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Investors may negotiate a board seat on the company’s board of directors.
When a startup forms a board of directors, the primary role of the board is to make key strategic and operational decisions for the company. The board typically holds regular three- to four-hour board meetings. These are often held quarterly or every six weeks; when a company is young they could be held monthly. In these meetings, the board discusses progress, goals, challenges, key hires, and all sorts of operational issues. A board meeting is used to align the operations with the interests of the investors and founders. While board meetings are often viewed as a tool for investor oversight, they are very much also about founders seeking the board’s counsel and advice.
Definition A board observer is an individual who participates in a company’s board meetings as though they were a board member, except that they are not permitted a formal vote and do not have the same level of responsibility to the company as full board members.*Venture capital funds like to ask for board observer seats in order to weigh in on matters of importance to them and show more inexperienced investors the ropes of how board meetings work. Some investors will negotiate for a board observer seat in addition to a full board seat, while others may negotiate only for one of these.** Although they are non-voting, board observers can have considerable influence on startups because they are present during board discussions.*
caution Granting board observer seats can be a dangerous and slippery slope. Board observer seats can be used as an indirect control mechanism. Though they are non-voting, board observers sit through the entire board meeting, participate in discussion, and have access to all board materials. Board observers change the dynamic of a board meeting by weighing in with thoughts and opinions. If your board is only three people and you grant a board observer seat to one of your investors, 50% of the room will now represent your investors’ firm and their interests. Finally, once you grant one firm a board observer seat, future investors will not only ask for observer seats as well, but many will insist you grant them one. All board observers are legally obligated to behave in accordance with confidentiality agreements, but they may be more likely than more senior investors to share board materials with outside parties in violation of these agreements. If a board observer behaves badly, they should not be allowed back, but you may not always know when something has been leaked.
It’s important to realize that boards of directors increase in size over a company’s life. When you’re first incorporating, your board can range from one to three people, but you want to keep it small. It may seem fair to have all three (or more) co-founders on the board, but it can be hard to ask your co-founder to step off the board later. Many startup boards can be as small as three people all the way through a Series A (two co-founders, or one co-founder and an outside board member, and a Series A investor). Boards of directors in general, including public boards, range from 3 to 31 members, with an average size of 9.* Boards are almost always an odd number in order to avoid tie votes. It’s worth noting that the state of California requires public companies to have at least one woman* on their boards.
important While not all pre-seed or seed-stage investors will take a board seat, many early-stage founders find it helpful to create a board of directors or hold board meetings and have one of their largest investors attend regularly. Without regular board meetings, it’s easy for founding teams to fall prey to groupthink, shrugging off valid criticism. Holding regular board meetings also helps early-stage teams get in a regular rhythm of setting objectives, making decisions, and reflecting on outcomes, which can help prepare founders for leading the company as it grows into a team with executives and a formal board of directors.
Definition An information rights provision in a term sheet outlines the information a company must deliver to investors beyond what state law requires.* Generally, this includes a commitment to deliver regular financial statements and a budget to investors. A term sheet’s information rights typically terminates in the event of an IPO and often gives investors access to the company’s facilities and personnel.*
While the default reporting period is quarterly, investors may ask for financial statements on a monthly basis early in a company’s life. Many companies elect to provide monthly financials to major investors for a long time.
Founders have a wide range of opinions about transparency. Some founders won’t mind sending every investor their financial statements monthly, and others will be less comfortable sharing information with too many people. Sending your financial statements to each different investor when they request it can become burdensome, and founders should consider how comfortable they are with their financial statements being in the hands of a large number of investors. If you do grant information rights to investors below your major investor threshold, make sure you aren’t committing to providing two different sets of documents on two different schedules to different investors after you raise a further round of funding.
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