Reading: Corporate Governance Provisions

The board of directors plays a crucial role in the governance of a company, as many decision rights lie with the board of directors. Representation on the board is therefore important for investors who want to protect their interests.

This is why term sheets usually include clauses that grant the investors a predefined number of board seats. A typical term sheet provision looks like this:

Board of Directors:
 
The size of the Company’s Board of Directors shall be set at [X]. At each meeting for the election of directors, the holders of the Series A Preferred, voting as a separate class, shall be entitled to elect [Y] member[s] of the Company’s Board of Directors which director shall be designated by Investor, the holders of Common Stock, voting as a separate class, shall be entitled to elect [Z] member[s], and the remaining directors will be [Option 1: mutually agreed upon by the Common and Preferred, voting together as a single class.] [ or Option 2: chosen by the mutual consent of the Board of Directors].

The typical board size of a new venture is 5 [X above]. Different term sheets allocate these seats differently between the founders, the investors, and independent members. In one frequently observed structure:

• Preferred stockholders are entitled to 2 seats [Y above];
• the common stockholders also receive 2 seats [Z above];
• and the remaining seat will be given to an "independent" director, who is acceptable to the shareholders [Option 1 above] or the other board members [Option 2 above]

An alternative popular structure is:

• Preferred stockholders are entitled to 2 seats;
• Common stockholders elect 1 representative;
• Preferred and Common vote together on an as-converted basis to elect the remaining two seats
  • One outsider recommended by the founders and acceptable to the investors
  • One additional outside director acceptable to the board.

Such board structures help to balance the power between the investors and the entrepreneurs.