Transcript

You Can't Fire a VC From Your Board: Here's Why | Wilson Sonsini Startup Legal Basics

0:06 Alright, everybody. Welcome back. Startup basics. Yes, that's right. This is where we spend just 10, 20, 30 minutes going over a basic concept. But you need To run your startup.

0:18 There's tons of blocking and tackling in finance, in AI. in customer acquisition and sales and Hm. Most of all legal. So if you want to see all the past episodes across all the different topics. This week in startups dot com slash

0:33 You guessed it. Basics. Today we're gonna continue. Today we will continue our legal basic series with My lawyer, Becky DeGras. From Wilson, Cincinnati, Goodrich and Rosani. We call them WSGR.

0:45 Here in the valley. Wilson, Wilson Cincini. The full name W S G R Should I know like what the right thing to say is or is it up to me and how I feel? However you feel, it's perfectly fine. Uh but Wilson Cincinnati is is good enough or a WSGR. I don't think I'd ever go through the full name Saturday. Yeah, but yeah. I noticed DeGras not up there yet. I guess for another year or two and keep working and uh yeah, yeah, sure. This is a seriously multi-decade.

1:18 Firm um And you and I have been doing this for a while. Today we've got some really important things to discuss. Board composure is something that founders get very animated about, very concerned about. And then some VC firms. Or extremely

1:37 Mm. Heavy handed, sharp elbowed. persistent About board seats and then others are like we don't ever want to take a board seat.

1:48 So Well, let's talk about what a board seat is, why an investor actually takes them. We'll go into independent. And then we'll also talk about observers, but What's the role of the board in my

2:01 seed or series A company. Let's start with that. So the board sets the strategic vision for the company. So think at the highest level. It manages the affairs of the company. All the day to day operational stuff that gets delegated down to the officers, but the really important stuff.

2:18 That's at the board level. So whoever you're adding to the board, you really want to make sure that you're aligned on what the future path is for the company. Now we all know startups can pivot, so that may change, but The best that you can. Make sure you like this person and you are aligned on today's vision. and that they're a thoughter in terms of where the company might go. The other thing I'll note about the board is

2:41 it has to approve certain material acts in order for them to be valid. So Any issuance of any security, so any stock. I don't care if you want to issue one share. It has to be board approved. Option. Yes. Any financing. That includes safes, convertible notes, preferred stock, bank debt, any anything.

3:01 MA transactions, certainly. Material contracts and one that's also Near and dear to all of our founders' hearts, hiring and firing. The C EO. So The board has a lot of control. Like that's it's it's a it's it's a very powerful

3:17 uh unit when you are looking at add it. In the early stages, you have some investors. Everybody's got an opinion on boards, of course. This is Silicon Valley and the technology industry. Um Some folks are like Don't do a board.

3:33 But push it off as far as you can. Other folks are like, We need to get going on You know, six board meetings a year. Ten board meetings a year. And I I have always fallen into Hey, series A, you're gonna have to have a board.

3:47 Before you have product market fit, you're probably not gonna have one. So there's something between those two moments in time. Typically you raise over a couple of million dollars or you start making over a coup coup couple of million dollars. You might want a board to help you structure it and see what's around the corner. So I tell folks

4:04 Hey, add up how much you've raised. Look at how much you're making. And you've probably never heard my speech on this, but Hey, if that number is greater than two or three million. Maybe a board, just one board member, one attorney, the two founders, just getting together.

4:19 And F formalizing some stuff. Would be in your best interest, and you start learning. So then when the series A investor comes along, hey, there might have been three board meetings, there might be three board decks, and there might be some resolutions that make them feel more comfortable. That's my philosophy. What's your philosophy? When do you advise your um founders.

4:39 that you're working with to start board meetings. Ideally at the beginning stages, it's just the founder or founders that are initially on the board. And if you have multiple founders, it doesn't mean that every single one of them has to be on the board either. uh there's a bit of a negotiation that goes into that and who should be the right folks. But one of the things that that's super important is you don't need to add five people to your board on day one, just like what you're saying.

