The LM Brief: Conditional Voting Rights in VC Term Sheets

This week’s World of DaaS LM Brief looks at a recent piece by Auren Hoffman, co-authored with Sushant Bhardwaj and Lily Petherick from Flex Capital, on a little-known but impactful clause in VC term sheets that can strip founders of their voting rights when they leave their company. We cover how this “employment-tied voting rights” provision, often overlooked until it is too late, can leave founders as shareholders without a voice and why Flex Capital advocates for its removal to foster trust...

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:01Auren Hoffman?

  Hello, fellow data nerds. Welcome to the LM Brief, a new series from World of DAS. I'm your host, Orin Hoffman, CEO of Incubate and GP of Flex Capital. In the LM Brief, we'll bring you quick, high-value summaries of some of the most interesting DAS-themed articles, podcasts, and ideas, which is powered by Google's Notebook LM. Discover more episodes, get weekly data-as-a-service news, original content, and articles on data and more at worldofdas.com. That's worldofdas.com. Talk to you soon.

• 0:35Speaker 01

  Imagine this.

• 0:35Speaker 02

  Yeah.

• 0:36Speaker 01

  Years of your life, blood, sweat, tears, poured into building something totally new. You navigate all the chaos. You raise the money. You actually create value.

• 0:47Speaker 02

  Right.

• 0:48Speaker 01

  And then, one day, you find out these, like, few boring words, hidden deep in some legal doc, words you probably signed off on ages ago.

• 0:57Speaker 02

  Mm-hmm. Barely glanced at.

• 0:59Speaker 01

  Exactly.

• 0:59Speaker 02

  Yeah.

• 1:00Speaker 01

  And those words could quietly strip away your fundamental, your voice

• 1:04Speaker 02

  Yeah.

• 1:05Speaker 01

  in the very company you built. It's pretty unsettling when you think about it.

• 1:08Speaker 02

  It really is. And that's exactly what we're diving into today. Venture capital term sheets, right? Specifically, this really subtle, often just glossed-over clause.

• 1:17Speaker 01

  Go on.

• 1:17Speaker 02

  Voting rights, but tied directly to your employment status. It's critical, yeah, but so often misunderstood. And for founders, it can be absolutely devastating.

• 1:25Speaker 01

  Okay, so our mission today is to really pull back the curtain on this, this hidden trap. We want to unpack this specific clause, show you what it really means for founders.

• 1:34Speaker 02

  Understand why it's even there in the first place.

• 1:36Speaker 01

  Yeah, why it exists. And then, look at how some, you know, more forward-thinking investors are actually challenging it, doing things differently.

• 1:43Speaker 02

  The goal, by the end of this, you'll know more than, what was the stat? Like, 90% of founders who just sign what's put in front of them.

• 1:50Speaker 01

  Yeah, be smarter than the 90%. And just to mention, a lot of our insights today come from a really strong piece by Orin Hoffman called Founder Beware: Voting Rights in VC Term Sheets.

• 2:01Speaker 02

  Great article.

• 2:02Speaker 01

  So, let's get into it. Where exactly is this hidden trap? How do you spot it in the documents?

• 2:10Speaker 01

  It often looks like standard boilerplate maybe tucked into the voting agreement section.

• 2:14Speaker 02

  Right. You need to look out for specific phrasing, something like, ah, key holders party to this voting agreement, holding a majority of the outstanding shares of common stock, who are then providing services to the company, something along those lines.

• 2:27Speaker 01

  Okay, providing services to the company, that sounds kind of innocuous.

• 2:30Speaker 02

  It does, and your lawyer might even wave it off, say, oh, that's standard. But it's anything but standard in its impact. This is where it gets really serious. Well, it means if you ever stop providing services, maybe you're fired, maybe you step down, maybe you transition out. You can lose your most important voting rights.

• 2:50Speaker 01

  Like what kind of rights?

• 2:51Speaker 02

  The big ones. The power to elect directors, gone. Your ability to block major changes like key financing terms, also gone.

• 3:01Speaker 01

  Wow. So wait, even if I'm still the biggest common shareholder, even if I'm the founder.

• 3:06Speaker 02

  Or have super voting shares.

• 3:08Speaker 01

  Yep. Even then, your voice can just be switched off. You could have poured your life into this thing and suddenly, poof, no vote on its future.

• 3:15Speaker 02

  That's, that's hard to swallow. It just feels fundamentally wrong.

