NOTE: This is the fifth post in our series about standard terms in early stage equity financings. These posts refer to the model Series A Term Sheet put out by the National Venture Capital Association (NVCA) and available for download here.

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Voting Rights and Protective Provisions define when investors vote with the other stockholders and when they have the right to a separate vote. Having separate voting rights in certain circumstances is important to investors because it prevents them from being outvoted by other stockholders with competing interests. The circumstances in which investors have the right to a separate vote will typically include at least (a) significant corporate events (ex. a sale of the company) and (b) actions that could adversely affect the rights of the investors (ex. amending the corporate Charter or changing the composition of the Board of Directors2). Sometimes more company-specific protective provisions will be included, such as the sale of a specific division of the company’s business. Note that the scope of the protective provisions should be commensurate with the size of the investment, so angel investors should not necessarily have the right to a separate vote on actions that typically require a separate vote by a VC investor, such as taking on debt or changing the size of the Board of Directors.

Most of the time you should not expend any energy fretting over the protective provisions, but do watch out for two things. First, make sure the percentage required to approve any action subject to the protective provisions is not so high as to make obtaining approval burdensome. Typically the threshold should be high enough so that approval of the lead investor(s) is always necessary, but not so high that a minor investor has a block. This becomes ever more important as the number of investors grows. Second, be sure the protective provisions don’t unduly inhibit the company’s freedom of action by requiring stockholder approval for routine matters. The Protective Provisions should protect the investors, not give them an additional means of controlling the company. If the investors are seeking a stockholder vote for day-to-day decisions, suggest instead that such decisions be made by the Board including the director(s) appointed by the investors. For a discussion of matters that typically require approval of the investors’ director(s), see this post.

This entry was posted on Friday, July 2nd, 2010 at 3:14 pm and is filed under Anatomy of a Term Sheet, Financing, Legal Basics. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.