What does it feel like when traditional notions of worker-ownership come face to face with venture capital and a deal gets hammered out? As you might expect, pretty exciting and hopeful.
One of our clients came to us a little more than a year ago as a group of workers and friends who left a major corporation to take back control of their destiny and chart a new course for their collective creative energy. Many of our clients come to us for our creativity and expertise with broad-based ownership, particularly designs and structures for worker ownership.
For a variety of (very good) reasons this group opted not to express their form of worker ownership as a cooperative corporation or limited cooperative association, but rather as a public benefit corporation. This meant hybridizing the corporate structure to provide for one-worker, one-vote governance, and profit allocation based on patronage. We have designed and structured countless “hybrid” corporate and LLC entities to operate on a cooperative basis. This PBC in fact has more democratic governance and labor-based economics than many cooperatives we have seen. All the while, this client knew they may want to bring on outside capital.
This PBC put strict eligibility qualifications on its voting common stock. They can only be held by full-time employee workers of the business. There is a minimum tenure requirement to become an owner. The common stock price is fixed at a $1.00 par value. Only one share can be held by a worker. If a worker resigns or is terminated, their share must be sold back and repurchased by the Company.
When they approached us with a term sheet from a venture capital firm, I have to admit I had my doubts that we could graft VC terms onto the democratic worker-owned PBC structure. This VC presented differently than most, however. For one, they are a strategic and “verticalized” shop; meaning they seek out and invest in companies in a specific market “vertical”, or segment. They are also a strategic investor, which means that in addition to contributing capital, they add value by making connections to other high value partners, and by offering strategic advice. This post will summarize the high points of the term sheet, which ultimately got signed. Both the VC shop and the client have consented to me writing about the deal.
The term sheet started out as a “lite” and less pro-investor version of the NVCA Seed Series Preferred Term Sheet. It ended up with the following high level terms:
- Series Pre-Seed Preferred Shares
- Issuer is a Public Benefit Corporation
- Six-figure check-size
- 12% post-money fully diluted equity interest
- Standard closing conditions (e.g. financial and legal due diligence)
- 1x participating liquidation preference
- Pre-Seed shares convertible into non-voting common stock. We negotiated for the creation of a separate class of non-voting common stock issuable upon conversion of Pre-Seed preferred. This way, the Pre-Seed do not interfere with the voting power of the worker shareholders, who have exclusive voting power of the PBC. In order to amalgamate the voting common stock with the non-voting common stock in the case of a liquidation event or for any other distribution, we’ll create a ratio mechanism that maintains and caps the 12% fully diluted interest of the Pre-Seed shareholder with the 88% fully diluted interest of the worker-owner shareholders (we’ll call this the “Sharing Ratio”).
- Pre-Seed have pro-rata participation rights in any dividends on an as-converted basis. The Sharing Ratio will be an important mechanism for this purpose.
- Pre-Seed will automatically convert into the non-voting common stock if the Company IPOs.
- Pre-Seed and the non-voting common stock issuable upon conversion are non-voting. This is an important energetic commitment of the VC to empower and support worker-ownership in this PBC. While this is common in Seed Preferred term sheets, it has extra significance in this democratic worker-owned PBC context.
- The entire Board of Directors is elected by the voting common stock holders. Notably, Pre-Seed and non-voting common stockholders have no Board seats or rights to elect directors.
- Future rights in subsequent series of preferred stock. This is relatively standard in the NVCA Seed Preferred term sheet.
- Relatively standard protective provisions, except that, notably, redemption of worker-owner common stock is excluded from consent rights. This investor also negotiated to approve revenue share or royalty agreements with current or former employees of the Company. This is a fairly standard compensation arrangement in this Company’s industry. Lead investor approval is required to pay any employees, officers, or directors in excess of an agreed upon salary cap. This may actually have the net effect of preserving a compressed high:low pay ratio.
- Standard “Major Investor” pre-emptive rights in any new securities offering.
- Standard reps and warranties in the definitive agreements.
- Company right of first refusal over proposed transfer of stock. Notably, no founder or Major Investor ROFR. This is more Company friendly than the norm.
- Standard co-sale and drag-along rights.
- Standard Major Investor information rights.
The crux of the term sheet revolves around the “synthesis” mechanism for the Pre-Seed/non-voting common stock (12% FD), and the worker-owned voting common stock (88%). If the PBC were to go through a liquidity event, while the Pre-Seed/non-voting common stock have no voting rights on the transaction, their total equity stake is limited to 12% and the voting common stock pool, which can only be issued to and held by workers, will remain at 88%. Ultimately, the workers, no matter how many of them there are, will always reap the largest share of upside.
All told, this executed term sheet represents a major breakthrough and validates the “investibility” of democratic, worker-controlled firms, particularly those committed as much (or more) to purpose as to profit. It also shows that outside investment doesn’t need to be scary, extractive, controlling, or anathema to democratic governance models. I’m not generally one to posit a single deal as a model, but it does portend positively as an investment structure in other forms of employee-owned entities that brings in capital and protects worker ownership and governance rights.
 In 2020, a report from Democracy at Work Institute and U.S. Federation of Worker Cooperatives showed that, among “workplaces participating in their survey reported an average top-to-bottom pay ratio of 2:1. This pay ratio is in stark contrast to the average pay ratio of traditionally structured businesses, which sits at 303:1.” https://www.fiftybyfifty.org/2020/02/worker-co-ops-show-significant-growth-in-latest-survey-data/
For more creative “impact” finance terms, check out this blog post.