• 3:18Speaker 01

  It does raise huge questions about control, doesn't it? Now, look, to be fair, there is a reason VCs put this in. There's a logic behind it.

• 3:25Speaker 02

  Okay, that's the rationale.

• 3:26Speaker 01

  They worry about what they sometimes call rogue founders.

• 3:29Speaker 02

  Rogue founders. You mean like, someone gets pushed out, feels bitter, and then uses their shares to deliberately block a sale or mess up a funding round, just out of spite? Exactly that scenario. It's not common, but it has happened. So from an investor's perspective, they see it as protecting their investment and, you know, the company's path forward.

• 3:49Speaker 01

  Okay.

• 3:50Speaker 02

  And it's also worth saying, it's not always just the investors pushing for this. Sometimes in startups with multiple founders, this kind of clause can be used internally too.

• 4:00Speaker 01

  Ah, so to prevent a co-founder who leaves from interfering later on?

• 4:04Speaker 02

  Precisely. A sort of internal governance mechanism among the founders themselves.

• 4:08Speaker 01

  Right. That makes a certain kind of protective sense. But it still feels like designing for the absolute, like, one in a million worst case, right?

• 4:15Speaker 02

  It does lean that way.

• 4:17Speaker 01

  I mean, the board already has the power to remove a founder from their job. As CEO or whatever, that's standard corporate governance.

• 4:23Speaker 02

  Sure.

• 4:23Speaker 01

  But Hoffman's article really nails this point. When your term sheet links voting rights to you providing services, getting fired isn't just losing your job. It's like political exile.

• 4:34Speaker 02

  That's a good way to put it. Political exile. You become a shareholder technically, but without a vote. You still own your equity. Maybe you even keep the title cofounder.

• 4:44Speaker 01

  Though sometimes they even try to erase that history.

• 4:46Speaker 02

  Yeah, in really bad situations, maybe. But the core thing is your actual, say, your agency over the thing you build, it's just gone, stripped away.

• 4:55Speaker 01

  The article uses some really strong analogies to hammer this home. It's like being taxed without representation. Or owning a house but having no vote in the homeowners association.

• 5:06Speaker 02

  Yeah, powerless despite ownership.

• 5:09Speaker 01

  Or, as Hoffman says, like building a company and then being told you're just not qualified anymore to even have an opinion on it. It's a complete loss of political power in your own creation.

• 5:18Speaker 02

  And what's really wild is how few founders seem to actually know this. The article mentions this kind of nine zero eight two rule.

• 5:25Speaker 01

  What's that?

• 5:26Speaker 02

  If you ask a hundred founders, hey, after you leave, do you still get to vote your shares? Ninety of them will confidently say, yeah, of course.

• 5:35Speaker 01

  Right.

• 5:35Speaker 02

  Eight will be like, hmm, I'm actually not sure. And only two, usually the ones who've unfortunately learned the hard way, will know the real, often harsh answer.

• 5:44Speaker 01

  Ninety percent ignorance. That's staggering. It really makes you wonder why it's not discussed more openly.

• 5:49Speaker 02

  Well, it's typically not something brought up in board meetings, right? Or highlighted in the investment memos. It just sits there, labeled standard term.

• 5:57Speaker 01

  Until it blows up into a crisis.

• 5:58Speaker 02

  Exactly. And by then, it's usually way too late to fix it.

• 6:02Speaker 01

  So, given how vulnerable this makes founders, is there another way? I mean, can investors actually bet on founders without this legal safety net?

• 6:13Speaker 02

  Well, interestingly, some are. And that brings us to a different approach championed by a firm called Flex Capital. Their whole stance is basically founders matter even after they leave the company day to day.

• 6:26Speaker 01

  Okay, Flex Capital. So how are they changing the game? What's their actual philosophy here?

• 6:30Speaker 02

  They actively return voting rights to founders. So even if you're no longer employed, you step down, you move on, whatever the reason, you keep your vote, your shares retain their power.

• 6:40Speaker 01

  How do they justify that? What's the thinking?

• 6:42Speaker 02

  They talk about actual ownership versus what they call conditional ownership. Their core belief is pretty simple. If we can't trust you, the founder, to vote your shares responsibly after you leave, well, maybe we shouldn't be investing in you in the first place.

• 6:55Speaker 01

  So it comes down to trust versus control?

