This is a big question and the deviation is very large depending on many circumstances. However, I will give some baseline information to help you prepare for the negotiation of terms. Your mileage will certainly vary.
Angel investors, early on, will not get anything except a promise of equity later via a convertible note or SAFE note. Their ownership stake is too small to have any real control, and the legal structure of a note gives them no real voting authority at annual stockholder meetings. So, control is usually not a big issue unless an investor is large enough to request certain covenants or guarantees. Giving out any rights at this stage can cripple a company to get the next deal done, so it is advisable to have a clean and simple note without any special privileges except the conversion discount. This might be warranted with a $250K plus investment. In this case the investor may want a board seat, board observation seat (non-voting member) or a special discount on conversion for being early and taking more risk. Typically, this discount is built into any note offer.
Venture capitalists have a long list of covenants and control, usually more than they deserve given their ownership stake but warranted to protect them from crazy founders and changes in control and equity they do not approve of. Samples of these covenants include:
- Board representation in some proportional to their ownership.
- Financial reporting, which can be monthly, quarter, but usually not annually. Typically, financial statements are provided to all board members anyway.
- Approval of all additional funding rounds. This might include specific limits on price dilution, pro rata participation (to maintain their percentage ownership), piggyback rights which allow them to ride along on any IPO or equity sales proportionately and other things. You can usually trust your attorney on the deal to counsel you on what is fair and negotiable and what might be “standard” in this kind of deal.
- Preferred stock, which has an interest rate and protections as first paid out on liquidations. It is common that the last money in gets this, wiping out the previous investors right here. At first this might not seem fair, but basically the newest investors usually has the best preferences unless it is a really hot deal, in which case it is very negotiable. There is therefore often a new Series of preferred created for each major round, each of which as some different but similar rights.
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Lawyers will be current in these things, especially in their industries, if they are the right lawyers. They can also be expensive. In my opinion, they are all vastly overpaid for what they do. I do try to keep them out of the basics of the deal and term sheet, though, as they can run up a large and unnecessary bill if you let them. They can also save your butt if you have little experience, so best to use with a tight leash and close monitoring of their bills, so you do not have a huge legal bill surprise at closing.
This is such a complex issue, I have only scratched the surface here. A VC deal can be 40, 50 or even 100 pages long and someone needs to pay attention to the details. This can be the lawyer, CFO or others, but the CEO should have a good grasp on this and not rely on anyone else entirely. What the company can and cannot do will depend on these terms, and they can be used by unscrupulous or greedy investors to get extra leverage or financial benefits. If you must give special rights, make sure they go away at the next round or have some time limit based on the justification for getting them in the first place.
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Bob Norton is a long-time Serial Entrepreneur and CEO with four exits that returned over $1 billion to investors. He has trained, coached and advised over 1,000 CEOs since 2002. And is Founder of The CEO Boot Camp™ and Entrepreneurship University™. Mr. Norton works with companies to triple their chances of success in launching new companies and products. And helps established companies scale faster using the six AirTight Management™ systems. And helps companies successfully raise capital.
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