Jun 8 2008 by Jason

Founders Termination Clause In Term Sheets?

Q: Thank you very much for your term sheet series.  Not being that familiar with "specific" term sheets, I have heard something about VC terms that effectively allow the VC to fire the founder(s) and in the process relieve them of their shares since they had then left the company before liquidity. I have read a previous Ask the VC post about the ‘moral’ and ‘reputation’ reasons that VC’s will not do this.

However I am more interested in the legal binds and would like to know if these sort of terms are something that is standard/negotiable in various term sheets.

A: (Jason).  There is certainly nothing in a standard term sheet that specifically addresses this.  I’ve seen founder / CEO termination clauses in term sheets that effectively say "if X, Y and Z doesn’t happen, you are fired."  I’ve always found these to be egregious and worse yet, sets up the VC and founder / CEO to be enemies, not collaborators trying to help the company be successful. 

As for different mechanics that a VC might use to remove a founder / CEO / founders, etc.:

1.  Board control – if the VC has board control, or the ability to elect a majority of the board, terminating founders and / or executives is fairly simple;

2.  Voting rights – be careful that there aren’t any non-standard control provisions in the voting rights that allow the VCs to vote people "off the island."

As far as acquiring the terminated party’s shares, I’ve never seen a VC with a contractual right to be able to do this.  I’ve seen some documents which gives the shares back to the company, but never the VC.

And shares going back to the company is rare as well, so long as we are talking shares that have vested under a option plan or are not subject to some sort of repurchase.  Those shares should be free and clear the property of the terminated party.