The terms sheet sets out Drag along rights and Protective Provisions
Drag along rights give the investor the right to force the shareholders (founders and others) to sell the startup. Drag along rights are common in VC deals.
The primary reason for a drag along rights clause is that the lead investors want out and require others to join.
Protective provisions state that if the founders want to take any action that might affect preferred shareholders’ investments, the founders have to inform the preferred shareholders and get their collective approval first.
Here’s a list of common protective provisions:
• Merge, sell, or liquidate the company, or any transaction that results in a change of control of the company.
• Change the capitalization structure of the company
• Issue stock senior to or equal to the stock held by the preferred share investor( s).
• Change the certificate of incorporation or bylaws.
• Change the composition or size of the board of directors.
• Pay or declare dividends.
• Take on a debt obligation such as a loan.
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Hall T Martin is the director of Investor Connect, which is a 501(c)(3) nonprofit dedicated to the education of investors for early-stage funding. All opinions expressed by Hall and podcast guests are solely their own opinions and do not reflect the opinion of Investor Connect. This podcast is for informational purposes only and should not be relied upon for the basis of investment decisions.