Key Control Terms: Protective Provisions
This post is a continuation of the discussion that covers everything a founder should know before raising their Series A. If you missed the first series of posts, you can find them here.
This post continues our discussion of important control terms with protective provisions.
Much as the name implies, protective provisions give the Series A preferred stockholders (the investors) protection over their investment; i.e. control over certain company actions.
Protective provisions can range from few to many, and state that the startup cannot take certain actions without the approval of the majority of the holders of the Series A preferred stock. Some of the more common protective provisions are as follows:
- Altering or changing the rights of the Series A preferred stock.
- Increasing or decreasing the authorized number of shares of common or preferred stock.
- Creating any new class or series of shares having rights that are senior to or the same as the Series A preferred.
- Any redemption or repurchase of any shares of common stock, other than pursuant to an equity incentive agreement.
- Entering into a merger, sale of control, reorganization, or any other transaction where all or substantially all of the startups assets are sold.
- Amending or waiving any provision of the startup’s certificate of incorporation or bylaws.
- Increases or decreases to the size of the startup’s board of directors.
- Payment of dividends.
- Issuance of debt in excess of a certain amount.
Remember, protective provisions require that you get a majority approval from the Series A preferred stockholders before you engage in the above actions.
When negotiating these provisions it is important to keep in mind that the investor is wanting some say when it comes to major company decisions; not the daily decisions you and your co-founders make. If the investor is trying to get provisions that seem too overt, or give away too much decision making of the company from those operating it, then push back on that provision. Having to get investor approval to sell your startup to Google makes sense. Having to get investor approval to order more printer ink doesn’t.
As always it is important that you discuss any protective provision in a term sheet with an attorney who routinely handles these matters as they will be able to give you insight into the terms and advise on which ones need to be pushed back on. In my next post, we will continue the conversation around important control terms in a term sheet by discussing conversion.