Who Is Looking Out For The Interests Of The Founders?

UK Private Capital (formerly, the BVCA) aims to standardise Series A transactions and focus negotiations on (fewer) key points. The increasing use of AI to generate initial drafts based on standard terms like these, which are effectively created by VCs and their lawyers, will likely only accelerate this trend.

While not necessarily unfair, this raises the question: who is looking out for the interests of the founders? Currently, founders lack a formal platform with industry-accepted tools to negotiate effectively. This article aims to provide some guidance.

1. Leavers and (Reverse) Vesting

On leaving the company the customary-ish position here is that all the shares held by a founder are forfeited if that event is owing to fraud, gross misconduct or breach of any compete-restrictions or any employment agreement (in other words, a bad leaver). On departure for any other reasons (that is, a good leaver) the forfeited shares are only those that are not vested. The standard vesting period is typically 36 or 48 months on a linear basis save that there will be likely be an initial 12 month cliff where no vesting applies.

What may additionally be negotiated is that:

- Resignation: the UK Private Capital terms flipped in 2023. Previously resignation would amount to being a bad leaver event. It is to be applauded that an industry body representing VCs was able to consider that a resignation should not necessarily lead to a founder losing everything. Sadly, some term sheets we see resile from this and re-flip. This has led to intermediary positions where, for example, the founder must not resign during an initial period but thereafter can resign and be considered as a good leaver (though this tends to apply to more mature businesses).

- Pre-vesting: there can be an iterative discussion that the founders have already earned some of their shares and those earned shares ought not be subject to vesting. This tends to apply to the "older" companies or to founders who have already navigated (even if only in part) vesting procedures in a prior seed round. This will be a Series B consideration, but we have seen this apply on a Series A. Be wary, this may be implemented as an adjustment to the vesting percentages; vesting in its standard format only applies to a good leaver – forfeiture of all shares on a bad leaver event does not look at the vesting schedule, so if a bad leaver is intended to keep shares a specific change must be made. Lastly, it should be clear to all these provisions should not apply to shares purchased or to be purchased by the founder for value.

2. Other thorny deal terms

Lastly, here are some thoughts on some common areas to consider in investor-driven financing documentation. Of course there are more:

- Lead investor: we are seeing fewer term sheets with the principal investor being prepared (at least, expressly) to take the "lead investor" role. Without it, alignment can become problematic if there are multiple investors contributing meaningful amounts. Please consider carefully at term sheet stage the process as between investors and the likely input from those that are less involved. Some of the terms defined by reference to share percentages need to be considered too. For example, if it is likely that some VCs will be marginally below an investor director appointment right threshold, how would the balance on the board be impacted if on a pre-emptive round that threshold is exceeded? Will there be further VC appointee director? Or does this remain as previously? Does an observer right need to be considered? Moreover, when making warranties, will these be made to all the investors or just the VC that ought to have been the lead? If more than one, it would be an odd conclusion if one decides to make a claim and the other(s) decide to pass? These may seem like the driest form of lawyers' points, but if not resolved at the outset more time can be lost later when less of it is available.

- Anti-dilute: this form of down round protection has now been the market standard for 20 years plus. There are two types, one used in the US (and adopted by the NVCA) and another used in Europe. It is regrettable that the latest round of changes the UK Private Capital terms were not adjusted to adopt the NVCA model, for that it is the original and is more widely-used (including across the Middle East). It is also simpler administratively. There are many articles on the internet to explain the differences; but what is important to note is that both lead to a balancing equity correction in favour of the VC if a down round occurs. The rebalancing is very rarely substantial unless the down round is significant; this must therefore be primarily regarded as an anti-embarrassment provision. I have written a lot about these clauses (as in my experience not many actually read them), but I will restrict myself to:

• A sunset provision should apply on the basis that there is no longer any embarrassment. This can be after a period of time (suggest, 12–24 months) or upon the occurrence of a higher price round. In any event Series B VCs (who were not part of the Series A) are always loath to agree to this compensation for earlier round investors.
• The underlying math is designed for one application only. This is because the corrective measure arising from a prior down round in not actually factored into the weighting used in the formula, unless adjusted. In nearly all circumstances, when the formula is retained that adjustment is not made. It is possible to argue that few really understand the formula and even fewer actually care about the result it delivers other than the fact that it delivers one (and it is "standard"). But one thing is for certain, the founders (as they are rarely also investors) are diluted the most.
• We are seeing instances where these terms are integrated into seed rounds. These clauses were designed for Series A and onwards; we would caution founders against agreeing to them on an earlier financing where the underlying valuation is less formulaic.

