What stockholder approval is necessary to complete a preferred stock financing?

Takeaway: Most often, the stockholder consent required to complete a preferred stock financing is (i) a majority of all shares (common and preferred), (ii) a majority of the preferred stock, and (iii) a majority of all shares.

Obtaining stockholder approval is a crucial step in all venture capital financings. In this post, we will discuss the importance of stockholder approval for Delaware corporations and outline the necessary approvals to complete a venture capital financing.

Why is Stockholder Approval Necessary for Delaware Corporations?

Stockholder approval is essential for Delaware corporations for several reasons:

  • Legal Compliance: Delaware's General Corporation Law (DGCL) mandates stockholder approval for specific transactions, such as issuing new shares, amending the company's charter, or altering the rights of existing stock classes.

  • Investor Protection: Obtaining stockholder approval helps protect investors' interests by ensuring that they have a say in significant decisions affecting the company and their investment.

  • Fiduciary Duties: Company directors have a fiduciary duty to act in the best interests of the company and its stockholders. Seeking stockholder approval for venture financing transactions helps ensure that directors fulfill their fiduciary duties under Delaware law.

  • Maintaining Stockholder Relations: Obtaining stockholder approval fosters transparency and trust between the company and its stockholders, maintaining healthy relationships and promoting long-term success.

Stockholder Approval Requirements for Delaware Corporations

The stockholder approval requirements for a venture capital financing transaction in a Delaware corporation typically depend on the company's charter, bylaws, and the DGCL. Here are the most common approvals that may be necessary:

  • Board of Directors: While not stockholders, the company's board of directors must approve the financing transaction before seeking stockholder approval.

  • Majority of All Stock: A majority of the company's stockholders may need to approve the venture financing transaction, particularly if the transaction involves amending the company's charter. According to DGCL Section 242, a charter amendment requires the approval of a majority of outstanding shares entitled to vote.

  • Majority of Preferred Stock: If the financing transaction impacts preferred stockholders' rights, such as increasing the number of authorized shares of such class of stock or altering liquidation preferences, dividend rights, or conversion rights, a majority of preferred stockholders may need to provide their approval. DGCL Section 242(b)(2) requires that any amendment that adversely affects the rights or preferences of a class or series of stock must be approved by a majority of the outstanding shares of that class or series, voting separately. The company’s existing charter may also have protective covenants that require the consent of the preferred stockholders.

California Law

Startups that are instead incorporated in California must adhere to the state's corporate law when completing preferred stock financings. Under California law, amending a company's charter and approving the issuance of preferred stock typically requires approval from the following parties:

  • Board of Directors: Similar to Delaware law, California law mandates that the board of directors must approve any proposed amendments to the company's financing documents. A majority of the board members must approve the proposed amendment and transactions before submitting them to the stockholders for their consideration.

  • Majority of All Stock: As a general rule, California law requires that amendments to the startup’s charter require the approval of a majority of the outstanding shares.

  • Majority of the Preferred Stock: Like Delaware, California requires the consent of the preferred stockholders if the amendment to the charter does certain things (e.g., increasing the number of authorized shares of preferred stock). Preferred stock financings do some of these things so their consent is required.

  • Majority of Common Stock: This is where California is different from Delaware. In California, a majority of the common stockholders is typically also required. This is because the preferred stock is convertible into common stock and the company needs to authorize sufficient shares of common stock to issue should the preferred stock ever elect to convert. Under California law, this triggers a common stock vote, which is one reason investors prefer Delaware corporations.

Steps to Obtain Stockholder Approval for Delaware Corporations

The steps to obtain stockholder approval of a venture capital financing are:

  • Review Charter, Bylaws, and DGCL: The first step is to review the company's charter, bylaws, and the relevant provisions of the DGCL to determine the necessary stockholder approvals for the proposed venture financing transaction.

  • Prepare Documentation: Prepare the necessary documentation, including resolutions, consents, and notices, to present to stockholders for their review and approval.

  • Communicate with Stockholders: Communicate with stockholders to explain the proposed transaction, its benefits, and any potential risks. This communication may take the form of written notices, conference calls, or in-person meetings.

  • Conduct Stockholder Vote: If required by the company's charter, bylaws, or the DGCL, conduct a formal stockholder vote to obtain approval. This may involve holding a stockholder meeting or, more commonly, obtaining written consents from the required majority of stockholders. DGCL Section 228 allows for stockholder action by written consent without a meeting, provided that the consent is signed by the minimum number of stockholders necessary to authorize the action.

  • Record the Results: Document the results of the stockholder approval process, including the vote count or written consents, and maintain these records in the company's corporate files.

  • File Necessary Documents: If the venture financing transaction involves amending the company's charter, file the restated charter with the Delaware Secretary of State to ensure compliance with DGCL requirements.

Conclusion

Stockholder approval is a critical aspect of the venture financing process for Delaware corporations, ensuring legal compliance and protecting investors' interests. Understanding the approval requirements under the DGCL and engaging in open communication with stockholders can facilitate a smooth financing transaction, fostering a collaborative environment that promotes the long-term success of both the company and its investors. By adhering to these guidelines and maintaining transparency, Delaware corporations can secure the necessary approvals to complete a venture capital financing and continue on their path to growth and success.