5:05 Because you think it's gonna help the company look better. Um in fact, if you do that You've just lost control of your own company. They're gonna be making the decisions for you. And even if we don't have board meetings. There's board actions that we need to take, right? You're probably gonna be hiring some folks and we wanna issue option grants to them. We do that. We can do it by a a written consent instead of having to do a meeting, but it is still a board act.

5:29 If we do it by written consent, every single investor, or mean sorry, every single uh director. Past a sign. That Written in order for it to be a valid act. So

5:40 If you do it at a meeting, it's a majority, but Oftentimes in those early days we're not having meetings, to your point. Once a company does a preferred stock financing round, that is when we often see An investor say. Hey, I'm leading this round, I'm writing a sizable check.

5:57 I want somebody for my team to be represented on the board. I want to see all this stuff and have a voice in. and things that are going going on with the company at that level. So I would expect to see, you know, a preferred uh director come in and at that seed or A stage. when it's a preferred stock round. If you're doing a safe financing. I wouldn't expect there to be um talk of whoever the lead investor is in the safe to say

6:21 I want a director. It usually counts the time of that that price round. Yes, and so convertibles Safes, those things occur, small amounts of money. The investors own basis points or low single digits.

6:35 They don't have enough skin in the game. They probably don't want to be on the board if they do. It's like why? But when they get to ten percent ownership, twenty percent ownership, in my experience, they say, You know what? probably should have a board seat here to represent You know that

6:49 ten, fifteen, or twenty percent of the cap table. That's where I seem to, you know. over the last ten years see it start happening. Am I directionally correct? Yep, absolutely. I think I think that's I think that's exactly right. Okay. Investors were writing a bigger check.

7:04 And they want some oversight to go along with their investment. They want to know Somebody's paying attention and and watching things um they have produce your duties to their LPs as well that they need to to fulfill. So that's often when we do do see that. Um

7:22 Prefer director start to come in. But I would say At that seed A stage. the common directors, the founders would still control the board. It's usually you know, we start to move to what I would call a a balanced board.

7:36 you know, maybe around the series B at that point. Maybe there's two common directors, there's two preferred directors. And maybe we start thinking about adding an independent director around that time as well. Okay, so I'm in my seed stage. The boards, me and my co founder. My attorney shows up.

7:53 Okay, now I'm at my series A. My series A investor joins the board. Two founders, one series A. I get to my series B. I'm adding that investor who's putting in ten million, twenty million. And then we're at an even number.

8:08 Which Doesn't take a genius to figure out you could have a tie. And then you put an independent on. How is the independent most often selected? by the board. Who gets to pick the independent because I've seen

8:22 situations where the series B ambassador or Series A ambassador says, Oh, got the most independent board member you ever met. And then you get that board member on, and magically they're always aligned with that series investor because they were in the same frat. They both worked at Bane. And uh their families go on vacation together for the last seven years. And doesn't there's not much independent in the independent director. So let's talk about that. The independent director. Yeah. So the independent director, we

8:47 Try to say when you're adding somebody at that stage, have it be an industry expert. Like Where do you need the most help? Where are you at? at the point in your your company, right? If you are like I'm struggling with with getting access to

9:01 this particular set of folks and that's what's gonna allow me to to scale to the next level. somebody who's well connected with that or really knows that space. that's probably a really valuable person to bring on at that point. Um We do see sometimes that there are relationships that happen around the board.

9:22 Oftentimes we do the w the way that the independent director is selected, at least What goes in the legal documents. It usually is common on one side preferred on the other. So maybe it's common, you get to designate it.

9:37 But if you designate them, I get to preferred it has to be acceptable to the rest of the board members. Um or vice versa. Or start over. So you bring in your brother or your mom or your fraternity brother. They say, Wait a second, your Surrari sisters joining the board doesn't make sense. So they can essentially have a veto.

9:57 But if you say, Hey, we need somebody, we're Airbnb and B, be great to have somebody who knows hospitality. Oh, okay. We've we've got Paris Hilton here and she's from the Hilton family. Let's get Paris Hilton on the board. And everybody's like, Okay, sounds great. And she knows hotels and she certainly knows marketing and Everybody approves.

