What should the composition of the board be like and how are the board seats allocated?
November 27, 2007
Investors in venture financings almost always demand representation on the board of directors. In a VC-led Series A financing, there are typically three or five directors immediately after the financing. As a practical matter, smaller size boards are easier to manage (i.e. scheduling board meetings for larger boards is extremely difficult; meetings seem to go faster when there are less people in the room whose opinions needs to be heard).
If there is one lead investor, then there are typically three directors, consisting of one Series A investor designee, one common designee (typically the founder/CEO) and one independent person (approved by the investor and the common stockholders or the common designee). The independent seat will oftentimes be left vacant at closing, with the intention of filling the seat sometime after closing.
If there are two lead investors, there there are typically five directors, consisting of two Series A investor designees (one from each investor), one common designee, the CEO (which will be a seat elected by the common stockholders) and one independent person.
In later rounds of financing, investors in the later rounds will also inevitably demand a board seat, which results in larger boards dominated by investor representatives. Investors in later rounds will sometimes request that investors in previous rounds relinquish their board seat to limit the size of the board. These early investors are typically given board observation rights, which allow them to attend and participate in board meetings, but not have an official vote in board decisions.
For the entrepreneur’s point of view on the subject, please read the Venture Hacks articles “Create a board that reflects the ownership of the company” and “Make a new board seat for a new CEO,” along with Dick Costolo’s post on “Early Stage Board of Directors.”
In some financings, especially non-VC led Series A financings, the board composition can simply be a closing condition to a financing with no other mechanism to guarantee a certain board composition. In such case, the composition of the board in future elections typically defaults to one vote per share (preferred converted to common basis) and may be favorable to the common stockholders as they typically control a majority of the outstanding shares.
In most venture financings, however, the board composition is set forth in the certificate of incorporation (i.e. common may elect one board member, Series A may elect one board member and the common and preferred voting together may elect all other board members). A voting agreement among the common and preferred stockholders forces the stockholders to vote in favor of director nominees selected in a certain manner (i.e. all of the Series A stockholders agree to vote in favor of the nominee from VC Fund X for the Series A seat).
In my experience, it seems like founders are overly concerned about board composition compared to other provisions in a term sheet. At the end of the day, most founders typically don’t control the board after a VC-led financing, as the investors won’t allow a situation where the common stockholders have significant control or veto power. As a practical matter, investors will typically end up with a significant amount of control due to the protective provisions and the drag-along provision, aside from board composition.