing the Series A and one CEO, who may or may not be the founder six months from now. This is, in legal parlance, “sucky”. If this is one investor doing the round, note that we might also raise our eyebrows and wonder why the institution’s partners have so much free time that two of them can take board seats in the same company.

Here’s a more straightforward Series A board structure: “One founder seat, one Series A seat, and an independent nominated by the founder and approved by unanimous consent of the board”. If you’re a multi-founder company, then I might change this to: “One founder seat (founder X), one CEO seat (currently held by founder Y), one Series A seat, and one independent nominated by the CEO and approved by unanimous consent of the board”. Frankly, you could keep it even more basic in the latter multi-founder case and just go with founder/founder & ceo/series A, but I personally enjoyed having an independent board member once we’d added one ourselves, and I think it’s helpful to get this person in sooner rather than later.

In the multi-founder case, when you do a 2nd round financing and you can keep the same general structure, you still have a nicely balanced board: something like two people from founder/management, two investors, and an independent. From here you can do things like layer in more independents as you grow, etc.

Rational investors are comfortable with these sorts of structures, and in fact, in our series B negotiation at FeedBurner, it was the investors who countered with “founder seat and ceo seat currently held by founder” when we originally redlined the first term sheet with two founder seats. This is a perfectly reasonable compromise in most cases and provides the investors with some security that a “renegade founder group” can’t hold management and investors hostage, while giving a strong founder group some assurance they will have significant and balanced participation in the board. There is no reason a founder should feel obligated to cede control of the company to a single investor on an early financing.