Demystifying the VC term sheet: Protective Provisions by Scott Edward Walker

  • Source link: https://venturebeat.com/2011/03/28/demystifying-the-vc-term-sheet-protective-provisions/
  • TL;DR: Defines what protective provisions are, gives examples of standard and non-standard provisions, and gives some advice regarding their negotiation
  • How helpful?: 5/5
  • Topic Tags: protective provisions, term sheets, negotiations
  • Relevant questions addressed:
  • What are protective provisions?
  • What are some examples?
  • Summary bullet points
  • Protective provisions: grant investors right to veto or block certain corporate actions
    • Even if BoD authorizes such an action, would need certain % of preferred stockholder approval
    • This is supposed to protect investors from majority stockholders

Standard protective provisions: The following protective provisions are viewed as pretty standard and non-controversial (and are actually the provisions agreed-to in FourSquare’s Series B financing led by Andreessen Horowitz):

  • A sale of the company or other “Liquidation Event”
  • Any amendment to the company’s Certificate of Incorporation or Bylaws so as to alter or change the powers, preferences or special rights of the shares of Preferred Stock so as to affect them adversely
  • Any increase or decrease (other than by conversion) in the total number of authorized shares of Preferred Stock or Common Stock
  • The authorization or issuance of any equity security having a preference over, or being on a parity with, any series of Preferred Stock with respect to dividends, liquidation or redemption
  • The redemption or purchase of shares of Preferred Stock or Common Stock (subject to certain exceptions)
  • Any declaration or payment of any dividends or any other distribution on account of any shares of Preferred Stock or Common Stock
  • Any change in the authorized number of directors of the company.

Non-standard/Controversial protective provisions: Beyond the usual provisions, some investors will push for additional items, such as the following:

  • Any hiring, firing or change in the compensation of any executive officers
  • The entering into any transaction with any director, executive or employee of the Company
  • Any incurrence of indebtedness in excess of $[100,000]
  • Any change in the principal business of the company or the entering into any new line of business
  • Any purchase of a material amount of assets of another entity.

Founders should push back on these – and should be able to knock most (if not all) of them out if they have strong negotiating leverage.

  • There should be a minimum % (25% for example) of the original preferred stock remaining in order for the protective provisions to apply
    • This is so that you don’t have one guy holding one preferred stock getting to trigger all of the protective provisions
  • Also watch out for high voting thresholds (66% is a good number)

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