• 6:58Speaker 02

  Exactly. They choose to bet on trust.

• 7:00Speaker 01

  That's a really different way of looking at it compared to the whole rogue founder fear? How do they handle that risk then if they're not using these clauses?

• 7:08Speaker 02

  They acknowledge it. They know the rogue founder scenario can happen. Maybe, you know, one in a thousand deals, something like that. But they see it as rare and fundamentally manageable when it does occur.

• 7:20Speaker 01

  So they don't build the entire system around that rare exception?

• 7:23Speaker 02

  Precisely. The key insight from Flex, I think, is that it forces you to ask, where does real security in venture capital come from? Is it from ironclad legal controls designed for worst-case scenarios?

• 7:36Speaker 01

  Or is it from building deep, genuine trust?

• 7:38Speaker 02

  Right. Their view is if your whole governance structure is built assuming the worst, you inherently start treating everyone like a potential threat. They'd rather protect the rights and dignity of the, say, 99.9% of great founders.

• 7:52Speaker 01

  Then optimize everything for the 0.1% who might cause trouble.

• 7:55Speaker 02

  Exactly. They believe enduring companies are ultimately built on trust. And the best investors should embody that. It's a significant philosophical difference.

• 8:05Speaker 01

  It really is. A profound shift in how you view the founder-investor relationship. Okay, so for everyone listening, particularly founders, here's your homework assignment, straight from Auren Hoffman's piece.

• 8:16Speaker 02

  Yeah, practical steps.

• 8:18Speaker 01

  Go find your term sheet. Seriously, pull out those documents. Look for terms like voting agreement, key holders, lever provisions, anything that links your voting rights to continued employment or providing services.

• 8:32Speaker 02

  And if you find language saying the board controls your vote after you leave, highlight it, circle it in red, make it stand out so you can't ignore it.

• 8:40Speaker 01

  And look, if you're staring at this legal jargon and you're not sure what it means, or you just want a sanity check, there are tools out there.

• 8:46Speaker 02

  Definitely. The article mentions a couple, GitLaw, it's like, cursor for law lets you upload contracts for quick review.

• 8:52Speaker 01

  Okay.

• 8:53Speaker 02

  And Sockston, which is an AI-powered law firm, apparently offers a free term sheet analyzer. They say it can get same-day analysis.

• 8:59Speaker 01

  Wow, okay. So resources exist to help decode this stuff. Using them could make you way more informed than, well, that 90% we talked about, who sign without really knowing.

• 9:09Speaker 02

  Absolutely. Knowledge is power here.

• 9:11Speaker 01

  Yeah.

• 9:12Speaker 02

  Then, once you've done that homework, start talking.

• 9:15Speaker 01

  Talk to who?

• 9:16Speaker 02

  Your lawyer, obviously. Your co-founders, make sure you're all on the same page. And definitely talk to future investors about this before you sign anything.

• 9:23Speaker 01

  Bring it up proactively.

• 9:24Speaker 02

  Yes. And maybe even chat with other founders you trust. See what their experiences have been.

• 9:29Speaker 01

  And here's a challenge, maybe directed at any VCs listening who do use this clause, maybe thinking it's just standard protection.

• 9:36Speaker 02

  Ask yourself honestly.

• 9:38Speaker 01

  Would you sign this clause if you were the founder, pouring your life into building this thing? Would you agree to potentially lose your voice like that?

• 9:44Speaker 02

  It's a powerful question. It really underscores the impact of what seem like small lines of text in a long document. Understanding these details is just crucial. It shapes your future as a founder, and it should definitely influence who you choose to take money from.

• 10:00Speaker 01

  Absolutely. So this was a big question, really. What does all this mean for the future of how founders and investors work together?

• 10:08Speaker 02

  Yeah.

• 10:08Speaker 01

  Is trust, even with its risks, ultimately a better foundation for building lasting, successful companies than a model based purely on control?

• 10:17Speaker 02

  Yeah. Definitely some food for thought there. Trust or control. What really builds the best companies in the long run?

• 10:25Auren Hoffman?

  Thanks for listening. If you haven't already done so, please subscribe to World of DAS wherever you consume your podcasts, YouTube, Apple, Spotify, and more. And please help us get discovered by leaving a review. And check out worldofdas.com. That's worldofdas, D-A-A-S, dot com. And of course, connect with me on Twitter, at Auren. That's A-U-R-E-N. Would absolutely love to hear from you.