10:16 The founder selected. the uh in the the investors approve The independents on the board. What do you give an independent board director? Uh, what's the range of compensation for them? Uh Hunter Biden got like uh a hundred thousand dollars a month and a couple million dollars a year. I'm assuming that's the standard. Maybe not.

10:36 For this stage of a company. Yeah you know, and and what directors get in private companies at this stage is also very different than what directors get pre-IPO or public company directors. I would say most times we're not even talking about cash consideration. Until we get to that.

10:55 Really late stage. pre-IPO, maybe right before pre-IPO. Depending on you know, how how big of a hot shot or that you're breaking in, you may need something like that to lure them. But oftentimes it's just equity.

11:09 Um, and if it's equity, it's usually besting monthly over a period of two years. And maybe it's something in over the course of the the two or four year period, maybe it's something around, you know, 0.51%. It's it's Yeah, maybe a little more than what you might give an advisor. Um, but um

11:30 Something in that range is. Pretty reasonable. Yeah. You can actually look it up to see what somebody at one of the largest companies in the world, say Apple, gets paid. A hundred K, two hundred K in cash. Maybe uh it seems like they're standardized on two hundred fifty thousand dollars in stock awards.

11:47 And they might get a little bonus for being on the uh audit committee of you know fifty thousand dollars. So you're looking at a total comp of about four hundred thousand dollars, and that's probably a four year term, five year term, something like that. So that's the highest end. Here at your startup. twenty five basis points, fifty basis points over Four years of service, two years of service, something in that range.

12:09 Yeah. Do sometimes the board members ask for their travel and expenses to be paid? And then what's your take on that at an early stage startup? Is a maybe a negative signal? No I would say most do. Um. Okay. Most do. Um Th these Cs are are mixed. Um as to whether they will ask for it.

12:28 Um I've never seen a VCS to be put up in the four seasons. Wow. That's I mean they won they may not ask for four Cs, but they may ask for Uh you want me to you want me to fly out, uh I would like you to pay for my And and you know, the company will have a travel policy.

12:47 And Usually it'll be okay, well Yes, as long as you follow this travel policy, which may not necessarily be a Live flat. See. Let's yeah.

12:56 Exactly. It's gonna get a little expensive these days. Fuels expensive for some reason. Um Let's talk about the difference between A board member. And a board observer. Yes.

13:07 So this is really important. I get this question a lot. Your board of directors is what we've been talking about so far. They are actually on your board. They are a director. They have voting power.

13:20 So, you know, they get to vote on every action that's presented to the board. A director also has fiduciary duties. that it owes to the company. So when that director is making a decision and saying, Yes, I want to vote for it, or no, I don't want to, To vote for this. Just because that director says, Oh

13:39 I actually I don't like this. This is not gonna be good for my fund or That's not gonna be good for me personally. But if it's in the best interest of the company and its stockholders, if you're exercising your fiduciary duties, you've got to say. Fine, I approve it. That does not exist.

13:56 At the observer level. Okay, so the so an observer doesn't have either one of those. An observer does not have voting power, does not have fiduciary duties. What they have is a right to be invited. I want to be invited to the party and that's about it. Right. They can attend the board meeting. They can receive the board materials.

14:12 They get to sit there, they get to observe. Now does that mean that they can't talk? No, they can talk, but um, and some board observers are very vocal. Um, and may even that the other direct that the actual directors

14:26 may go when it comes time for a vote. But ultimately that board observer themselves, they do not have a vote on the matter. Yeah, pretty sure a duty point I would just emphasize on on the board observer side. Make sure you're getting

14:40 A board observer provision or letter in place. 'Cause otherwise you don't have confidentiality. You don't have other things that you already have what's built into the fiduciary duty. component of being a director. But they can expect hear all the same stuff. So it is important that they are

14:57 are uh bound to the to similar confidentiality provision. And from the other side of the table. Um, I have moved a lot since our firm has really started to investing and having a large portfolio. I've even had board seats where I've said, You know what? We're okay dropping down to a board observer if that's what you like. I'm gonna send an associate, I'm gonna send a you know uh a an analyst.

