Investors holding Preferred Stock typically can elect one or more directors on the Company’s Board of Directors. Those who they elect are called “Preferred Directors.” These Investors can negotiate which board decisions require those Preferred Directors’ approval. The terms set out the required number of Preferred Director votes, from one to unanimous, before the Company is allowed to continue. This typically applies to larger decisions that could affect the Company at a very high level and doesn’t apply to ordinary course operational decisions.
- The term sheet gives several examples of what decisions companies cannot make without Preferred Directors’ approval. A few examples in the term sheet include:
The Company can’t give a loan/advance or own stock/security of another entity that is not wholly owned by the Company;
- The Company can’t promise to owe someone or something money except if it involves trade accounts;
- The Company can’t fire, hire, or change compensation of Company executives (including make option grants); and
- The Company can’t do anything outside of the ordinary course of business regarding the Company’s technology and IP.
- Term Sheet Language: So long as the holders of Series A Preferred are entitled to elect a Director, the Company will not, without Board approval, which approval must include the affirmative vote of [at least one/each of] the then-seated Preferred Directors: (i) make any loan or advance to, or own any stock or other securities of, any subsidiary or other corporation, partnership, or other entity unless it is wholly owned by the Company; (ii) make any loan or advance to any person, including, any employee or director, except advances and similar expenditures in the ordinary course of business [or under the terms of an employee stock or option plan approved by the Board of Directors]; (iii) guarantee any indebtedness except for trade accounts of the Company or any subsidiary arising in the ordinary course of business; [(iv) make any investment inconsistent with any investment policy approved by the Board of Directors]; (v) incur any aggregate indebtedness in excess of $[_____] that is not already included in a Board-approved budget, other than trade credit incurred in the ordinary course of business; (vi) hire, fire, or change the compensation of the executive officers, including approving any option grants; (vii) change the principal business of the Company, enter new lines of business, or exit the current line of business; (viii) sell, assign, license, pledge or encumber material technology or intellectual property, other than licenses granted in the ordinary course of business; or (ix) enter into any corporate strategic relationship involving the payment contribution or assignment by the Company or to the Company of assets greater than [$________].]