You Can't Fire a VC From Your Board: Here's Why | Wilson Sonsini Startup Legal Basics

Today's show: Can a founder actually fire a board member? Short answer: almost never. And the reason why may surprise a lot of founders. On this edition of Legal Basics, Wilson Sonsini partner Becki DeGraw joins Jason for a deep dive into who really controls your board, when investors start earning seats, and the differences between a board member and a board observer. Check out an episode that might just save your cab table someday. PLUS they walk through the full lifecycle of your startup's board, exploring what it actually controls, when founders should start adding their own board members, the ownership threshold that means investors will start asking for seats, and how boards evolve from seed rounds to Series B> Timestamps: 0:06 Welcome back to Legal Basics 1:47 When should a seed stage founder add their first board member? 7:47 From founder-controlled to "balanced" 10:31 Private vs. public company board pay 12:18 Do board members get expenses covered? 14:34 Why observers need a confidentiality provision 15:36 The "sign in the next 24 hours" pressure tactic 17:46 How to remove a director 24:01 When to use "Pled" vs. "Pleaded" Check out all of the Startup Basics episodes here: https://thisweekinstartups.com/basics Subscribe to the TWiST500 newsletter: https://ticker.thisweekinstartups.com Check out the TWIST500: https://www.twist500.com Subscribe to This Week in Startups on Apple: https://rb.gy/v19fcp Follow Becki: LinkedIn: https://www.linkedin.com/in/rebecca-degraw-639bbb62/ Follow Jason: X: https://twitter.com/Jason LinkedIn: https://www.linkedin.com/in/jasoncalacanis Follow TWiST: Twitter: https://twitter.com/TWiStartups YouTube: https://www.youtube.com/thisweekin Instagram: https://www.instagram.com/thisweekinstartups TikTok: https://www.tiktok.com/@thisweekinstartups Substack: https://twistartups.substack.com

• 0:05Speaker 00

  All right, everybody. Welcome back to Startup Basics. Yes, that's right. This is where we spend just 10, 20, 30 minutes going over a basic concept that you need to run your startup. There's tons of blocking and tackling in finance, in AI, in customer acquisition and sales, and most of all, legal. So if you want to see all the past episodes across all the different topics, this week in startups.com/ you guessed it, basics. Today, we're going to continue. Today, we will continue our legal basics series with my lawyer, Becky DeGraw from Wilson, Cincini, Goodrich and Mozotti. We call them WSGR here in the Valley.

• 0:46Speaker 00

  I mean, people call you Wilson, Wilson Cincini, the full name, WSGR. Should I know like what the right thing to say is, or is it up to me and how I feel?

• 0:56Speaker 01

  However, you feel is perfectly fine. But Wilson Cincini is good enough, or WSGR. I don't think I'd go through the full names that way.

• 1:07Speaker 00

  Yes, I noticed DeGraw is not up there yet. I guess another year or two and keep working.

• 1:11Speaker 01

  Oh, yeah, yeah.

• 1:13Speaker 00

  Yeah, we'll pull the DeGraw out. This is a seriously multi-decade firm. And you and I have been doing this for a while. Today, we've got some really important things to discuss. Board composure is something that founders get very animated about, very concerned about. And then some VC firms are extremely heavy-handed, sharp-elbowed, persistent about board seats. And then others are like, we don't ever want to take a board seat. So let's talk about what a board seat is, why an investor actually takes them. We'll go into independents, and

• 1:56Speaker 00

  then we'll also talk about observers. But what's the role of the board in my seed or Series A company?