15:18 Yeah, they don't even have to have their camera on. They're gonna you know, they may ask you a question, but I kind of instruct them to take notes. And I'm really looking for two things. Like how is the firm Doing. Where are they going?

15:31 And when's the next financing or corporate, you know, major corporate activity. If I just know those things. Because when you're not on the board very you know, for the angel investors listening or for for seed funds. When you're not on the board, you get this weird phone call. Hey. We've raised our series A. And you're like, Okay. And they're like, Yeah, you need to sign in the next twenty four hours. And you're like, uh what's happening here? And they're like

15:51 Everything's changed. You're the last person who didn't sign. You don't want us to succeed. You need to sign right now. And it's like Wait a second, I need to read the documents. I gotta call my attorney. So there's a little game that gets played of like, hey, we've everything's agreed and now you're the blocker, and it's like Wait a second, but you're issuing like fifty percent more shares? Like that's not okay with me. I'm not signing. And I've gotten into this a whole bunch in the past where shenanigans sometimes ensue. And when I say a lot of times, like count on one hand times in six hundred investments, but

16:20 It is so much easier. To just be a board observer. Mm. Chef's kiss. They try I'm just

16:28 that the company's profitable or running out of money or racing around Like DM me on Slack, hit me up on Signal, send me a i message. Just that's all I care about from the board. Like, are they in trouble and they need my help? Yeah.

16:44 Is there a great opportunity here? Are they selling? Like sometimes we get told about a sale and like what's the process? It's like Oh yeah, I know six months ago we ran a process and I'm like, Oh, I know the CEO of that company. I I could have called them. And they say, Oh yeah, no, we picked this terrible company that's giving us common shares and we're all getting washed out. Ah, so frustrating. Um so How do you remove a director?

17:07 And under what circumstances can you Legally. But then pragmatically. So let's say, you know, for Acme Ventures. I hope there's no Acme Ventures out there, because I say Acme Ventures aren't our dogs all the time. If there is, I apologize. There is? Okay.

17:23 Acme Beta Delta Ventures. Can't be an ABD Ventures. Acme Beta Delta Ventures. If they Send somebody to be on the board and that person's I don't know just kills the vibes. The founders don't like them. They're too pessimistic. They're annoying. They show up late. They call in from a

17:42 Cab on the way to the You know, and they got a big speech they're gonna give and they're breaking up on the phone man, that was my favorite from early in my career the same. VC would call in from a car on the way to the airport and then wanted to everybody to hear a speech. How do you how do you appro Practically.

17:59 And legally. Two different things. Remove a director. Yeah, this is this is a question I get a lot and it's usually not when things are going well. It's it's when we're already in it and we're like How this is not working.

18:13 I want. I want out. Um I will often compare preferred directors to

18:19 Like anybody that you add to your board, right? We've talked about how important it is. Like it's like a marriage. Like before you get into it, do your diligence, make sure you're in line, do they want kids? All that stuff, right? You don't want to talk about. Do you want a second home or are you okay with going to a hotel? Which is it? How is that that's a big one. Same vacation every summer or we or different. Uh but but get it all out there. The big difference With marriage?

18:48 And Prefer directors. In a marriage you can say, Man, this is not working out. I'm out. I unilaterally. can can can remove myself from the situation.

18:59 Mm. That's not the case for preferred directors. Unless they are willing to go and they agree to go. can do as a common holder to do it. I'll tell you why so

19:12 Directors are elected by Stockholders. They're removed by stockholders. The way that we set up the board and a venture backed company is to specify that certain classes or series of stock are entitled to elect certain seats.

19:27 So what this means is we're gonna say Hey, you've got two common states. Which means those two seats are elected by common the majority of the outstanding common stock, whatever you say. That's who's gonna set in those seats. When we had a series A

19:43 Uh investment come in and the direct and the lead investor says, I want a director. We create a series A preferred stock seat. Which is only elected by You guessed it.

19:56 Series A preferred stock. Yes. So you can hold super voting stock. You can have Your common shares a hundred votes per share. And The preferred will have one vote per share.