- Investor consents: even though investor consents now tend to take a common form, I still am asked about these. They are a major change in governance for the founder (especially those who have not undertaken a meaningful seed round). The three areas on which I ask founders to consider are:

• The capital related consents, that is the need for an investor consent to agree to issue shares or rights to shares. There is a lot to unpack here, including the legitimacy of a VC being afforded a veto in circumstances where they have the ability to pay-to-play through pre-emption but decline. But that is for another day; the veto has become "standard". What is left is that the founders should consider whether further issuances are contemplated shortly after closing or whether any option plan is to be implemented so that these can be excluded from the consent right (essentially, they are pre-approved);
• The business-related consents, as these come from a customary template, these should be assessed as whether they are appropriate or germane to the business. If they are not, the offending consent rights should be amended or deleted; and
• The nature of the investor majority which decides matters is different for each business. If it relates to a percentage and that percentage is too high, this will mean that smaller investors will wield power beyond that merited from the capital they have introduced.

- Founders' warranties: the UK Private Capital terms are based on warranties being given by the company. We see the VCs departing from their own standard terms, by inserting that the warranties must additionally be given by the founders. Standardisation here is problematic, this is because the limitations (of liability) set out elsewhere in those terms are based on the warranties only being given by the Company. Additional terms need to be added to protect the founders here as (for example) they should have a liability capped at a much lower value than the total funds raised. We commonly see drafts where these protections are (hopefully, mistakenly) omitted in the opening draft.

- Deal fees: information on deal fees is less widely available and is to some extent anecdotal. As to arrangement fees there is a fair amount of disagreement between VCs as to whether they should be chargeable at all and, if not, whether they are to be baked into the underlying valuation. We find that some of the larger VCs with an international footprint are less keen on deducting an arrangement fee from introduced funds. Elsewhere we see fees calculated at 2–3% of those introduced funds, though we are seeing a slight nudge beyond that from time to time. A contribution to VC legal fees is typically capped at the first £30k of fees accrued. Founders who have been through a seed round will be accustomed to a quarterly monitoring fee (at say £20k–£30k per annum). This mostly (but not always) falls away on a Series A. For those VCs with – let us say – a PE heritage, this monitoring fee may be replaced with a director's fee contribution. This can be up to £50k per annum (which in our opinion is on the high side). In all cases, we suggest that these fees should at least be discussed, the final agreement being heavily coloured by the weight of bargaining power.

3. "We want to reward our people, but we run the business"

It is surprising to me that non-voting shares are not introduced at an earlier stage. The first gating moment tends to be upon the implementation of (if in the UK, a tax-efficient) option scheme. In most (but admittedly, not all) instances shareholders other than the founders who become stakeholders at an early stage are less interested in voting and management. The chief requirement is a right to a future economic return, perhaps as a compensation for reduced income. It's an easy change to the articles and gives more decision-making authority to the founders through the later aspects of their corporate journey.

4. Housekeeping: the Register of Members, Cap Table, and Share Certificates

Many of my founder clients do not appreciate that their company must have a Register of Members. This is distinct from making filings at Companies House and is not the same as a cap table. As a matter of law the entries in the Register of Members are the primary evidence as to identity of the shareholders and the shares they own. The cap table must reflect this; it is not supposed to be the other way round. We are now beginning to see tools which can help with these tasks. We recommend creating the Register at an early stage when there are fewer shareholders. Recalling the requisite detail at a later stage is sometimes not straightforward. Before the term sheet stage, please ensure any promises to issue or transfer shares are fulfilled or clearly documented for completion at closing. Unresolved share promises often surface during financing rounds. This can frustrate VCs, risks losing momentum and can delay closing.

