When accepting money from outside investors, entrepreneurs are generally asked to give up some degree of control over their start-up, exchanging equity in their company for cash. In an effort to minimize the control they relinquish, upon formation of their company entrepreneurs can grant themselves equity that comes with special rights. These rights, such as special voting privileges or guaranteed board seats, allow founders to maintain control of their company in spite of a dwindling ownership percentage. They may also include special rights that make it possible for a founder to cash out some of his equity prior to an IPO or other exit event.
Investors, of course, may prefer that founders not be granted these special rights, and the extent to which these rights survive a round of financing will be the product of negotiation and leverage between the parties. But even though none of these rights may survive, they can play a crucial role in leveling the playing field heading into negotiations, while also signaling to investors that the founders want to be active collaborators in the growth of the company going forward. A reasonable and balanced approach will also let investors know that the founders will be savvy, but practical, partners. We believe that the special rights granted to founders under our model formation documents are a balanced approach that fairly aligns the interests of founders and investors.
FOUNDER CONTROL
Our model formation documents provide that founders are issued a special class of common stock dubbed the "Entrepreneur's Shares" or "Class E" Common Stock. These shares carry protective provisions, similar to those typically granted to holders of preferred stock, requiring a majority vote of Class E stock for the company to undertake certain actions: (1) amend the Certificate of Incorporation or by-laws of the company, (2) acquire or dispose of capital stock of a subsidiary other than a wholly owned subsidiary, (3) change the size of the board of directors, (4) create an additional class or series of capital stock, or change the authorized number of shares of any class or series of capital stock, and (5) liquidate, merge or consolidate the company.
Class E stock also carries special rights with respect to the company's board of directors. Holders of Class E stock, voting separately from all other stockholders, are entitled to elect a majority of the members of the board of directors serving at any given time, ensuring that at all times the founders will maintain majority control of the board. Further, a unanimous vote of the Class E appointments to the board is required in order for the company to make changes to its stock option plan, or to issue any debt securities.
Notably absent from our formation documents are across-the-board "super-voting" rights for Class E stockholders. Other initial capitalization schemes provide, for example, that founders' shares carry 10-1 voting rights on all matters brought before the stockholders. We believe such a structure is particularly unappealing to investors, who may not want to purchase preferred shares with voting rights dwarfed by those of the founders. Our model, in which all shares carry equal voting rights, promotes an atmosphere of collaboration between founders and investors, while vesting ultimate control in the company in the founders through protective provisions and board seats. While investors may also balk at our model, we believe it appears more reasonable than super-voting provisions at first glance, and will lead to more productive negotiations regarding post-investment control over the company.
FOUNDER LIQUIDITY
As a collateral benefit to our approach, founders holding Class E Common Stock can also enjoy greater liquidity of their shares. Unless they are bought out or the company undertakes an IPO, it can be difficult for founders to convert their equity in a company into cash — Investors are rarely willing to buy common stock from a founder during a round of preferred financing. Moreover, if a founder se