20:08 Guess what? Your common shares don't vote. So you can't vote to remove That's it. On top of that, what gets negotiated in these referred stock financing documents is that the lead investor will negotiate to say,

20:21 I have designation rights with respect to that seat, so long as I continue to hold Fill in a blank is usually twenty five to fifty percent of the shares that I'm purchasing. And everybody else has to vote this way. We're dragged along. We ensure that's the case by putting in place a voting agreement. All the common stockholders, all the preferred stockholders, you're gonna be partying this voting agreement.

20:44 When lead investor says, I want John Doe to sit in my seat. Everybody. Has to vote in favor. Uh. Mm.

20:51 Oh there's just No way of getting around. Yeah. Um That

20:57 Early stage investor says Okay, you've you've you've had a grown up conversation with them, you've explained that the alignment isn't there, that I'm going in a different direction and won't you please step off? Or it may be You're a series D E company and the board is getting really lopsided. You're getting some later stage VCs that do want to join the board and they're the ones that are actually supporting the company to be able to get to that next stage. And maybe this early stage investor. They're out of funds. This isn't really the space that they play in. Maybe they aren't as valuable as they once were. And your family and like, I've got 10 people on my board. I need to get rid of somebody.

21:35 Yeah. Practically. It's having a conversation. Trying to Get folks to come to the same

21:43 place of what's best for the company. And Hey, you still have your investment in the company, you want it to continue to grow. This is the direction. Can be amicably. And so if you best advice for a founder. Is

21:59 Hey, build that relationship fabric. Go for a walk along the embark. Barcadero with your board member, invite them to come out a day early and have lunch with you and visit the management team. If they're leaving the next day, I had one. F founder who would always insist on driving me back to the airport and we'd have a conversation there. Sometimes we'd sit in the car for twenty minutes. You know, waiting for my my my uh plane to board.

22:22 You invest in those relationships so that later on when you need to have hard discussions, you know, a little bit of um Sugar helps the medicine go down, doesn't it? Yeah. That's right. When you started saying you're gonna take a walk along the embarkader, I thought you were taking my marriage analogy a little too far, but yeah. We gotta go for a walk, honey. We're going down the end of the period. It gets very dark. Yeah. Okay. No, it's I I I do find that the People let things You know, these are very important relationships. They don't invest in them.

22:56 Mm. when things get hard and and this is, you know, back to dating or marriage. If you guys have had a you know strong marriage And then something happens that's difficult. Somebody gets sick, God forbid, or whatever, you have a challenging child, whatever it happens to be, at least you have that relationship fabric to you know, as your foundation. So build that foundation if you're a founder. If you're an investor.

23:17 Be a good person. Be good person. That's it. Pretty simple. Be a good party. Doesn't mean you have to give up your board seat. In those situations I'll say, you know what? Um I don't want to be at the party. If I if people don't want me at the party, I I'll just move to an observer. And uh that's usually my concession. Like you if I'm not valuable, the good news is I've become increasingly valuable in my career because I work hard.

23:37 And then people are like Do we not want Jake to come to the board meeting? That would be kinda dope for him to be at the board meeting and he's also fun. So If you're uh it sounds crazy, but you've been up boards where there are some people who are just miserable. And then there are some people who are like positive and like you leave the board meeting feeling like hey, even though there's some challenges here. Hey, we're in it together, esprit de corps, and you know, we we c we can solve these problems. I think that is something board directors

24:04 you know, sometimes miss in their mission. Like you you're not here to be the most abrasive person in the world, you're here to be constructive. I mean this I mean criticism can't happen, but random legal question, Becky. Okay. Is it plaid? Or pleaded.

24:20 If somebody pled guilty Or did have they pleaded guilty? I keep seeing this coming up. Everybody's pleading and pledging and I don't know What's the right word? Do you know?

24:31 I don't know. I don't d I don't deal with the I don't get for it. I don't know. Prepararis as pled. He doesn't like when he sees pleaded. So he says plead. Uh all right. Becky DeGras Wilson Cincini. Go to Startup Basics at this week in Startups dot com slash basics. We'll see you next time.