• 2:03Speaker 01

  Let's start with that. So the board sets the strategic vision for the company. So think at the highest level, it manages the affairs of the company. All the day-to-day operational stuff that gets delegated down to the officers. But the really important stuff, that's at the board level. So whoever you're adding to the board, you really want to make sure that you're aligned on what the future path is for the company. Now, we all know startups can pivot, so that may change. But the best that you can, make sure you like this person, and you are aligned on today's vision, and that they're a thought leader in terms of where the company might go. The other thing I'll note about the board is it has to approve certain material acts in order for them to be valid. So any issuance

• 2:48Speaker 01

  of any securities, so any stock, I don't care if you want to issue one share, it has to be board-approved. Option, yes. Any financing, that includes safes, convertible notes, preferred stock, bank debt, any, anything, M&A transactions, certainly, material contracts, and one that's also near and dear to all of our founders' hearts, hiring and firing the CEO. So the board has a lot of control. Like, that's, it's, it's, it's, it's a very powerful unit when you are looking at, at it.

• 3:20Speaker 00

  In the early stages, you have some investors, everybody's got an opinion on boards, of course. This is Silicon Valley and the technology industry. Some folks are like, don't do a board. Push it off as far as you can. Other folks are like, we need to get going on, you know, six board meetings a year, 10 board meetings a year. And I have always fallen into, hey, Series A, you're going to have to have a board. Before you have product-market fit, you're probably not going to have one. So there's something between those two moments in time. Typically, you raise over a couple of million dollars, or you start making over a couple, couple of million dollars. You might want a board to help you structure and

• 4:02Speaker 00

  see what's around the corner. So I tell folks, hey, add up how much you've raised, look at how much you're making. And you've probably never heard my speech on this, but hey, if that number is greater than two or three million, maybe a board, just one board member, one attorney, the two founders, just getting together and formalizing some stuff would be in your best interest. And you start learning. So then, when the Series A investor comes along, hey, there might have been three board meetings. There might be three board decks, and there might be some resolutions. That makes them feel more comfortable. That's my philosophy. What's your philosophy? When do you advise your founders that you're working with to start board meetings?

• 4:41Speaker 01

  Ideally, at the beginning stages, it's just the founder or founders that are initially on the board. And if you have multiple founders, it doesn't mean that every single one of them has to be on the board either. There's a bit of a negotiation that goes into that, and who should be the right folks. But one of the things that that's super important is you don't need to add five people to your board on day one, just like what you're saying, because you think it's going to help the company look better. In fact, if you do that, you've just lost control of your own company. They're going to be making the decisions for you. And even if we don't have board meetings, there's board actions that we need to take, right? You're probably going to be hiring some folks, and we want to issue option grants to them. We do that. We can do it by a written consent, instead of having

• 5:26Speaker 01

  to do a meeting, but it is still a board act. If we do it by written consent, every single investor, or I mean, sorry, every single director has to sign that written in order for it to be a valid act. So if you do it at a meeting, it's a majority. But oftentimes, in those early days, we're not having meetings, to your point. Once a company does a preferred stock financing round, that is when we often see an investor say, hey, I'm leading this round, I'm writing a sizable check, I want somebody from my team to be represented on the board, I want to see all this stuff and have a voice, and, and things that are going, going on with the company at that level. So I would expect to see, you

• 6:07Speaker 01

  know, a preferred director come in at that seed or A stage, when it's a preferred stock round. If you're doing a safe financing, I wouldn't expect there to be talk of whoever the lead investor is in the safe to say, I want a director. It usually comes at the time of that, that price round.

• 6:25Speaker 00

  Yes. And so convertibles, safes, those things occur, small amounts of money, the investors' own basis points or low single digits. They don't have enough skin in the game. They probably don't want to be on the board. If they do, it's like, why? But when they get to 10% ownership, 20% ownership, in my experience, they say, you know what? Probably should have a board seat here to represent, you know, that 10, 15, or 20% of the cap table. That's where I seem to, you know, over the last 10 years, see it start happening. Am I directionally correct?