As to the cap table, it is common to see shares and options (allocated and unallocated) being treated together. This has a clear function in terms of calculating fully-diluted share capital. But it is more useful if the totals are also calculated separately by reference to shares, allocated and unallocated options. In terms of consent rights and voting, these will relate to (voting) shares only. The definitive documents when it comes to resolutions and consents will refer to shares only. Voting percentages are highly relevant to the definitive documents, so – to avoid surprises, especially for those heading directly to Series A (without a prior seed round) – it is preferable to have these set out clearly at term sheet stage.

Share certificates are an outdated legacy. They are not legal proof of ownership and serve little purpose. Shareholders frequently lose their share certificates and replacing them is an administrative burden that can be complicated by uncooperative shareholders. A simple one line change to the articles can be made to enable shares to be uncertificated with certificates being available only on request (i.e. to a VC).

5. Diligence and Disclosure; they are not the same.

We get asked a lot about this. In short:

- Diligence is the exercise whereby an investor seeks information about the company, its assets and liabilities before committing to the transaction. This information is provided in an online data room. On a Series A this is typically run by the company with limited involvement from counsel. We recommend that work is begun on this as the term sheet process starts (and any pitch deck must be consistent with those documents uploaded). It is essential that the folders are structured and populated on a logical basis. Our data room schema can be found here.

- Disclosure is a formal response to the warranties (broadly, legal promises) required to be given by the company and the founders to the VCs in a Disclosure Letter, which contains statements of fact to counteract the circumstances where the warranties are not true. If properly drafted an investor will not be able to bring a warranty claim in respect of that disclosed matter. Previously, a general disclosure of all documents in the data room was sometimes accepted, but the standard has reverted: founders must now provide specific, detailed disclosures for them to be effective.

These are arduous (and frankly, boring) exercises for the founder, more so than on a seed round. If the company has reached an element of maturity by Series A, consideration should be given as to whether a person other than the founders has sufficient knowledge to front this exercise, thereby alleviating the burden on the founders.

6. "What? The company does not own the intellectual property"

A general principle of English law is that the first owner of any intellectual property is the person who designed or created it. The important rights here are usually copyright and/or patents. One of the exceptions in in both cases is that the company will be the first owner if the copyright or patent is designed or created by employees in the normal course of their employment.

Early-stage companies often use contractors rather than employees. These contractor agreements must assign all intellectual property rights to the company. Correcting this oversight later with a separate assignment document can be challenging if the contractor is not easily contactable or has emigrated to the foothills of the Carpathians.

Since intellectual property is often a company's primary asset, VCs will almost certainly require ownership issues to be resolved on or before closing.

7. Initialisms: CLNs and ASAs

There is plenty on online commentary on (debt and equity-based) CLNs and ASAs. My colleague, Mark Ward, has provided a good summary which can be found here.

When using CLNs, it is crucial to pull out all stops (or the tarot cards) to set a reasonable valuation cap. A cap that is too low can give early lenders an excessive discount. Stacking, that is the accumulation of multiple CLNs, can be a blight too. VCs may require those notes to convert on a same price paid basis. Alternatively, they only come in at a much lower valuation (nearer to that cap) or simply walk away if they feel that value has been excessively eroded.

As to ASAs we are regularly asked about EIS and SEIS, whether as part of a Delaware Flip or otherwise. My tax colleagues have updated their overview of these schemes following the 2025 budget (which can be found here). As an overall comment (to a question regularly posed to me), the more nuts and bolts aspects to this, such as making the requisite filings directly to HMRC, are normally handled by the founder or the company, possibly with help from an accountant.

8. "We just gave the shares back"

In those rare what-if moments or at 3am in the morning, some of us do consider how we would reform the maintenance of share capital rules. Share capital rules exist to protect creditors, as shareholders have limited liability for the company's debts. Because creditors rely on the stated share capital (or so it is said), the process for reducing it (that is by cancelling or buying back shares) is intentionally complex.

No practising lawyer invented these rules. But they did invent the ruse technique to circumvent them, essentially creating a separate class of deferred shares with negligible value. This means that when shares are forfeited, they can be converted into these deferred shares, rather than being handed back to the company. This does need an amendment to the articles, but it is worthwhile step to take early on, particularly for handling leaver shares.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.