Empty Chairs in the Board Room

I was speaking recently with an entrepreneur in Texas who had just raised a round of capital under unusual circumstances. The venture capitalists who had led both his Series A and Series B rounds had departed from their firms, leaving the entrepreneur with empty seats on his board. When an outsider-led round failed to materialize, he had no champions among his insiders to catalyze a bridge round, an insider-led round, or any other option. Out of choices, the founder, in a bravura seventy-two hour sprint, put together a financing package from untraditional investors that saved his company and allowed him to live to fight another day. It could easily have gone the other way, resulting in the termination of dozens of employees and the abandonment of hundreds of customers who had come to depend on the startup’s critical system to run their businesses.

Putting aside the specifics of the deal, I spent the rest of the day reflecting on what a founder could do ahead of time, if faced with a situation involving a lost sponsor, to avoid the eleventh hour heroics that were needed to save this particular company. I came up with a few ideas:

Demand a new board member: The moment you receive the email with one of the usual subject lines (“Moving On,” “A Next Step in my Journey,” etc.), email the managing partner of the venture firm that led your round. Get a meeting booked — not for next month, but the very soonest both of your can meet, ideally within days. Ask the managing partner to take up your board seat himself or herself. When you’ve experienced sponsor turnover, you want the person with the most power at the firm to step up on behalf of your company. Filling your board vacancy with the managing partner will send a message, both within the firm and without, that your company matters to your investor. If the managing partner is unwilling to step in, ask the firm to appoint someone to fill the seat immediately. Show up at the Monday morning meeting, if you have to, to ask for a volunteer.

Ask another investor to serve on the board: If no one from your lead firm is willing to serve on the board after your sponsor leaves the firm, then you need to ask the lead investor to waive their right to appoint a person to your board. Then you need to get someone else in that seat ASAP. The most likely candidate is a partner at any firm already on your cap table, but who did not lead your most recent round.

Appoint an outside board member: If no investor wants to take the vacant board seat, you’ve got problems. You need the board seat filled no matter what, so you need to appoint someone. Ask the venture firms to waive their right to the board seat, and fill it with a friendly, experienced outsider.

Read your docs: At the same time, you should also ask your lawyer to review your financing documents to understand which actions require board approval, which require approval from specific investors or classes of investors, and which require approval from the overall shareholder base. You need to be crystal clear as to where you stand, especially if your share count has changed between the time of your last raise and the time of your board member’s resignation. Share counts and control provisions can change between rounds due to the issuance or conversion of notes, the exercise of stock options, or any other reason that changes your cap table.

Any VC firm no longer on your board should lose blocking rights and control provisions: If you could not convince your lead firm to appoint a new board member, you should ask your lawyer to present the firm with documents to sign waiving their right to pro rata, their right to approve future funding rounds, their right to approve M&A transactions, and anything else that might give that firm undue control over the future of your company.

Start your raise now: Unless you were already profitable, chances are that you intended to raise additional capital at some point. If your lead investor appointed a replacement board member as part of a smooth transition, you probably do not need to change your funding plans. But if the process was not smooth, then your next round will be harder to raise than you were expecting, and you should probably begin the process sooner than you had planned, if not now.

Venture capitalists, like anyone else, do not stay in the same job forever. Founders shouldn’t let the career decisions made by their investors negatively impact their startups. Hopefully some of the ideas discussed in this post can help avoid such a situation in the future.