You Can't Fire a VC From Your Board: Here's Why | Wilson Sonsini Startup Legal Basics

0:05Hi, everybody. Welcome back to Startup Basics. Yes, that's right. This is where we spend just 10, 20, 30 minutes going over a basic concept that you need to run your startup. There's tons of blocking and tackling in finance, in AI, in customer acquisition and sales, and most of all, legal. So if you want to see all the past episodes across all the different topics, thisweekinstartups.com slash, you guessed it, basics. Today, we're going to continue. Today, we will continue our legal basics series with my lawyer, Becky DeGraw from Wilson Sinciti, Goodrich and Rosani. We call them WSGR here in the Valley.

0:46I mean, people call you Wilson, Wilson Sonsini, the full name, WSGR. Should I know, like, what the right thing to say is, or is it up to me and how I feel? However you feel. It's perfectly fine. But Wilson Sonsini is good enough, or WSGR. I don't think I can ever go through the full names out of it. I noticed DeGraw is not up there yet. I guess another year or two, and keep working. Yeah, yeah, sure. We'll pull the DeGraw. This is a seriously multi-decade firm. And you and I have been doing this for a while. Today, we've got some really important things to discuss. Board composure is something that founders get very animated about, very concerned about.

1:33And then some VC firms are extremely heavy-handed, sharp-elbowed, persistent about board seats. and then others are like, we don't ever want to take a board seat. So let's talk about what a board seat is, why an investor actually takes them. We'll go into independence, and then we'll also talk about observers. But what's the role of the board in my seat or series A company? Let's start with that. So the board sets the strategic vision for the company. So think at the highest level, it manages the affairs of the company. All the day-to-day operational stuff that gets delegated down to the officers.

2:16But the really important stuff, that's at the board level. So whoever you're adding to the board, you really want to make sure that you're aligned on what the future path is for the company. Now, we all know startups can pivot, so that may change. But the best that you can, make sure you like this person and you are aligned on today's vision and that they're a thought leader in terms of where the company might go. The other thing I'll note about the board is it has to approve certain material acts in order for them to be valid so any issuance of any security so any stock i don't care if you want to issue one share it has to be board approved option yes any financing that includes safes convertible notes preferred stock bank debt any anything m &a transactions certainly material contracts and one that's also near and dear to all of our founders' hearts, hiring and firing the CEO.

3:11So the board has a lot of control. Like that's, it's a very powerful unit when you are looking at it. In the early stages, you have some investors, everybody's got an opinion on boards. Of course, this is Silicon Valley and the technology industry. Some folks are like, don't do a board, Push it off as far as you can. Other folks are like, we need to get going on six board meetings a year, 10 board meetings a year. And I have always fallen into, hey, Series A, you're going to have to have a board. Before you have product market fit, you're probably not going to have one. So there's something between those two moments in time.

3:53Typically, you raise over a couple of million dollars or you start making over a couple of million dollars. you might want a board to help you structure it and see what's around the corner. So I tell folks, hey, add up how much you've raised. Look at how much you're making. And you've probably never heard my speech on this, but hey, if that number is greater than two or three million, maybe a board, just one board member, one attorney, the two founders, just getting together and formalizing some stuff would be in your best interest. And you start learning. So then when the Series A investor comes along, hey, there might have been three board meetings.

4:28There might be three board decks and there might be some resolutions that makes them feel more comfortable. That's my philosophy. What's your philosophy? When do you advise your founders that you're working with to start board meetings? Ideally, at the beginning stages, it's just the founder or founders that are initially on the board. And if you have multiple founders, it doesn't mean that every single one of them has to be on the board either. There's a bit of a negotiation that goes into that and who should be the right folks. But one of the things that that's super important is you don't need to add five people to your board and day one, just like what you're saying, because you think it's going to help the company look better.

5:08In fact, if you do that, you've just lost control of your own company. They're going to be making the decisions for you. And even if we don't have board meetings, there's board actions that we need to take, right? You're probably going to be hiring some folks and we want to issue option grants to them. We do that, We can do it by a written consent instead of having to do a meeting, but it is still a board act. If we do it by written consent, every single director has to sign that written consent in order for it to be a valid act. So if you do it at a meeting, it's a majority, but oftentimes in those early days, we're not having meetings, to your point.

5:46Right. Once a company does a preferred stock financing round, that is when we often see an investor say, hey, I'm leading this round. I'm writing a sizable check. I want somebody for my team to be represented on the board. I want to see all this stuff and have a voice and things that are going on with the company at that level. So I would expect to see a preferred director come in at that seed or A stage when it's a preferred stock round. If you're doing a safe financing, I wouldn't expect there to be talk of whoever the lead investor is in the safe to say, I want a director. It usually comes at the time of that price round.