• 6:58Speaker 01

  Yep, absolutely. I think, I think that's, I think that's exactly right, is investors are writing a bigger check, and they want some oversight to go along with their investment. They want to know somebody's paying attention and watching things. They have pretty sure duties to their LPs as well, that they need to, to fulfill. So that's often when we do, do see that preferred directors start to come in. But I would say, at that seed A stage, the common directors, the founders, would still control the board. It's usually, you know, we start to move to what I would call a balanced board, you know, maybe around the Series B. At that point, maybe there's two common directors, there's two preferred

• 7:41Speaker 01

  directors, and maybe we start thinking about adding an independent director around that time as well.

• 7:47Speaker 00

  Okay, so I'm in my seed stage. The board's me and my co-founder. My attorney shows up. Okay, now I'm at my Series A. My Series A investor joins the board, two founders, one Series A. I get to my Series B, I'm adding that investor who's putting in 10 million, 20 million. And then we're at an even number, which doesn't take a genius to figure out you could have a tie. And then you put an independent on. How is the independent most often selected by the board? Who gets to pick the independent? Because I've seen situations where the Series B investor or Series A investor says, oh, got the most independent board member you ever met. And then you get that board member on, and magically, they're

• 8:30Speaker 00

  always aligned with that Series A investor, because they were in the same frat, they both worked at Bain, and their families go on vacation together for the last seven years. And there's not much independent in the independent director. So let's talk about that, the independent director.

• 8:45Speaker 01

  Yeah. So the independent director, we try to say, when you're adding somebody at that stage, have it be an industry expert. Like, where do you need the most help? Where are you at, at the point in your, your company, right? If you are like, I'm struggling with, with getting access to this particular set of folks, and that's what's going to allow me to, to scale to the next level, somebody who's well-connected with that, or really knows that space, that's probably a really valuable person to bring on at that point. We do see sometimes that there are relationships that happen around the boards. Oftentimes, we do, the way that the independent director is selected, at least from a, what goes in

• 9:29Speaker 01

  the legal documents, it usually is common on one side, preferred on the other. So maybe it's common, you get to designate it. But if you designate them, I get to preferred, it has to be acceptable to the rest of the board members, or vice versa.

• 9:44Speaker 00

  Or start over. So you bring in your brother, or your mom, or your fraternity brother, they say, wait a second, your sorority sister's joining the board, doesn't make sense. So they can essentially have a veto. But if you say, hey, we need somebody, we're Airbnb, it'd be great to have somebody who knows hospitality. Oh, okay, we've, we've got Paris Hilton here, and she's from the Hilton family. Let's get Paris Hilton on the board. And everyone's like, okay, sounds great. It's going to be a great press release. And she knows hotels, and she certainly knows marketing. And everybody approves. The founder selected, the, the investors approve the independents on the board. What do you give an independent board director? What's the range of compensation for them? Hunter Biden got like $100,000

• 10:29Speaker 00

  a month, and a couple million dollars a year. I'm assuming that's the standard.

• 10:33Speaker 01

  Standard for for this stage of a company. Yeah, you know, and and what directors get in private companies at this stage is also very different than what directors get pre IPO or public company directors. I would say most times we're not even talking about cash consideration until we get to that really late stage pre IPO, maybe right before pre IPO, depending on, you know, how how big of a hot shot or that that you're bringing in, you may need something like that to lure them, but oftentimes it's just equity. And if it's equity, it's usually vesting monthly over a period of two years.

• 11:15Speaker 01

  And maybe it's something in over the course of the the two or four year period, maybe it's something around, you know, point five, one percent. It's it's, you know, maybe a little more than what you might give an advisor. But something in that range is pretty reasonable.

• 11:32Speaker 00

  You can actually look it up to see what somebody at one of the largest companies in the world, say, Apple gets paid a hundred K, two hundred K in cash. Maybe it seems like they're standardized on $250,000 in stock awards and they might get a little bonus for being on the audit committee of, you know, $50,000. So you're looking at a total comp of about $400,000 and that's probably a four year term, five year term, something like that. So that's the highest end here at your startup, 25 basis points, 50 basis points over four years of service, two years of service, something in that range.

