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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.
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)
There are three situations to consider:
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.
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:
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.