Delaware Blank Check Preferred Stock

The Directors’ Trump Card For Attracting Early Investors, Maintaining or Gaining Control, Rewarding Key Participants, Going Public And Avoiding Bankruptcy

Every Delaware General Corporation must have one class of common stock, but it can also have a second class of stock (or more) with customized terms for the different classes. The most popular second class of stock is called preferred stock because it can contain terms, negotiated between the Board of Directors and the recipient, that are preferred over the rights of common stockholders.

Delaware’s brand of preferred stock is so powerful and flexible as a business tool that the top U.S. and international corporate lawyers refer to it as Delaware blank check preferred stock.

If you’re thinking of starting a business, raising capital and going public, or if your company is ready to go public, you should be aware of the power this type of stock offers.

delaware blank check preferred stockWhy would anyone want more than one class of stock in a Delaware corporation?

Common stock has two fundamental characteristics that are written in the Delaware General Corporation Law, and they are mandatory.

The first is that every share of common stock carries one vote. If you own 100 shares, you have 100 votes to cast on all matters presented for votes at stockholder meetings.

The second is the right to your pro-rata share of any dividends issued by the Directors to the common stockholders. If the total dividend is $1,000,000 and you own ten percent of the total outstanding shares of common stock, you’re entitled to 10% of the $1,000,000. You cannot get cheated on those two issues.

After all, common stockholders own the company. They have invested their money in the company and they have a keen interest in their share of the profit. If the company does not profit, the shareholders receive nothing. If the company does profit, the Board of Directors decides where the profit is to be spent, invested and/or distributed.

A stockholder's dividend is a distribution of profits. If the Board of Directors saves and/or invests all the profit with the best of intentions, and does not regularly declare a dividend, the stockholder has little recourse.

If the Board of Directors decides not to declare a dividend, the shareholders do not get a share of the profit. In the case of Apple, until recently, shareholders did not get a dividend but they did get an extreme increase in the valuation of their stock, so everyone was happy.

In other cases, like Wal-Mart, the shareholders have been given a distribution of profit in the form of a dividend for many consecutive years, and that dividend has increased every year. Neither of these examples is more right or wrong than the other; it’s just how it works. The same is true for any Delaware General Corporation.

All entrepreneurs admit there are extreme challenges that can occur in the life of a company, and often it is wise to make deals with new investors, the founder or creditors that are made on better terms than those that the common stockholders typically get. Delaware blank check preferred stock can do all this and more.

In fact, owners of Delaware blank check preferred stock can get dividends before common shareholders and, unlike common shareholders, can be guaranteed a security interest in the company’s assets, equipment and Intellectual Property. If properly stated, they can even be guaranteed a percentage of gross sales before any money is directed towards paying bills or paying dividends to common shareholders. (ergo the subtitle: The Trump card)

How does an inspired entrepreneur obtain this silver sword?

There are three situations to consider:

  1. If you have not yet formed a Delaware corporation to pursue your vision, be sure to specify it when you initially form your company. This is the time when it’s least expensive to obtain. You don’t need to outline the specific terms of the preferred stock when you form the company, just the number of shares and a nominal par value. You will specify the terms for each series of your blank checks as you use them. You just want to declare the Preferred Stock in the beginning so you can utilize it later.
  2. If you already own a Delaware General Corporation with only one class of stock, then your Board of Directors, with shareholder approval, can authorize a second class of preferred stock. If you can’t get your Board to approve it, or if you can’t get your stockholders to approve it, you’re effectively blocked and powerless. Once the shareholders approve the authorization of the stock, the Board is free to negotiate the terms to attract capital, to inspire top people or to create strategic alliances using the blank check preferred stock as a form of currency.
  3. If you own a corporation in any state other than Delaware, you may want to consider forming a Delaware General Corporation, authorizing both common and blank check preferred stock and then merging your current company into your new Delaware General Corporation. It’s a little expensive, but it could still be worth it if your vision is long-term.

blank check preferred stock

Now here’s the best part: the total number of shares of preferred stock that your Certificate of Incorporation authorizes may be split into any number of different series of the preferred stock, with each series having its own separate terms.

