Veto Rights - Who Needs Them?

  • By TLV Partners
  • 26 Jul, 2017
There is no simple solution for all potential conflicts in your startup.
But you can encourage your investors to collaborate by giving them veto rights as a group. Avoid giving veto rights to a single investor.  

What are Veto Rights?

In VC investments, the investor usually does not control the company. Even large investors will hold a minority stake – often as little as 10-25%. Most investors find this troubling because they are putting their money at risk. As a result, many investors insist on veto rights.

Veto rights do not entitle your investors to make decisions on behalf of the company. But rather allow them to prevent a decision being made that they disagree with.  Some of the issues covered by veto rights are crucial for the adequate governance of the company. It is also in the entrepreneur’s best interest to involve his/her lead investors in these crucial matters (sale of the company, allocation of more ESOP, Fund raising, etc.).

However, veto rights provide its holders with significant power. When give to a single investor, this power can sometimes be abused.


Who should get Veto Rights?

When negotiating a term sheet, you should seek to form a well-functioning partnership among your investors. Building a company is a long process with unpredictable ups and downs. A good partnership is a source of great power and support, but it requires compromise - from everyone.  

The challenge with veto rights is typically not the rights themselves but rather who holds them. Most investors, when leading a round, will request veto rights. Meaning that, they will have the power to veto any major decision. When conflicts arise, investors with veto rights are less likely to compromise. Giving veto rights to single investors will increase forceful interactions. And unfortunately, conflicts are a part of building a company with many parties.

Conflicts are highly likely to arise throughout the journey of building your company. However, you can solve conflicts through open discussions and compromises to reach decisions and solve issues. The way to do this is by giving veto rights to the investors as a group instead of to single investors.  Each investor will not be able to cast a veto, but as a group they can stop the CEO from making unreasonable decisions. 

Why keep veto rights at all?

As a founder you want a mechanism of control over the board, especially as you add more investors. If you don’t like veto rights you can replace them with affirmative voting rights. Affirmative voting rights give the investor the right to approve all major decisions . We don’t like, and never ask for affirmative voting rights. Reaching each investor in order to get decision approvals is highly inefficient when running a company. Casting a veto is a big deal and investors will think twice before doing it. On the other hand, delaying a decision approval is a lot easier and your investors will not consider it as big of a deal. If you ask for affirmative voting rights, you should expect lengthy decision making processes.


TLV Partners’ approach and recommendations

We take veto rights seriously, for us it can become a show stopper when doing a deal. We insist on sharing veto rights even if we are the largest investor. If previous investors are not willing to share their veto rights, we may pass on the deal. We also cut veto rights as much as possible and reserve it only for the most crucial of matters.


To summarize:

  1.  Limit veto rights to only crucial matters.
  2.  Insist that no single Investor can exercise them.
  3.  Avoid affirmative voting rights.
  4. Check carefully who you bring as a powerful partner into your company.

Have a great summer!

Rona

TLV Partners Blog

By TLV Partners 16 Oct, 2017

For years VCs have preached to their companies the importance of tracking metrics that accurately measure their day to day operations.

Giving advice to others is much easier than implementing it yourself, and it takes guts to honestly measure yourself. When Eitan and I started TLV Partners, one of our earliest decisions was to track our key metrics. One of our top priorities in ensuring a professional experience for entrepreneurs, therefore we defined a set of metrics around our response time. More specifically, how many days it takes us to respond to emails (“respond”), set initial meetings (“set a meeting”), return with an answer whether we would like to proceed (“answer”) and conduct due diligence (“DD”).

Once we defined our metrics (we officially began tracking this data at the beginning of this calendar year), it was time to take a look at our performance. . We were pleasantly surprised to see the results, but there was clearly still room for improvement:

By TLV Partners 26 Jul, 2017
There is no simple solution for all potential conflicts in your startup.
But you can encourage your investors to collaborate by giving them veto rights as a group. Avoid giving veto rights to a single investor.  
By TLV Partners 14 Jun, 2017

There is a common belief that participating preferred is always better for investors.


Here’s a brief overview of the various liquidation preferences investors may ask for. Liquidation preferences determine how to divide the proceeds from the exit.

  • Pro-rata distribution: Each shareholder receives their percentage in the company.  i.e. - shareholders that hold 20% receive $20M in an exit of $100M, 20%x$100M=$20M).

  • Non-participating preferred:  The investors receive their money back OR pro-rata distribution. Whichever yields more money to the investor.

  • 1x participating preferred: The investor get their money AND pro-rata distribution. This is often referred to as “double dipping”.

  • 2x+ participating preferred: The investor get 2x on their money AND pro-rata distribution.  In some cases, investors ask for a higher multiple - 3x-5x.

  • Interest: Investors often ask for annual interest of 4-8% on their investment.