• 12:09Speaker 01

  Yep.

• 12:10Speaker 00

  Do sometimes the board members ask for their travel and expenses to be paid? And then what's your take on that at an early stage startup? It's a maybe a negative signal?

• 12:18Speaker 01

  No, but I would say most do.

• 12:20Speaker 00

  Most do, okay.

• 12:21Speaker 01

  Most do.

• 12:24Speaker 01

  VCs are are mixed as to whether they will ask for it.

• 12:29Speaker 00

  Oh, I've never seen a VCS to be put up in the four seasons. Wow.

• 12:35Speaker 01

  I mean, they will, they may not ask for four seasons, but they may ask for. You want me to, you want me to fly out, I would like you to pay for my.

• 12:43Speaker 00

  Yeah.

• 12:44Speaker 01

  And in, you know, the company will have a travel policy and usually it'll be, okay, well, yes, as long as you follow this travel policy, which may not necessarily be a lie flat seat.

• 12:55Speaker 00

  Let's, yeah, exactly. It's gonna get a little expensive these days. Fuel's expensive for some reason. Let's talk about the difference between a board member and a board observer.

• 13:07Speaker 01

  Yes, so this is really important. I get this question a lot.

• 13:12Speaker 01

  Your board of directors is what we've been talking about so far. They are actually on your board. They are a director. They have voting power. So, you know, they get to vote on every action that's presented to the board. A director also has fiduciary duties that it owes to the company. So when that director is making a decision and saying, yes, I want to vote for it, or no, I don't want to to vote for this, just because that director says, oh, I actually, I don't like this. This is not going to be good for my fund, or this is not going to be good for me personally. But if it's in the best interest of the company and its stockholders, if you're exercising your fiduciary duties, you've got to say, fine, I approve it. That does not exist at the observer level.

• 13:57Speaker 01

  Okay, so that so an observer doesn't have either one of those. An observer does not have voting power, does not have fiduciary duties. What they have is a right to be invited. I want to be invited to the party and that's about it, right? They can attend the board meeting, they can receive the board materials, they get to sit there, they get to observe. Now, does that mean that they can't talk? No, they can talk, but and some board observers are very vocal and may even sway the direction that that the other direct, that the actual directors may go when it comes time for a vote. But ultimately, that board observer themselves, they do not have a vote on the matter. The fiduciary duty point, I would just emphasize on the board observer side, make sure you're

• 14:40Speaker 01

  getting a board observer provision or letter in place, because otherwise you don't have confidentiality, you don't have other things that you already have built into the fiduciary duty component of being a director. But they get that we hear all the same stuff. So it is important that they are are bound to the to similar confidentiality.

• 15:00Speaker 00

  And from the other side of the table, I have moved a lot since our firm has really started to investing and having a large portfolio. I've even had board seats where I've said, you know what? We're okay dropping down to a board observer if that's what you like. I'm going to send an associate, I'm going to send a, you know, an analyst. They don't even have to have their camera on, they're going to, you know, they may ask you a question, but I kind of instruct them to take notes. And I'm really looking for two things, like, how is the firm doing? Where are they going? And when's the next financing or corporate, you know, major corporate activity? If I just know those things, because when you're not on the board, very, you know, for the angel investors listening or for for seed funds, when you're not on the board,

• 15:43Speaker 00

  you get this weird phone call, hey, we raised our series A. And you're like, okay, and they're like, yeah, you need to sign in the next 24 hours. You're like, uh, what's happening here? And they're like, everything's changed, you're the last person who didn't sign, you don't want us to succeed, you need to sign right now. And it's like, wait a second, I need to read the documents, I gotta call my attorney. So it's a little game that gets played of like, hey, we've, everything's agreed and now you're the blocker. And it's like, wait a second, but you're issuing like 50% more shares? Like, that's not okay with me, I'm not signing. And I've gotten into this a whole bunch in the past where a shenanigan sometimes ensue. And when I say a lot of times, like count on one hand times in 600 investments, but it is so much easier to just be a board observer. Hmm, chef's kiss.