6:25Yes. And so convertibles, safes, those things occur, small amounts of money. The investor's own basis points are low single digits. They don't have enough skin in the game. They probably don't want to be on the board if they do. It's like, why? But when they get to 10 % ownership, 20 % ownership, in my experience, they say, you know what, probably should have a board seat here to represent, you know, that 10, 15 or 20 % of the cap table. That's where I seem to, you know, over the last 10 years, see it start happening. Am I directionally correct? Yep, absolutely. I think that's exactly right. Investors are writing a bigger check and they want some oversight to go along with their investment.

7:08They want to know somebody's paying attention and watching things. They have pretty sure duties to their LPs as well that they need to fulfill. So that's often when we do see that preferred directors start to come in. But I would say at that seed A stage, the common directors, the founders would still control the board. It's usually, you know, we start to move to what I would call a balanced board, you know, maybe around the series B at that point. Maybe there's two common directors, there's two preferred directors, and maybe we start thinking about adding an independent director around that time as well.

7:46Okay. So I'm in my seed stage. The board's me and my co-founder. My attorney shows up. OK, now I'm at my Series A. My Series A investor joins the board. Two founders, one Series A. I get to my Series B. I'm adding that investor who's putting in$10 million,$20 million. And then we're at an even number, which doesn't take a genius to figure out you could have a tie. And then you put an independent on. how is the independent most often selected by the board who gets to pick the independent because i've seen situations where the series b investor or series a investor says oh got the most independent board member you ever met and then you get that board member on and magically they're always aligned with that investor because they were in the same frat they both worked at bain and uh their families go on vacation together for the last seven years and there's not much independent and the independent director.

8:42So let's talk about that, the independent director. Yeah, so the independent director, we try to say when you're adding somebody at that stage, have it be an industry expert. Like where do you need the most help? Where are you at at the point in your company, right? If you are like, I'm struggling with getting access to this particular set of folks and that's what's gonna allow me to scale to the next level. Somebody who's well connected with that or really knows that space, that's probably a really valuable person to bring on at that point. We do see sometimes that there are relationships that happen around the board.

9:22Oftentimes, the way that the independent director is selected, at least from what goes in the legal documents, it usually is common on one side, preferred on the other. So maybe it's common, you get to designate it. But if you designate them, I get to preferred, it has to be acceptable to the rest of the board members or vice versa. Or start over. So you bring in your brother or your mom or your fraternity brother. They say, wait a second, your sorority sister's joining the board. Doesn't make sense. So they can essentially have a veto. But if you say, hey, we need somebody, we're Airbnb. Be great to have somebody who knows hospitality.

10:02Oh, okay. We've got Paris Hilton here and she's from the Hilton family. let's get PowerChilton on the board. And everyone's like, okay, sounds great. It's going to be a great press release. And she knows hotels and she certainly knows marketing and everybody approves. The founder selected, the investors approve the independence on the board. What do you give an independent board director? What's the range of compensation for them? Hunter Biden got like $100 ,000 a month and a couple million dollars a year. I'm assuming that's the standard. for this stage of a company. And what directors get in private companies at this stage is also very different than what directors get pre-IPO or public company directors.

10:48I would say most times we're not even talking about cash consideration until we get to that really late stage pre-IPO, maybe right before pre-IPO, depending on, you know, how big of a hot shot or that you're bringing in, you may need something like that to lure them. But oftentimes it's just equity. And if it's equity, it's usually investing monthly over a period of two years. And maybe it's something in over the course of the two or four year period. Maybe it's something around, you know, 0.5, 1%. It's maybe a little more than what you might give an advisor, but something in that range is pretty reasonable.

11:32You can actually look it up to see what somebody at one of the largest companies in the world, say Apple, gets paid$100K,$200K in cash. Maybe it seems like they're standardized on$250 ,000 in stock awards, and they might get a little bonus for being on the audit committee of$50 ,000. So you're looking at a total comp of about$400 ,000, and that's probably a four-year term, five-year term, something like that. So that's the highest end. Here at your startup, 25 basis points, 50 basis points over four years of service, two years of service, something in that range. Yep. Do sometimes the board members ask for their travel and expenses to be paid?

12:14And then what's your take on that at an early stage startup? Is it maybe a negative signal? No, but I would say most do. Most do. Okay. Most do. VCs are mixed as to whether they will ask for it. Oh, I've never seen a VCS to be put up in the four seasons. Wow. I mean, they may not ask for four seasons, but they may ask for, you want me to fly out, I would like you to pay for my flight. And, you know, the company will have a travel policy and usually it'll be, okay, well, yes, as long as you follow this travel policy, which may not necessarily be a lie flat seat. Let's, yeah, exactly. It's going to get a little expensive these days.

