Veto Rights: When the Investor doesn't like what the Company is doing.

24.03.2019
Nimrod Vromen, Partner at Yigal Arnon & Co. | Reading Time: 5 min.
The origin of the word "veto" is in Latin, meaning "I forbid". Every so often the word seeps into day-to-day conversion - "I'm vetoing on this", or in other words, "I decide and I am forbidding you to take this action".

 Such are the veto rights granted to investors infusing Startups with capital. These veto rights are comprised of a finite list of decisions and actions in which the applicable right-holders can intervene unilaterally to prevent.

Veto rights, by definition, are utilized only in situations of disagreement, and therefore many entrepreneurs have a negative experience in relation to them. They may be perceived as an overbearing and aggressive tool and often turn into an especially painful point in negotiations surrounding an investment.  

The topic is loaded to the point where investors often camouflage the term "veto right" with various laundered descriptions such as "minority rights", "protective provisions", and more.

Veto rights arise primarily in connection with strategic decisions for the company or decisions with the potential to change the investor's status. The list of decisions which may become subject to veto rights may be divided into three categories:

 The first category is the least controversial - decisions to basic protections for the investor on the financial value of his investment.

 For example: A decision to liquidate the company (what if the investor wants the company to continue to exist?); a decision regarding an interested-party transaction - so that the investor will be capable of preventing a situation where the founders exploit their majority in order to funnel the money and resources of the company to themselves or their relatives. Sometimes veto rights allow the investor to prevent an exit in which the investor would not even make back her/his investment or a basic multiplier of the original investment.

The second category is made up of decisions which allow the investor to interfere more in the day-to-day management of the company. Veteran entrepreneurs with management experience are quick to reject this category of decisions, behind they touch on who the company can hire, taking on obligations of the company, approving a budget or deviating from that budget.

The third category is the most interesting. This is a list of decisions, all of which lead to one thing - the ability of the investor to block a future round of financing. In this category can be found, for example, a veto right on amending the Articles of Association, a veto right on increasing the size of the Board of Directors, a veto right on increasing the number of shares reserved for grant as options, or simply a veto right on any issuance of new securities - all things which occur at a financing. Here, one must first come to a consensus with the investor on the principle itself - can the investor prevent a round of financing. Sometimes a middle ground is found, allowing the investor to block a round of financing under bad terms (what constitutes "bad terms" is also, of course, subject to negotiation).

 In negotiating veto rights, its important to emphasize from whom permission must be requested: a director appointed by the VC who is subject to duties of trust and caution towards all interested parties in the company, and therefore will not always be able to able to solely take into account the interests of the investor. If the investor is one of many, for example, it begs the question as to whether a special majority of the class of shares held by the investors, and in such case the veto right is transferred along with the shares if they are sold.   

 The forgoing is general knowledge and does not constitute legal advice.

Nimrod Vromen is a Partner at Yigal Arnon & Co. with 10 years of experience in representing Startups, and is CEO of YTech Runway Ltd.