For example, let’s say the company has 1,000,000 shares of common stock and 100,000 shares of preferred stock. The Board can designate that the preferred stock be split into any number of distinct series, giving you, literally, not just one blank check but as many as you want, numbered one through whatever number you choose.

How do I use preferred stock?

I’m going to enumerate some specific examples of how Delaware blank check preferred stock has been used to attract investors, maintain or gain control, reward key participants, go public and avoid bankruptcy, as they relate to the rights of each series of preferred stock, but first, some general legal knowledge is appropriate.

Stock ownership comes with certain rights. You can’t avoid giving common shareholders the two basic rights I described above. At the same time, you cannot give common shareholders any special rights like a guaranteed dividend, a guaranteed percentage of the profit or a security interest in the company’s assets. The Delaware law guarantees them two particular rights and doesn’t leave a lot of room for changing those rights.

The rights of a preferred stockholder, on the other hand, can be negotiated before the stock is issued. These are the three most notable rights that are important in the negotiations:

  • Voting rights: Common shareholders get one vote per share, but the Board can give one or more series of the preferred stock super voting power, such as two votes per share, or ten or 100 or 1,000 votes per share. Why do this?

    Let’s say the company is trying to attract more capital from a key shareholder who already owns a big percentage of the common stock and the Board doesn’t want him to take control. The Board can create a series of preferred stock with no voting rights but a guaranteed 10% dividend paid quarterly. Your investor might be enticed to invest more money but give up any increased voting rights in order to get a guaranteed return on his investment.

    Or let’s say you are raising capital and you’ve sold 45% of your stock. Once you sell more than 50% of the company, you lose control. So what do you do? Bring out a series of preferred stock designated as Founder’s Stock, in which the 10,000 shares have 100 votes per share. Have the Board of Directors issue the whole 10,000 shares to you. Now you can sell more of the common stock to investors and still keep control of the company.

    These maneuvers are sophisticated tricks and should be undertaken with the assistance of a very good corporate lawyer.
  • Dividend Rights: Common stockholders have the right to a share of the profits only if the company has profits and if the Board of Directors declares a dividend. Preferred stockholders, however, can be guaranteed a certain dividend per share ($1.00 per share, for example) or a dividend based on a business calculation that suits the deal (x% of increase in net profits, for example).

    These dividends can be guaranteed, cumulative and convertible to common stock if the deal makers agree and a good lawyer drafts it correctly. If properly stated, preferred dividends can be paid before the common stockholders see any return.
  • Security Rights: Preferred stockholders can hold a security interest in a company-owned asset. This can include a patent, real estate, a major piece of equipment, the company’s website or any other company asset.

    In a typical example, the company is desperate for an influx of cash. Bankruptcy is the next step if a deal isn’t put together in time to save the company. No one will buy the common stock if they fear a company is going out of business.

    However, someone might invest if you gave him/her a security interest in the assets that will revert to him/her if the company declares bankruptcy. I hope you never need to use this technique, but if you find yourself in that position, you’ll be glad you have a Delaware corporation with blank check preferred stock.

If you’re about to form your Delaware General Corporation and expect to sell stock in the company to raise money, it would be a good idea to consider getting the preferred stock right from the start by including it in the Certificate of Incorporation. This way, you won’t need the shareholders' approval to authorize it when you need it.

The Directors will be able to issue the stock in the best interests of the company without the necessity of shareholder approval. If you already run a Delaware General Corporation, you will need shareholder approval to amend the Certificate of Incorporation, authorizing the preferred shares.

If you control the Board and the common stock now, you might be well-advised to consider authorizing a preferred class of stock at your next shareholder meeting so when you need it, it will be there.

*Disclaimer*: Harvard Business Services, Inc. is neither a law firm nor an accounting firm and, even in cases where the author is an attorney, or a tax professional, nothing in this article constitutes legal or tax advice. This article provides general commentary on, and analysis of, the subject addressed. We strongly advise that you consult an attorney or tax professional to receive legal or tax guidance tailored to your specific circumstances. Any action taken or not taken based on this article is at your own risk. If an article cites or provides a link to third-party sources or websites, Harvard Business Services, Inc. is not responsible for and makes no representations regarding such source’s content or accuracy. Opinions expressed in this article do not necessarily reflect those of Harvard Business Services, Inc.

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