The reasons investors want to remove founders can vary greatly, from loss of aspiration by management to buying the company for the technology knowing that they can bring in their own team. There also may be unscrupulous investors who remove founders to gain cheap equity. So, protecting yourself as a founder is essential when deciding to take a venture capital investment. Here are some preventive measures from the founder’s perspective.
Retain control of at least Series B. Your investors may block a lucrative sale. The founders who had control of the board on average received more during any sale or takeover․ Having seats on the board and non-affiliated with VC independent directors is vital for strategic protection.
Drag right. As time goes on and as further investment rounds close, you may find your shareholding in the company diluted which can have an effect on your ability to influence decisions at the shareholder level. However, if you are likely to remain as the majority shareholder for a period post-investment, you should ensure that a “drag right” is included in the articles. If an offer is made to buy the company by a third-party purchaser, a drag right will allow the majority shareholder to compel the remaining shareholders to sell their shares to the purchaser, on the same terms as would have been offered to him.
Leaver provisions. In a funding scenario, the principal purpose of leaving provisions is to put the equity of the founders at risk if they leave the company, or if the company doesn’t perform as forecast during the pitch to investors. Because investors have established their valuation and invested based on the founders’ commitment to the business, it’s deemed fair that the founders lose some of their equity if they bail early. Were you to exit the company for any reason, and provided you’ve been diligent enough, you will not be required to give up your own shares. Certainly not straight away in any event. It’s entirely possible that investors will expect you to stay active in the company for a pre-agreed timescale, allowing a certain portion of the shares to vest each year.
Restrictive covenants. Likely, post-investment, you will be required to have a service agreement in place with the company, if you haven’t already got one. Included in your service agreement will be a number of restrictive covenants which will apply to you both during your employment and for a certain period of time after you cease to be employed. These restrictive covenants typically restrict you from working with or being involved in another business which competes with the startup and from poaching clients or employees. While it is entirely usual for an investor to require these terms to be included, as a founder, you will obviously want to ensure that they are limited in terms of time, location, and business sector, so that you are able to work in another business if you leave or are forced to leave earlier than you have anticipated.
Note, that Armenian law does not offer a wide variety of adaptable safeguards for the founder’s rights by default. The relevant special agreements should be signed to cover those gaps.