Term Sheet (7) Protective Provision|How Investors Prevent Founders from Doing Adverse Actions?

Venture Capital Terms and Conditions for Founders to Read and Understand Term Sheet by Themselves ~ I'm Xiaoxiao Liu, a U.S. lawyer.

Protective Provisions may be abstract when you look at the literal meaning of the term, but it may actually be easier to understand from another perspective, which is the right to veto.

The following are common examples of Protective Provisions in Term Sheets.

In fact, there are usually more than ten or twenty protective clauses, and the ones I've listed here are just the most common and typical ones.

Protective clauses are usually the focus of Term Sheet negotiation. Entrepreneurs of course want fewer and fewer protective clauses from investors, but investors definitely want more and more protective clauses.

1. Why is the right of veto so important?

Of all the Venture Capital Terms, these four are the primary ones that reflect control:

a. Board seats:

Through this article, find a representative in each major stakeholder, and require each board member to serve the interests of the company as a whole, and not simply serve their own type of equity. A good example of this is Northman Technology, where Hong Qigong, the GP of Beggar's Capital, the most important director of Northman Technology, once made such a difficult entanglement process. Hong Qigong optimistic about Huang Rong, will beat the dog stick method taught to Huang Rong, and will be beggars gang leader status passed to Huang Rong. In fact, if out of selfishness, Hong Qigong can persuade Huang Rong with Guo Jing to join the Beggar's Association, the Beggar's Association development and growth, which is Hong Qigong as the capital of the Beggar's Association GP maximize the interests of the decision. However, Hong Qi Gong still attaches great importance to the fiduciary duty (fiduciary duty) as the director of Northman Technology, to the big picture of Northman Technology, let Huang Rong (CFO & COO) to assist Jing (CEO & CTO), first to Northman Technology's Huashandaq listing dream is completed, Huang Rong's freedom of wealth, retired from work, then come back to comprehensively help the development of beggar's capital.

b. Shareholder votes:

Preferred shares are voted in accordance with the corresponding number of common shares. There is no more to be said on this point.

c. Class votes:

A majority of the preferred shares and a majority of the common shares are required to approve a major issue. Common Stockholder and Preferred Stockholder shall be entitled to vote, each as a seperate class. co-founder Huang Rong's joining of Northman Technology actually reflects this. Northman Technology has always had this seperate class voting system, that is to say, although at the beginning of the founder's shares alone can be counted more than half of the shares, but it does not mean that everything is the founder's say, but the founder and the investor side of the two sides of the majority respectively. Angel round of time, angel investors Genghis Khan want to let Princess Hua Zhen as a co-founder to join, obviously do not support Huang Rong to join, although Guo Jing side of the common stock has been more than 50% of the company's total stock, but also can not make decisions directly to let Huang Rong as a co-founder to join. To the A round of Jiangnan seven monsters is also not support, B round of the whole real capital is also not support, until the C round of the beggar capital to join, with some things change, A round of Jiangnan seven monsters and B round of the whole real capital of the idea has also changed, so it is led to preferred shares this side of the co-founder of Huang Rong to join the thing over half. In this way, Guo Jing's common shares and the preferred shares of the four rounds of investors each exceeded half, which led to the success of co-founder Huang Rong to join Northman Technology.

d. Protective provisions:

Preferred stock can be used to veto certain matters, and some companies even have their own protective provisions for each round of investors. That's what we're going to talk about in this issue.

2. The content of the veto

When an investor enters a company, especially in the early rounds, the investor only occupies one or two shares of the company, which is insignificant compared to the founder's shares, so he or she has no say at all in the company's major decisions, in which case the veto power is particularly important. It prevents the founder from making major unfavorable decisions, such as:

a. selling the company to the founder's cronies for $1, sweeping the preferred shares under the rug. Yang Kang, the founder of Wanyan AI, colluded with Wanyan Honglie's five masters in the royal family after he got the A round of financing from Quanzhen Capital, and sold the whole company to Peng Lianhu and Sha Tongtian in a low-priced way, so that Qiu Qi, the founder of Quanzhen Capital, was bought out for no apparent reason, and with a veto, Qiu Qi could have perfectly prevented this plot.

b. the founder to 10 million dollars to let the company buy back some of their shares, and then their own live a leisurely good life. We all know the three siblings of Iron Palm Energy, Qiu Zhuan, Qiu Qian Ren and Qiu Qian Ruler, among them, Qiu Qian Ruler chose love and gave up his career, and left the company before the cliff of vesting schedule arrived, so Iron Palm Energy is the two brothers, Qiu Zhuan and Qiu Qian Ren, as the founders. And one of the older brothers, Qiu Zhangu, impersonates his younger brother, Qiu Qianren, every day. One day, posing as his brother, he signed a share buyback agreement with himself in the name of Iron Palm Energy, and Iron Palm Energy bought back Qiu Qian Ren's shares for $10 million. If Shangguan Jiannan, the investor, were still alive, he would have had to exercise his veto power to stop the deal.

c. the company issued a huge amount of shares to the founders, diluting the proportion of preferred shares to close to zero. We all know that this beggar's gang is divided into two factions, one is Elder Peng on behalf of the Pure Clothes School, one is Elder Lu on behalf of the Dirty Clothes School. Originally, the Beggar's Association, are dirty clothes, but the people of the net clothes faction at this time played some small mind, coincidentally, Yang Kang in the village of Oxfordshire Qu Lingfeng's tavern picked up Huang Rong's lost dog stick, the net clothes faction would like to take the opportunity to support Yang Kang, and so on, Yang Kang became the gang leader, then you can let Yang Kang to increase the huge amount of shares to the net clothes faction, so that the proportion of equity of dirty clothes faction is close to zero. Then at this time, minority shareholders are especially important if they have veto power.

3. Exercise threshold

You will notice that there is a threshold in the first sentence of the veto, as in the example sentence "2/3 of the preferred shares outstanding", why is there such a threshold?

The Seven Monsters of Jiangnan, as the Series A investors of Northman Technology, were seven at the beginning, but after Zhang Ah Sheng, the Laughing Maitreya, was killed by Chen Xuanfeng, there were only six left. Then later in the Peach Blossom Accelerator ran into GP Ouyang Feng, who was pretending to be Huang Yushu, and Yang Kang, the founder of Wanyan AI, who was desperately seeking an injection of capital from West Poison Capital at that time when the capital chain was broken, and after a melee, the Seven Monsters of Jiangnan were left with Ke Zhenqi alone. Then only 1/7 of the outstanding Series A preferred shares are left, and the Seven Monsters of Jiangnan in Northman Technology has obviously become unhealthy. It would be unreasonable to continue to maintain the veto power of Jiangnan Seven Monsters at this time. So it is still very necessary to set such an exercise threshold.

The founders certainly hope that this threshold is as high as possible, in practice, the more common is 50% or 66.7%. That is to say, half or two-thirds of the investors of a certain round of investors are still in the case, in order to give this round of investors a certain privilege, if the round of investors themselves do not have a lot of strength left, the power will also be cut accordingly.

Here is the Venture Capital Terms and Conditions, so that founders can read the Term Sheet by themselves ~ I'm Liu Xiaoxiao, a U.S. lawyer, and I'll see you in the next issue.