VC and Angel Contracts: Why Over-Optimistic Entrepreneurs Lose Control of Their Companies - (Series
Board Control in a Venture Backed Company
Over the last couple of posts I have described a common scenario wherein an entrepreneur loses control of her company because of several factors. In this post I will be discussing the Board of Directors. Investors know that appointment to the board of directors is critical in terms of control. A venture capitalist's control over a start-up's board of directors is a critical source of its governance powers. Founders rarely keep control of the board after an initial venture investment.
“The traditional series A board consisted of two founders, two VCs, and one independent member. More recently the recipe is often one founder, one VC, and one independent. In either case the founders lose their majority.”
Venture capitalists in most instances negotiate outright control of the board typically through a voting majority, and sometimes through explicit contractual agreements.** Although the board does not usually run the day-to-day affairs of a company, it does have the power and responsibility of managing the corporation. This includes control of the entrepreneur or founder. VCs will exercise this control by selecting the officers who will actually manage the corporation and replacing them when they deem necessary.
Venture capitalist’s control over the board is closely coupled with the contractual provisions that are the subject of the next post and when exercised allow VCs to terminate the founder and to decide when to sell the company.
This article was written by Curtis Roberts, the founder of The Founder's Attorney.
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.
*Paul Graham, Founder Control, (Dec 2010) http://www.paulgraham.com/control.html.
**See Thomas Hellmann, The Allocation of Control Rights in Venture Capital Contracts, 29 RAND J. Econ. 57, 58 (1998) (stating that venture capitalists “hold effective control over the board, ”