Voting Rights: Control, Consent & Red Flags

As a founder, securing investment is a monumental step, but it’s equally vital to understand the intricate details of the term sheet that accompanies that investment. Among the many clauses, Voting Rights stand out as a cornerstone, directly impacting who makes decisions and steers the future of your company.

Definition

In simple terms, “Voting Rights” refers to the ability of shareholders to cast votes on company matters. When you take on investment, you’re bringing in new shareholders (your investors), and how their shares vote—and yours—is important.

  • Common Shares: Typically held by founders and employees, these usually carry one vote per share, often referred to as “one share, one vote.”
  • Preferred Shares: These are the shares usually issued to investors. While they often have the same voting power as common shares on an “as-if-converted” basis (meaning if they were converted to common shares), they often come with additional, powerful voting rights in specific situations, known as “protective provisions” or “veto rights.”
  • Board Seats: Beyond share-based voting, voting rights are significantly influenced by the composition of your company’s Board of Directors. Board members, whether founders, investors, or independent directors, have voting power on key operational and strategic decisions.

Why It Matters

Voting rights are the essence of control. For founders, retaining sufficient voting power means maintaining the ability to execute your vision, make swift decisions, and prevent your company from being steered in a direction you don’t agree with. For investors, these rights are crucial to safeguarding their investment and ensuring the company’s long-term growth and success. The balance of these rights dictates who truly “calls the shots” on critical decisions like:

  • Appointing or removing senior executives.
  • Changing the company’s business model.
  • Raising future capital.
  • Issuing Employee Stock Option Plans (ESOPs).
  • Approving major transactions like mergers or acquisitions.
  • Amending the company’s Articles of Association or bylaws.

Common Variations

Voting rights clauses can come in various forms, each with different implications for founders:

  • One Share, One Vote (Standard): This is generally considered the fairest practice, where each share, whether common or preferred, carries equal voting power. Founders should aim for this standard whenever possible, especially in early rounds, to retain majority control.
  • Super-Voting Rights: This is a red flag. Some investors may propose shares with disproportionately higher voting power (e.g., 10x or 20x the votes of common shares). While sometimes used by founders to maintain control as they dilute their equity, investors requesting such rights can lead to founders losing control of their own company, even with a substantial equity stake.
  • Protective Provisions (Veto Rights): Investors will almost always demand certain veto rights over specific corporate actions. These are designed to protect their investment from potentially harmful decisions. While some are reasonable (e.g., approval for selling the company or incurring significant debt), others can be overly restrictive and give investors a “blocking power” on day-to-day operational or strategic decisions. Examples of common protective provisions include:
    • Approval for any future equity fundraising.
    • Changes to the company’s articles of incorporation.
    • Approval for large capital expenditures.
    • Declaration of dividends.
  • Board Composition: The structure of your board is a direct reflection of voting power.
    • Founder-Friendly: A 2-1 structure (two founder seats, one investor seat) is generally preferred for founders to retain decision-making control.
    • Balanced: A 2-2-1 structure (two founders, two investors, one independent director) is common in later stages but can lead to founders losing control if the independent director sides with investors.
    • Investor Majority: Investors seeking a majority of board seats can effectively sideline founders from critical decisions, even if founders hold significant equity. This is a crucial point of negotiation.
  • Differential Voting Rights (DVRs): In some jurisdictions, companies can issue shares with differential voting rights (more or less voting power than ordinary shares). While founders might use superior DVRs to maintain control, investors typically prefer standard voting rights.

Let us understand with the help of some examples

Imagine a startup with three founders (30% equity each) and a new investor (10% equity).

  • Scenario 1 (1 share, 1 vote): Founders collectively hold 90% of voting power, maintaining strong control. The investor has 10% voting power.
  • Scenario 2 (Super-Voting Rights): If the investor’s 10% preferred shares carry 5x voting rights, their effective voting power becomes 50%, significantly impacting founder control, even with a smaller equity stake.
  • Scenario 3 (Protective Provisions): Even with a 1 share, 1 vote structure, an investor with protective provisions might be able to veto a critical decision, like a new funding round, if it doesn’t align with their specific interests, regardless of the founders’ majority vote.

Evolv’s Recommendations

  • Prioritize Board Control: Maintaining a founder-majority board, especially in early rounds, is essential. This ensures your vision for the company remains at the forefront.
  • Understand “Protective Provisions”: Don’t just gloss over these. Scrutinize every item that requires investor approval. Some are standard and necessary; others can be overreaching. Negotiate to limit these to truly significant events (e.g., selling the company, taking on massive debt) rather than day-to-day operations.
  • Beware of Super-Voting Rights for Investors: While founders might use them, investors seeking super-voting rights can be a major red flag as they can lead to a loss of control. Aim for “one share, one vote” for all common and preferred shares.
  • Negotiate Based on Business Logic, Not Ego: Understand that investors need certain protections. Be prepared to compromise on some aspects, but hold firm on those that genuinely impact your ability to run the business.
  • Seek Legal Counsel with VC Expertise: This cannot be stressed enough. A lawyer specializing in venture capital financing will help you identify problematic clauses, explain their implications in plain English, and guide you through negotiations. They are your best defence against unfavourable terms.
  • Compare Multiple Term Sheets: If possible, try to get term sheets from multiple VCs. This gives you leverage to negotiate for more favourable voting rights and other clauses.
  • Know Your Deal-Breakers: Before negotiations begin, identify which voting rights scenarios are non-negotiable for you. This will help you know when to push back and when to walk away.
  • “Reserved Matters”: Pay close attention to “reserved matters” lists, which detail decisions requiring investor consent. Ensure these are specific and reasonable, not broad and encompassing.

Understanding and strategically negotiating voting rights is not just a legal formality; it’s about securing your autonomy and ensuring you can effectively lead your startup to success. Be prepared, be informed, and protect your right to drive your company’s future.