VCs have one common goal - they all aim to increase shareholder's value. Many Israeli entrepreneurs share this dream as they want to build long-lasting companies. This alignment of interests makes sure everyone is working to achieve the same goal.

Yet, participating preferred creates an inherent misalignment of interest between VCs and entrepreneurs.

Take for example an entrepreneur who faces a decision whether to sell the company now for $150m. His investors agree that the company’s potential could be much higher in 2-3 years. But the company would have to raise another $20M to reach said potential. Luckily, there is a late stage investor who is eager to invest in the company at a reasonable valuation. The decision should be simple -  a good opportunity to increase the value at a reasonable price. But here is where the participating preferred misalignment kicks in. The entrepreneur, upon an exit, will have to pay back an extra $20m plus interest before seeing any profits. Not to mention the fact that he/she will be further diluted. VCs are professional investors and part of their job description is to take risks. Entrepreneurs are dreamers that dedicate their life to build companies. Some entrepreneurs at this point will decide to sell the company and reduce their personal risk. The investors will lose much more than the potential profit from the participating preferred.

By TLV Partners 05 Jun, 2017
By Eitan Bek
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Cloud computing is an area we find especially exciting. It has brought enormous change to the world of applications and it would be no exaggeration to say that most of the innovation in IT over the past decade has been enabled, catalyzed, or caused by cloud computing. Currently, we are in the midst of a microservices revolution, one that has, until now, been championed by containers. Through our investment in Aqua Security over a year ago, we have witnessed first hand the rapid growth this market is experiencing, and believe it will continue to proliferate enterprises across the globe.  We are now on the cusp of another revolution in cloud infrastructure: the move to serverless computing.


By TLV Partners 11 May, 2017
By Rona Segev
By TLV Partners 27 Apr, 2017
After a half-decade of quiet advancments in artificial intelligence (AI), 2016 was a turning point in AI. Computers are now smarter and learning faster than ever. The timing of this progress is no coincidence, rather it comes as a result of several coinciding market factors.

Take image recognition for example. Recent advancements in this field can be traced back to a team of University of Toronto researchers, who won the world’s top image-recognition competition in 2012. That team was eventually recruited by Google, and its approach, which relied on a technique called deep learning (a subset of AI), was quickly adopted by the company. In a short period of time image recognition systems based on deep learning have become much more accurate; test error rates are down to about 5%, roughly on par with a human’s performance.

By TLV Partners 02 Mar, 2017

We are pleased to share with you our glossary of must know terms that all entrepreneurs should understand. Founding a start-up is a significant undertaking, knowing the basics is the best place to start! 

Good luck!

http://bit.ly/VCglossaryTermsTLVPartners


By TLV Partners 07 Feb, 2017
Not long ago, I was invited to an event held by one of the world’s leading investment firms. The similarities between most people in attendance were uncanny: powerful men, wearing suits worth thousands of dollars, and watches that probably cost a small fortune. Not surprisingly, the atmosphere surrounding the event was almost a cliche of how powerful men talk and behave.

Throughout the day, many panels on doing good business were held, and each speaker shared their version of proper behavior when investing. Most of the ideas revolved around taking good opportunities, and aggressively attacking them. For example, one speaker said that the first thing he does when investing in a company, is getting rid of all the members of management, and appointing members of his own.

But then, someone different took the stage. He was head of one of the smaller firms in attendance (still in the billions, though), and from the minute I saw him, in his modest-looking tweed blazer, he attracted my attention. When asked what he thought is the most important aspect of business, he used a word that was previously not uttered that day: “Nice.”

“To me,” he said (and I’m paraphrasing), “as important as it is to find good opportunities, being decent and nice to the entrepreneurs you work with, is no-less important.” The room fell to silence. An air of contempt was felt, as he calmly continued to explain the reasoning behind his word-choice. “Being nice is good for your business, great teams will want to work with you, will be willing to give you better terms - not to mention that you all benefit from the pleasant atmosphere. It’s important to me that if my kids meet someone I do business with, they would hear: ‘your dad is a really good guy.’”

I was in awe of this man. There he was, in a proverbial shark tank, surrounded by these corporate warriors, discussing the importance of being nice. What really impressed me was the fact that he wasn’t hesitant or apologetic, and showed as much confidence as any other speaker there, while presenting his rare business philosophy. In an ocean of forceful language, he was an island of calmness. As powerful as all the other men in the room were, in my eyes, he was the bravest speaker there.

I admire people who are not afraid to do things their way. If there’s something I’ve learned in my many years in the field of venture capital, it’s that there’s no one way to succeed. So many of us in the industry yield to these notions of power, and forceful language, and forget that things could be done differently. I think the most important thing I took from this event is the notion that, when you’re good at what you do, you can be successful without having to give up on what you believe is right. When doing business, it is important to be assertive, make good decisions, and take advantage of good opportunities - but you could still be “nice” when doing so.

By TLV Partners 13 Dec, 2015
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