legal-structure
What are protective provisions in a VC deal?
Protective provisions give preferred stockholders (VCs) veto rights over major company decisions like raising new capital, selling the company, or changing the charter.
Protective provisions (also called negative covenants) are rights that allow preferred shareholders — typically VCs — to block certain major company actions without their approval.
Common protective provisions include veto rights over: - Raising additional equity financing - Selling or merging the company - Amending the company's certificate of incorporation or bylaws - Changing the rights of preferred stockholders - Increasing or decreasing the size of the board - Paying dividends - Taking on significant debt - Liquidating or dissolving the company
Why they exist: VCs invest in preferred stock with specific rights. Without protective provisions, a founder could take actions that directly harm those rights — like issuing new shares that dilute the VC, or selling the company for less than the liquidation preference.
How they're exercised: A majority vote of preferred stockholders is usually required to block an action. This prevents any single small investor from holding the company hostage.
For founders: Protective provisions are standard and reasonable. The key is to negotiate which actions require approval and what percentage of preferred votes are needed. Watch out for provisions that require consent from specific investors (not just a majority) — these create individual veto powers that can become problematic.
Related glossary terms
Related questions
What is a board of directors and how does it work at a startup?
A startup's board of directors is the governing body that hires/fires the CEO, approves major decisions, and represents shareholders. Early boards typically have 3-5 members.
What is a term sheet?
A term sheet is a non-binding document that outlines the key terms of a proposed investment — valuation, amount, ownership percentage, and governance rights. It's the starting point for negotiating a deal.
What is a liquidation preference?
A liquidation preference gives investors the right to receive their money back before common stockholders (founders and employees) get paid in any sale or liquidation of the company.