• 16:27Speaker 00

  They, I'm just, the second you tell me that the company's profitable or running out of money or raising around, like DM me on Slack, hit me up on Signal, send me a iMessage, just, that's all I care about from the board. You know, like, are they in trouble and they need my help? Or is there a great opportunity here? Are they selling? Like, sometimes we get told about a sale and like, what's the process? It's like, oh, yeah, no, six months ago, we ran a process and I'm like, oh, I know this CEO of that company, I could have called them. And they say, oh, yeah, no, we picked this terrible company that's giving us common shares and we're all getting washed out. Ah, so frustrating. So how do you remove a director?

• 17:07Speaker 00

  And under what circumstance can you legally, but then pragmatically? So let's say, you know, for Acme Ventures, I hope there's no Acme Ventures out there because I say Acme Ventures on our blogs all the time. If there is, I apologize. There is? Okay, Acme Beta Delta Ventures, can't be an ABD Ventures, Acme Beta Delta Ventures. If they send somebody to be on the board and that person's, I don't know, just kills the vibes, the founders don't like them, they're too pessimistic, they're annoying, they show up late, they call in from a cab on the way to the, you know, and they got a big speech they're going to give and they're breaking up on the phone. And that was my favorite from early in my career, the same.

• 17:50Speaker 00

  VC would call in from a car on the way to the airport and then wanted to everybody to hear a speech. How do you, how do you practically and legally, two different things, remove a director?

• 18:03Speaker 01

  Yeah, this is, this is a question I get a lot and it's usually not when things are going well. It's, it's when we're already in it and we're like, how, this is not working. I want, I want out. I will often compare preferred directors to like anybody that you add to your board, right? You've talked about how important it is, like, it's like a marriage, like before you get into it, do your diligence, make sure you're aligned, do they want kids, all that stuff, right? You, you're the one to talk about.

• 18:30Speaker 00

  Do you want a second home or are you okay with going to a hotel? Which is, how is that, that's a big one.

• 18:38Speaker 01

  It's a big one.

• 18:39Speaker 00

  Same vacation every summer or we are different?

• 18:43Speaker 01

  But but you know, out there, the big difference with marriage and preferred directors, in a marriage, you can say, man, this is not working out. I'm out. I unilaterally can can can remove myself from this situation. That's not the case for preferred directors. Unless they are willing to go and they agree to go, there's nothing you can do as a common holder to do it. And I'll tell you why. So directors are elected by stockholders. They are removed by stockholders. The way that we set up the board in a venture backed company is to specify that certain classes or series of stock are entitled to elect certain seats.

• 19:27Speaker 01

  So what this means is we're going to say, hey, you've got two common seats, which means those two seats are elected by common, the majority of the outstanding common stock, whatever you say, that's who's going to sit in those seats. When we have a series A investment come in and the director and the lead investor says, I want a director, we create a series A preferred stock seat, which is only elected by, if you guessed it, series A preferred stock.

• 19:57Speaker 00

  Yes.

• 19:57Speaker 01

  So you can hold super voting stock, you can have your common shares 100 votes per share and the preferred will have one vote per share. Guess what? Your common shares don't vote for that director. So you can't vote to remove that seat. On top of that, what gets negotiated in these preferred stock financing documents is that the lead investor will negotiate to say, I have designation rights with respect to that seat, so long as I continue to hold, fill in the blank, it's usually 25 to 50% of the shares I'm purchasing. And everybody else has to vote this way.

• 20:33Speaker 00

  Yeah, dragged along.

