Term Sheet: Indemnification and Assignment
We’re down to our last two sections on a typical VC term sheet. Since they are both things that most entrepreneurs simply live with as part of a financing, we decided to combine them into one post.
The first clause is indemnification and usually looks as follows:
“Indemnification: The bylaws and / or other charter documents of the Company shall limit board member’s liability and exposure to damages to the broadest extent permitted by applicable law. The Company will indemnify board members and will indemnify each Investor for any claims brought against the Investors by any third party (including any other shareholder of the Company) as a result of this financing.”
Given all the shareholder litigation in recent years, there is almost no chance that a company will get funded without indemnifying its directors. The first sentence is simply a contractual obligation between the company and its board. The second sentence – which is occasionally negotiable – indicates the desire for the company to purchase formal liability insurance. One can usually negotiate away insurance in a Series A deal, but for any follow-on financing, the major practice today is to procure director and officer (D&O) insurance.
The next clause – assignment – looks as follows:
“Assignment: Each of the Investors shall be entitled to transfer all or part of its shares of Series A Preferred purchased by it to one or more affiliated partnerships or funds managed by it or any or their respective directors, officers or partners, provided such transferee agrees in writing to be subject to the terms of the Stock Purchase Agreement and related agreements as if it were a purchaser thereunder.”
The assignment provision allows venture funds to transfer between funds and make distributions to their limited partners (their investors). This is something companies must normally live with and is a term that is rarely availed upon by investors.
Neither of these terms should be controversial. The company should be willing to indemnify its directors and will likely need to purchase D&O insurance in order to attract outside board members. The assignment clause simply gives VC firms flexibility over transfers which they require to be able to run their business and – as long as the VC is willing to require that any transferee agrees to be subject to the various financing agreements – the company should be willing to provide for this (although entrepreneurs should be careful not to let the loophole of “assignment without transfer of the obligation under the agreements” occur.)