We’ve all read countless headlines and articles about the removal and swift return of Sam Altman as CEO of OpenAI over the past several weeks. Simply put, the nonprofit board voted to remove Altman as a result of a disagreement concerning the safety of AI and allegations that Altman was not consistently candid in his communications with the board.[1] Altman was reinstated as CEO just five days later, after having communicated an intention to join Microsoft, and a threat to quit from nearly all of OpenAI’s employees if he was not reinstated. While the specific details of what happened and why have not been confirmed, this series of events begs the question, how did a board of four do this? And for founders, how can they protect themselves?
The answer to how is quite simple. While OpenAI’s governing documents are not public, and the operational Open AI entity is a capped-profit company run by a nonprofit[2] entity making this an imperfect analogy to most startup companies, market practices offer a simple explanation as to how a board could oust its founder. In Delaware, where most corporations are formed, the Delaware General Corporation Law (“DGCL”) lays out default corporate governance procedures which are assumed unless the corporation’s certificate of incorporation (“Charter”) provides otherwise. Section 142(b) of the DGCL states that officers of a corporation are appointed and removed by the board of directors or as stipulated in the bylaws of the corporation.[3] In other words, the board of directors generally has carte blanche to hire and fire executive officers as they see fit.
However, it is common practice for these rights to be limited through protective provisions in a company’s Charter. Many Charters include language that outlines certain actions that a board cannot take without shareholder consent, such as a sale of all or substantially all of the company’s assets, executing contracts which create financial responsibilities for the company over a certain threshold, and entering into or altering existing contracts with certain persons, usually officers of the company among others. Those clauses are intended to create a barrier on certain board actions that are deemed to be outside the ordinary course of business. While this sort of language can remove the unilateral power of a board to terminate an executive, it does not stop the board from taking such action with the consent of shareholders. Some ways to do that are super voting rights, veto rights, and a few key terms in employment agreements.
Super Voting Rights
Super voting rights are a right granted to specific shareholders that increase the number of votes per share that the specific shareholder may exercise at a time. For example, when Meta (at the time Facebook) went public in 2012, Mark Zuckerberg’s shares in the company granted him 10 votes per share, compared to the standard one vote per share. This resulted in Zuckerberg having 57% of the voting power but only 28% of the economic stake in the company.[4] In 2016, when Snapchat went public, it only listed non-voting shares for sale to the public, creating a three-tier structure with the founders holding super voting shares, pre-IPO investors holding standard shares with one vote per share, and the non-voting shares.[5] When a founder has super voting rights, those rights essentially establish a veto power where no actions can pass a shareholder vote without the founder’s backing.
It’s important to note that super voting shares should and often do have transfer restrictions which ensure that a founder can’t give away that degree of power, willingly or unwillingly, to an outside party. Often the transfer restrictions will convert the shares of stock with super voting rights into standard shares with one vote per share if the shares are transferred to anyone other than an enumerated permitted transferee. Permitted transferees are typically entities or individuals that are under the control of the transferor or family members of the transferor.
Veto Rights
A founder can gain additional protections from ouster via veto rights. Simply put, an action proposed by the board cannot be approved by the shareholders without the approval of an individual with such rights. This type of right, if agreed to, would usually be narrowly tailored to only grant the holder veto power in major changes such as a merger or sale of the company, or the removal of one or more officers. If founders can negotiate a veto right specific to termination of themselves or of officers, they would insulate themselves from both the board and shareholder’s ability to remove them.
Employment Agreement Language
Employment agreements are not especially common with founders, but they should be to protect both the company and the founder from foul play by the other, especially when outside investment grants some control to those outside investors. To create protection from ouster, a founder could ensure there is language in his/her employment agreement that requires termination be for cause. Most employment agreements stipulate at-will employment, which means that an employee can be terminated at any time for any or no reason. Ensuring a founder can only be terminated for cause allows the founder to protect himself/herself from ouster based on differences in opinion on strategy, or frivolous disputes. Instead, the board would need to articulate a specific breach of the founder’s employment agreement in order to seek termination.
It’s important to closely review any other agreements discussing the founder’s employment, such as equity agreements, to limit the possibility of triggering a breach which would create cause for termination. A founder can also protect his/her interests by negotiating an equitable payout or severance in their employment agreement in the event of termination. This creates the financial protection for the founder, but can also create a deterrent against terminating the founder to avoid having to pay the severance or payout.
Conclusion
While the short-lived firing of Sam Altman was shocking to most people, and worrying for some, there are plenty of actions that an individual can take to maintain their control in a company. These issues are especially important when an early-stage company brings in outside investment. The funds gained through outside investment are critical to the growth of a company and often pivotal to its success, but if not carefully negotiated, these transactions can severely limit a founder’s control.
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[1] https://openai.com/blog/openai-announces-leadership-transition
[2] https://openai.com/our-structure
[3] https://delcode.delaware.gov/title8/c001/sc04/index.html#:~:text=bylaws%20otherwise%20provide.-,(b),-Officers%20shall%20be
[4] https://www.reuters.com/breakingviews/zuckerberg-motivates-supervoting-stock-resistance-2022-10-27/
[5] https://corpgov.law.harvard.edu/2017/02/07/snap-inc-reportedly-to-ipo-with-unprecedented-non-voting-shares-for-public/