12:59Feels expensive for some reason. Let's talk about the difference between a board member and a board observer. Yes. So this is really important. I get this question a lot. your board of directors is what we've been talking about so far. They are actually on your board. They are a director. They have voting power. So, you know, they get to vote on every action that's presented to the board. A director also has fiduciary duties that it owes to the company. So when that director is making a decision and saying, yes, I want to vote for it or no, I don't want to to vote for this just because that director says oh i actually i don't like this this is not going to be good for my fund or this is not going to be good for me personally but if it's in the best interest of the company and its stockholders if you're exercising your fiduciary duties you've got to say fine i approve it that does not exist at the observer level okay so that so an observer doesn't have either one of those an observer does not have voting power does not have fiduciary duties, what they have is a right to be invited.

14:06I want to be invited to the party and that's about it, right? They can attend the board meeting, they can receive the board materials, they get to sit there, they get to observe. Now, does that mean that they can't talk? No, they can talk. But and some board observers are very vocal and may even sway the direction that the actual directors may go when it comes time for a vote. But ultimately, that board observer themselves, they do not have a vote on the matter. The fiduciary duty point, I would just emphasize on the board observer side, make sure you're getting a board observer provision or letter in place, because otherwise you don't have confidentiality, you don't have other things that you already have that's built into the fiduciary duty component of being a director.

14:52But they get that we hear all the same stuff. So it is important that they are are bound to similar confidentiality. And from the other side of the table, I have moved a lot since our firm has really started to investing and having a large portfolio. I've even had board seats where I've said, you know what, we're okay dropping down to a board observer, if that's what you like, I'm going to send an associate, I'm going to send, you know, an analyst. They don't even have to have their camera on. They may ask you a question, but I kind of instruct them to take notes. And I'm really looking for two things.

15:27How is the firm doing? Where are they going? And when's the next financing or major corporate activity? If I just know those things, because when you're not on the board, for the angel investors listening or for seed funds, when you're not on the board, you get this weird phone call. Hey, we raised our series A. And And you're like, okay. And they're like, yeah, you need to sign in the next 24 hours. And you're like, what's happening here? And they're like, everything's changed. You're the last person who didn't sign. You don't want us to succeed. You need to sign right now. And it's like, wait a second.

15:58I need to read the documents. I got to call my attorney. So it's a little game that gets played of like, hey, everything's agreed. And now you're the blocker. And it's like, wait a second, but you're issuing like 50 % more shares? Like, that's not okay with me. I'm not signing. And I've gotten into this a whole bunch in the past where shenanigans sometimes ensue. And when I say a lot of times, I count on one hand times in 600 investments. But it is so much easier to just be a board observer. Chef's kiss. The second you tell me that the company's profitable or running out of money or raising around, like DM me on Slack, hit me up on Signal, send me an iMessage.

16:39That's all I care about from the board. Are they in trouble and they need my help? or is there a great opportunity here? Are they selling? Like sometimes we get told about a sale and like, what's the process? I was like, oh yeah, no, six months ago, we ran a process and I'm like, oh, I know the CEO of that company. I could have called them. And they say, oh yeah, no, we picked this terrible company that's giving us common shares and we're all getting washed out. Ah, so frustrating. So how do you remove a director? And under what circumstance can you? Legally, but then pragmatically. So let's say, you know, for Acme Ventures, I hope there's no Acme Ventures out there because I say Acme Ventures on hard dogs all the time.

17:20If there is, I apologize. There is? Okay. Acme Beta Delta Ventures can't be an ABD Ventures. Acme Beta Delta Ventures, if they send somebody to be on the board and that person's, I don't know, just kills the vibes. The founders don't like them. They're too pessimistic. They're annoying. They show up late. They call in from a cab on the way to the, you know, and they got a big speech they're going to give and they're breaking up on the phone. And that was my favorite from early in my career. The same. VC would call in from a car on the way to the airport and then wanted everybody to hear a speech.

17:56How do you practically and legally, two different things, remove a director? Yeah, this is a question I get a lot. And it's usually not when things are going well. it's it's when we're already in it and we're like how this is not working i want i want out um i will often compare preferred directors to like anybody that you add to your board right you've talked about how important it is like it's like a marriage like before you get into it do your diligence make sure you're aligned do they want kids all that stuff right you you're the one to talk about do you want a second home are you okay with going to a hotel which is how is that that's a big one.

