A board of directors, often simply referred to as “the board,” has the highest level of legal authority in the operation of a company. It is responsible for making important corporate decisions, such as budgets, option plans and declaring dividends. The board also decides on the exit paths for a startup as it approves the company’s plan on mergers or IPOs. Furthermore, it has the power to fire the CEO. The board is considered the most powerful element in a company’s management structure. Under state law, a board must be put in place when the company is incorporated. Most seed stage companies will have a small board consisting of only the founders (and less than a handful of employees).
For smaller rounds, investors may not ask for a board seat. But for more significant rounds, the rule of thumb is generally that the lead investor for each round will take a board seat.
Under the board in the Series Seed term sheet, there are three items to be negotiated, which includes the number of directors to be elected by (i) a majority of common stock, (ii) a majority of the Series Seed investors and (iii) mutual consent. The negotiation outcome of this clause indicates the balance of the composition in the board.
Historically, it was common for the board to be composed exclusively of the founders until Series A. However, as the size of seed rounds have increased, it’s become more common for investors to request a seat on the board. Simply put, if they are cutting a big check of more than $1 million, for instance, they want some control. For smaller seed rounds, it’s common to not give investors any board seats.
If you have a round that is large enough, then you want to ensure you have a balanced board. A typical structure is:
- one founder (elected by a majority of common stock),
- one representative from the investors (elected by a majority of Series Seed investor), and
- one independent director. The independent director should be mutually agreed between the founders and the investors.
The goal is to maintain a proper balance in the board. The independent director represents an outside representation who should not be a major investor or executive in the company. Independent directors are usually experienced personnel from relevant industries the company participates in. The independent directors are expected to help the company with networking and provide insights to the board on major trends in the industry. They are an important source of impartial opinions in the board, and they can help resolve conflicts that arise between founders and investors.
In the Series Seed term sheet, the participation right is as follows:
Board of Directors: [___] directors elected by holders of a majority of common stock, [__] elected by holders of a majority of Series Seed and [___] elected by mutual consent.
Thus, the founders and the investors will negotiate the seats on the board. If the round is relatively small, the founders may insist on keeping all board seats.