Read the term sheet control clause carefully

The control clauses on the term sheet can reorient the power of investors or owners regardless of share percentage.

Investors and entrepreneurs share a common financial motivation in their company. The entrepreneur grows the value of her shares when the company performs well, and the investor maintains good prospects for a multiplied return on investment. When both parties think wisely about the long-term effect on the company, they will negotiate economic terms that offer mutual motivation to see the company succeed. The control clauses; however, are another story.

No entrepreneur wants to confine themselves to the decisions they may make about their company. When the entrepreneur incorporated the company, she had total authority to make or change any decision about the company she wants. If it goes poorly, she may want to sell. If it goes well, she may want to secure additional funding to accelerate growth. Investors do not share the entrepreneur’s sentiment.

Investors may not set out to seize total control of the company, but they certainly want to curtail the powers of any who’s decisions could affect their financial outcome. Whether by direct effect, such as a conversion of the investor’s preferred stock to common stock, or indirectly by the licensing of intellectual property rights, the entrepreneur initially holds power to dramatically influence the financial outcome of an investment. Investors rarely agree to supply any amount of funding without a slew of protective provisions that restrain the entrepreneur from carte blanche decisions.

For any entrepreneur, and even more so for the entrepreneur whose values encompass multiple bottom lines, control of the company may be more important than financial success. Investors may supply entrepreneurs a share of the profits if only to motivate them to make good on their investment, but control is less willingly shared. Entrepreneurs must guard themselves from hedging their decisions so much that the company could deadlock from an investor’s veto. These controls don’t have to directly influence the entrepreneur’s priorities to be risky.

An entrepreneur who highly values social impact may invent a remarkable new mosquito repellent. Eager to spread this wonder to the world, she may accept several rounds of investment and many protective provisions on subjects she cares little about, such as the authorization of stock or the power to change the bylaws. When an outbreak of Zika virus in Venezuela threatens to damage a generation of babies, she’s convinced that her mosquito repellent be sent in bulk at a reduced rate to protect the innocent. She’s shocked to learn that her investors reject this decision because it will lengthen the time that the company can be profitably sold by several years, and that they threaten to veto any attempts to sell the company or the patent to the mosquito repellent if she does not comply to their wishes. She’s faced with a terrible decision - choose to help Venezuela now and possibly cripple her chances to help the world, or abandon Venezuela for the hope of a greater impact.

Control is where the true concern lies when accepting investment. A wise investor can be a positive addition to a company; no entrepreneur need worry about sharing control with an investor they trust absolutely. The balance of control may actually protect the company by allowing cooler heads to prevail when an irrational decision from the entrepreneur could cripple the business. As with marriage, another commitment that can control one’s future, investment with protective provisions can alter the future of a company in every part. When I consider the non-monetary bottom lines we’ve discussed in this MBA, these are the first to be swayed by the influence of investors. An entrepreneur who cares only for money has little to concern himself with except the most radically unjust provisions, but the rest must take a more wary stance to protect spiritual, cultural, or social bottom lines from undue control by investors who do not share the entrepreneur’s values.

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