When negotiating funding deal terms, investors will often ask for a board seat, known as an Investor Director position. Founders then need to decide whether or not to allocate investors a seat on the board or not.
Until now that was all done without any knowledge of whether you were the only person in the world to be agreeing to this, or the only one not agreeing to it. Now, as part of our Deal Data series, SeedLegals is able to provide unbiased insight to help founders on this important decision. Our unique data set collates the decisions from over 500 funding rounds on SeedLegals and democratises access to legal and funding round expertise regardless of founder experience or the size of a funding round.
Let's start with some background to this:
The board of directors agrees and signs off strategic company decisions, including long-term vision, hiring and firing of key personnel, major business changes, etc., and so this is an important decision for the founding team to make.
There are a number of factors that usually influence the composition of the board:
1) Value Add
Whether investors and directors can add value or not
2) Shareholder Weight
Whether the board reflects the various constituents of the shareholder base
Whether directors goals are fully aligned with the founders and there is not conflict of interest.
However, after a company is incorporated, the board usually has 2-3 directors, comprised of the founders. The question is then, at what point would you add one or more Investor Directors?
We ran the numbers to find out.
The graph shows the % of funding rounds in which an Investor Director was initially proposed in the Term Sheet, versus the % of funding rounds where an Investor Director position was actually granted.
From the data set we can see that in smaller funding rounds, founders rarely need to offer their investors a seat on the board (32% of the time), whereas raises nearing £1 Million or above often requires Investor Directors (67% of the time).
Perhaps more importantly, we can see that although founders often propose that they do not need an investor on the board, there is often push back and it is eventually agreed that there should be an Investor Director. There are several reasons for this. Firstly, the type of investor (friends and family, angel, fund) investing in the company varies with the size of the investment. This impacts the likelihood of an investor director appointments:
Friends & Family Investors
Smaller raises will typically be funded by friends and family or crowdfunding backers, who are less likely to have the financial or technical expertise which would add input to the board.
Smaller raises will also typically be furnished by angel investors or accelerators, who will be making several investments every year and may not have the time to be a board member to all of them. Some angel investors are passive investors but many of them will be genuinely interested in your business and have one interesting perspective to bring. They represent a collective force that can help your business in term of expertise and network as investors or entrepreneurs themselves. They often have a significant weight in the company collectively at 20-30%, and will often be an ally on the board because of their natural alignment.
Funds and VCs invest larger amounts and will want to have more control over a company’s decisions and so typically demand a seat on the board. VCs have a duty of care over their investors’ money, and so must take reasonable steps to ‘look after’ their money as well as ensure maximum return on their investment - even if this includes steering the company in another direction. Furthermore, VCs are often ex-entrepreneurs and pride themselves on their ability to help their portfolio companies, therefore being on the board is a natural position from which to do this. They often fully control the investor majority and have a huge influence on the key decisions and should do so. They are generally aligned except on the timing of the exit since they are usually late investors and are ready to wait longer in order to see a return on their investment.
Secondly and very simply, regardless of whether the investor is an Angel or a VC, the more they invest the more they care about the outcome of the investment and the more likely they are to want a board seat. This is where the balance of representation on the board is the most critical factor in your success so all the parties can be heard.
Lastly, and regarding the discrepancy between what is requested by a founder and the outcome that they achieve, a founder should be pushing for what they believe to be the best possible outcome for the company. In our view, if a particular person will add value to your board then, great, appoint them as a director. If not, then push back on that. As the data shows, founders end up giving Investor Director positions more often than they initially planned to, which also means that if an investor demands it, this data shows you're not the only one getting that request, and perhaps how best to respond.
If you don't want to give the investor a seat on the board, there is an intermediate position available. This is that the investor becomes a board Observer, able to attend board meetings and have their say, yet without the right to a vote. This option is also popular with founders, with 23% of startups on SeedLegals suggesting it to their investors, and 35% of deals eventually including a board Observer.
To conclude, no board wants to be prevented from making operational decisions and giving a board seat does mean there is another opinion to consider around the table. However, in smaller rounds several factors combine to mean that a board seat is typically not required, and at intermediate amounts it is not a must, but mostly depends on the type of investor that the money is coming from.
If you have any questions, or would like more data from SeedLegals to help calculate any aspect of your own round, hit the chat button and our team will be more than happy to help. You can also book some time with a member of the team.