18:38It's a big one. Same vacation every summer or different. But get it all out there. The big difference with marriage and preferred directors, in a marriage, you can say, man, this is not working out. I'm out. I unilaterally can remove myself from the situation. That's not the case for preferred directors unless they are willing to go and they agree to go. So there's nothing you can do as a common holder to do it. And I'll tell you why. So directors are elected by stockholders. They are removed by stockholders. The way that we set up the board in a venture-backed company is to specify that certain classes or series of stock are entitled to elect certain seats.

19:27So what this means is we're going to say, hey, you've got two common seats, which means those two seats are elected by common. the majority of the outstanding common stock, whatever you say, that's who's going to set in those seats. When we have the Series A investment come in and the lead investor says, I want a director, we create a Series A preferred stock seat, which is only elected by, you guessed it, Series A preferred stock. So you can hold super voting stock. You can have your common shares, is 100 votes per share and the preferred will have one vote per share guess what your common shares don't vote for that director so you can't vote to remove that seat on top of that what gets negotiated in these preferred stock financing documents is that the lead investor will negotiate to say i have designation rights with respect to that seat so long as i continue to hold fill in the blank is usually 25 to 50 % of the shares I'm purchasing.

20:30And everybody else has to vote this way. Yeah, dragged along. We ensure that's the case by putting in place a voting agreement. All the common stockholders, all the preferred stockholders, you're going to be partying this voting agreement. When lead investor says, I want John Doe to sit in my seat, everybody has to vote in favor of that. So there's just no way of getting around it. That early stage investor says, okay, you've had a grown up conversation with them. You've explained that the alignment isn't there, that I'm going in a different direction. And won't you please step off? Or it may be, you're a series D, E company, and the board is getting really lopsided.

21:16You're getting some later stage VCs that do want to join the board. And they're the ones that are actually supporting the company to be able to get to that next stage. And maybe this early stage investor, they're out of funds. This isn't really the space that they play in. Maybe they aren't as valuable as they once were. And you're feeling like, I've got 10 people on my board. I need to get rid of somebody. Practically, it's having a conversation, trying to get folks to come to the same place of what's best for the company. And hey, you still have your investment in the company. You want it to continue to grow.

21:51This is the direction. Can we amicably? This is where relationships really matter. And so best advice for a founder is, hey, build that relationship fabric. Go for a walk along the Embarcadero with your board member. Invite them to come out a day early and have lunch with you and visit the management team. If they're leaving the next day, I had one founder who would always insist on driving me back to the airport and we'd have a conversation there. And sometimes we'd sit in the car for 20 minutes, you know, waiting for my plane to board. You invest in those relationships so that later on when you need to have hard discussions, you know, a little bit of sugar helps the medicine go down, doesn't it?

22:31Yeah. That's right. When you started saying you're going to take a walk along the Embarcadure, I thought you were taking my marriage analogy a little too far. Yeah, we got to go for a walk, honey.

22:42We're going down the end of the pier. It gets very dark. No, I do find that the people let things, you know, these are very important relationships. They don't invest in them. When things get hard, and this is, you know, back to dating or marriage, if you guys have had a, you know, strong marriage and then something happens that's difficult, somebody gets sick, God forbid, or whatever, you have a challenging child, whatever it happens to be. At least you have that relationship fabric to, you know, as your foundation. So build that foundation. If you're a founder, if you're an investor, be a good person, be a good person.

23:19That's that pretty simple. Be a good person. Doesn't mean you have to give up your board seat in those situations. I'll say, you know what? Um, I don't want to be at the party. If people don't want me at the party, I'll just move to an observer. And, uh, that's usually my concession. Like if I'm not valuable, the good news is I've become increasingly valuable in my career because I work hard. And then people are like, do we not want Jacob to come to the board meeting. That would be kind of dope for him to be at the board meeting. And he's also fun. So if you're, it sounds crazy, but you've been at boards where there are some people who are just miserable.

23:50And then there are some people who are like positive and like, you leave the board meeting feeling like, Hey, even though there's some challenges here, Hey, we're in it together, esprit de corps. And, you know, we can solve these problems. I think that is something board directors, you know, sometimes miss in their mission. Like you're not here to be the most abrasive person in the world, you're here to be constructive. I mean, this doesn't mean criticism can happen, but random legal question, Becky. Okay. I'll try. Is it pled or pleaded? If somebody pled guilty or did have they pleaded guilty?

24:23I keep seeing this coming up. Everybody's pleading and pledding and I don't know what's the right word. Do you know? I don't know. I don't, I don't deal with guilty. I don't get it for it. I don't know. Prepararis says pled. He doesn't like when he sees pleaded. So he says pled. All right. Becky DeGraw, Wilson Sonsini. Go to Startup Basics at thisweekinstartups.com slash basics. We'll see you next time.