• 20:35Speaker 01

  We ensure that's the case by putting in place a voting agreement. All the common stockholders, all the preferred stockholders, you're going to be parting this voting agreement. When lead investor says, I want John Doe to sit in my seat, everybody has to vote in favor of that. So there's just no way of getting around it. Unless that early stage investor says, okay, you've, you've had a grown up conversation with them, you've explained that the alignment isn't there, that I'm going in a different direction and won't you please step off? Or it may be, you're a series D E company and the board is getting really lopsided, you're getting some later stage VCs that do want to join the board and they're the

• 21:20Speaker 01

  ones that are actually supporting the company to be able to get to that next stage and maybe this early stage investor. They're out of funds. This isn't really the space that they play in. Maybe they aren't as valuable as they once were. You're feeling like, I've got 10 people on my board. I need to get rid of somebody.

• 21:35Speaker 00

  Yeah.

• 21:36Speaker 01

  Practically, it's having a conversation, trying to get folks to come to the same place of

• 21:44Speaker 00

  Yes.

• 21:45Speaker 01

  what's best for the company. And hey, you still have your investment in the company. You want it to continue to grow. This is the direction. Can we amicably?

• 21:53Speaker 00

  This is where relationships really matter. And so if you're best advice for a founder is, hey, build that relationship fabric. Go for a walk along the Embarcadero with your board member. Invite them to come out a day early and have lunch with you and visit the management team. If they're leaving the next day, I had one founder who would always insist on driving me back to the airport and we'd have a conversation there. Sometimes we'd sit in the car for 20 minutes, you know, waiting for my, my, my plane to board. You invest in those relationships so that later on, when you need to have hard discussions, you know, a little bit of, um, sugar helps the medicine go down, doesn't it? Yeah.

• 22:32Speaker 01

  That's right. When you started saying you're gonna take a walk along the Embarcadero, I thought you were taking my marriage analogy a little too far, but.

• 22:38Speaker 00

  Yeah, we gotta go for a walk, honey.

• 22:42Speaker 00

  We're going down the end of the pier. It's gets very dark. Yeah.

• 22:48Speaker 00

  No, it's I, I, I do find that the people let things, you know, these are very important relationships. They don't invest in them. When things get hard, and this is, you know, back to dating or marriage. If you guys have had a, you know, strong marriage and then something happens that's difficult, somebody gets sick, God forbid, or whatever, you have a challenging child, whatever it happens to be, at least you have that relationship fabric to, you know, as your foundation. So build that foundation. If you're a founder, if you're an investor, be a good person. Be a good person. That's it. Pretty simple. Be a good person. Doesn't mean you have to give up your board seat. In those situations, I'll say, you know what? Um, I don't want to be at the party. If people don't want me at the party, I'll just move to an observer.

• 23:29Speaker 00

  And that's usually my concession. Like, if I'm not valuable, the good news is I've become increasingly valuable in my career because I work hard. And then people are like, do we not want Jacob to come to the board meeting? That would be kind of dope for him to be at the board meeting. And he's also fun. So if you're, it sounds crazy, but you've been up boards where there are some people who are just miserable. And then there are some people who are like positive and like you leave the board meeting feeling like, hey, even though there's some challenges here, hey, we're in it together, esprit de corps. And, you know, we, we can solve these problems. I think that is something board directors, you know, sometimes miss in their mission. Like you're not here to be the most abrasive person in the world. You're here

• 24:11Speaker 00

  to be constructive. I mean, this, I mean, criticism can't happen, but random legal question, Becky.

• 24:16Speaker 01

  Okay.

• 24:17Speaker 00

  Is it pled or pleaded? If somebody pled guilty or did have they pleaded guilty? I keep seeing this coming up. Everybody's pleading and pledging and I don't know what's the right word. Do you know?

• 24:31Speaker 01

  I don't know. I don't, I don't deal with guilty. I don't get it for it. I don't know.

• 24:35Speaker 00

  Preparara says pled. He doesn't like when he sees pleaded. So he says pled. All right. Becky DeGraw, Wilson Sonsini. Go to startup basics at this week in startups.com slash basics. We'll see you next time.