After several years of hard work, a client has gained so much traction that venture capitalists – on their own initiative – are asking to make an investment. When the first term sheet arrived, however, the founder / CEO was disappointed – the valuation was fine, but his ability to make significant decisions would be curtailed. I pointed out: If you accept venture capital, you will lose control of your company.
The loss of control does not result from a change in voting power: The VC will own a minority of the corporation’s shares and will control a minority of the seats on the board of directors.
Rather, the loss of control results from protective covenants, which specify that certain actions cannot be taken without the VC’s approval. Examples include:
- Authorizing or issuing additional shares
- Taking on debt outside the normal course of business
- Amending the articles / certificate of incorporation or bylaws
- Changing the number of directors
- Paying dividends
- Redeeming shares
- Entering into a merger or acquisition
- Liquidating the company or selling assets
In other words, the VC can veto any action that might alter the VC’s financial position or change the structure of the corporation.
If you are looking to achieve explosive growth, venture capital may be the right way to go – but be aware of what you will have to give up.
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Dana H. Shultz, Attorney at Law +1 510 547-0545 dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.