A commonplace among emerging companies is the need to promise investors seats on the board of directors. For a lot of different reasons, it makes sense to make this promise. It is usually a condition to receiving the investor’s capital, so there’s that. But also a board is supposed to be generally representative of the company’s stockholders and sophisticated investors bring valuable experience and important perspective to the boardroom. Choosing the right board members is an important step in the growth of any company.
From a legal perspective, how do you effectively promise your investor a board seat? This may seem like a simple task; it would not take much brain damage to include a clause in any contract that says, “Investor shall have a seat on the board.” Unfortunately, the topic is deceptively simple and such a clause is insufficient. A board is a mechanism, created by statute and subject to a charter and bylaws, designed to govern the company and give stockholders the ability to change the company’s governance if desired.
A contractual clause between the company and investor promising the investor a board seat does not, in and of itself, accomplish the necessary steps of (1) creating the board seat, (2) appointing the investor to the board seat, and (3) binding the stockholders to vote in favor of appointing the investor to the board seat. Absent accomplishing all 3 of these steps in the right manner, a company runs the risk of having board actions invalidated, the investor crying foul when the board seat is proven to be ineffectively granted, or the stockholders voting the investor off the board. In order to promise the investor the board seat in the right way, you should take care to:
1. Validly create the board seat and appoint the investor to fill the board seat. Depending on the company’s existing charter and bylaws, this may be accomplished by either amending the company’s charter and/or bylaws or by board resolution.
2. Bind the company’s existing stockholders to vote in favor of the investor’s election to the board. This is usually accomplished by a voting agreement signed by the stockholders collectively holding the necessary number of outstanding shares of each relevant class or series of the company’s capital stock. As you create and sell additional classes or series of capital stock, you should also take care to determine whether new stockholders should sign the voting agreement.
In the rush to acquire capital, it can be difficult to remember that promises made to an investor do not always translate nicely into binding agreements that work with your existing capital structure and voting rights. Promising investors board seats can be a necessary, and wise, step in the growth of your company, and it can be easily accomplished if done the right way.
For more practical advice on the topic, see Susan Schreter’s article “How to Organize a High-Powered Board of Directors“.
As startup lawyers, we often receive inquiries from passionate entrepreneurs and founders seeking guidance on when they should consider taking their side projects to the next step by forming a legal entity. Forming a company is a “crossing the Rubicon” moment for any startup. It’s an essential step…
Given this week’s headlines, many emerging companies may be asking themselves: “Why am I holding so much cash?” The Investment Company Act of 1940 (the 1940 Act) may be to blame. “But I don’t have any intention of being an investment company. Aren’t those mutual funds or…
In the three days since federal authorities announced sweeping measures to protect depositors of Silicon Valley Bank (SVB) and Signature Bank and help prevent additional bank failures (as discussed in our update of March 12, 2023), the U.S. banking system appears to have stabilized, at least temporarily.…