Companies planning to go public one day will typically form general corporations. In these blogs, we explain all you need to know.
The Delaware general corporation has had the strongest type of company structure in the United States since the late 1800s.
At that time, major entities, such as the railroads, Standard Oil and The DuPont Company, needed to arrange themselves into organizational structures that could provide for the governance of the companies once they had grown beyond their famous founders.
The general corporation is perfectly designed as an entity for engaging in business, yet it also provides a way to raise capital, as needed, throughout the life of the company.
In its simplest form, the general corporation has three tiers of power: the shareholders, the directors and the officers. The shareholders own the company; the directors manage the company; and the officers run the company on a day-to-day basis.
The bylaws of the company set forth the powers and the limits of power in each of the three tiers. Each group may have separate priorities, and they may clash occasionally.
When one tier rises up against the others, a takeover battle may ensue; takeover battles are usually fought and resolved in the Delaware Court of Chancery.
In this unique business court, a single judge decides the case—there are no juries, no tribunals and no 12 angry men. One judge determines—quickly—which party shall prevail, according to 200 years of laws and legal precedents.
It is said that the Chancellors of the Court respect the good faith decisions of directors over the profit priorities of shareholders, but a majority of shareholders can generally elect a new Board of Directors if they don’t like their current directors.
The rules on how these three tiers interact with each other are embodied in three general knowledge bases. The code, which is the written law passed by the state legislature (in this case, the Delaware General Corporation Law).
The case law, handed down by the Delaware Court of Chancery and the Delaware Supreme Court over the past 200 years; and Letter Rulings, which are individual, judicial decisions on a myriad of minute details that come up in court cases.
Stockholders are granted two rights that directors and officers are not permitted: the right to vote for the Board of Directors and the right to share in the dividends of the company when the directors declare dividends.
The shareholders, however, cannot operate the company; they cannot walk in and start telling people what to do. They act as a group, in a meeting, not individually. (Unless one person owns more than 50% of the company, in which case s/he could control the entire company and all three tiers of power.)
The Board of Directors also acts as a group in meetings. Directors generally do not act individually. Meetings must be announced in advance, to all Directors, and each meeting much be attended by a majority of directors in order to be a legal meeting.
The Board of Directors makes all the important decisions in the company; it is responsible for company policy and overseeing the managers.
The directors determine what the company will do with its profits, and they control the sale of stock in the company. They hire the officers of the company to run the business on a day-to-day basis.
The officers work at the pleasure of the Board of Directors, or by contract with the Board of Directors. Officers are usually the President, Vice President, Secretary and Treasurer, but the company’s bylaws can prescribe any officers and their titles, responsibilities and duties.
Officers are responsible for the conduct of the company as well as the profitability. If they fail, they usually get fired, quickly; if they succeed, they become superstars.
This unique structure, with its three mandatory tiers of power, deserves a great deal of credit for the success of the American Industrial Revolution, the American economy (since 1900) and the success of Wall Street itself.
This structure differs greatly from other forms of company organization, such as the sole proprietorship or the partnership, both of which precede it, as well as the LLC, which followed it chronologically.
If your vision is to form a big company, like Apple, Google or Dell, you couldn’t pick a better corporate organizational structure than a Delaware general corporation.
A Delaware Certificate of Incorporation is the foundation upon which a Delaware corporation is built.
Until you receive the approved Certificate of Incorporation back from the Delaware Division of Corporations, you do not yet have a valid Delaware company.
The state of Delaware requires very little information to be made public in order to form a corporation; the Certificate of Incorporation only requires a few pieces of information.
In Delaware, your officers/Directors and shareholders are not usually listed on the Certificate of Incorporation. The preparation, execution and filing of the Delaware Certificate of Incorporation is handled by an incorporator.
An incorporator is an individual or company that forms a corporation on behalf of the corporation's Board of Directors by filing the Certificate of Incorporation with the Delaware Division of Corporations.
The incorporator then names the initial Directors of the corporation until the successors are elected (and qualified internally) within the company. The powers of the incorporator are then terminated, and the incorporator shall no longer be considered a part of the corporation.
Harvard Business Services, Inc. is the incorporator, on behalf of all our clients, for the companies we file. The Delaware Certificate of Incorporation is signed by Richard H. Bell, II, as president of Harvard Business Services, Inc.
The powers of the incorporator are limited to executing the filing of the document with the Division of Corporations. Once the document is filed, the incorporator releases the company to the initial Directors.
No information about the officers or Directors is required to be filed publicly in Delaware in the formation process. It is a nice feature of Delaware; this way, should an officer or Director change, the company is not obliged to file amendments with the Division of Corporations to update that information.
Instead, the change is recorded internally, which allows the business owners to focus on the operation of the corporation rather than tedious paperwork. All Delaware corporations are required to file an annual report each year on or before March 1, naming the Directors and officers.
Harvard Business Services, Inc. is here to assist you if you have any questions or concerns about the company formation process and/or the Delaware Certificate of Incorporation.
To file a new company Delaware LLC or corporation now, visit our easy-to-use order form. You can also call us anytime between the hours of 9 AM and 5 PM, Monday through Friday, at 1-800-345-2677.
What Does It Mean to Be a Shareholder of a Delaware Corporation?
A shareholder can also be referred to interchangeably as a stockholder.
As an equity holder, a shareholder is a part-owner of a corporation and participates in the increase or decrease in the company’s value.
The bylaws may provide different classes of stock with different economic (and other) rights, and holders of preferred stock receive priority and preferred distributions over holders of common stock.
One of the key features of share ownership is limited liability. A corporate shareholder is not liable for the debts and obligations of the corporation.
Under certain circumstances, a court can look through a corporation and hold its shareholders responsible for certain debts and liabilities, most commonly in cases of fraud or other misconduct.
Such an action, referred to as “piercing the corporate veil,” is not common, as it undermines the general principal of limited shareholder liability, a fundamental feature of the corporate form.
Many terms related to shareholders’ rights can be set forth in a corporation’s Certificate of Incorporation or bylaws.
Corporate shareholders’ rights often vary, depending on the size of the corporation. For example, shareholders’ rights in a private corporation with only a few key holders will differ greatly from rights afforded a shareholder in a large, publicly-traded company.
In close corporations, shareholders’ rights will be set forth with specificity in a shareholder’s agreement among the holders. In larger corporations with a larger number of shareholders, the Certificate of Incorporation and the bylaws are the primary governing documents.
Delaware law sets forth default rules and rights that will govern in the event that a corporation’s governing documents are silent on an issue and, importantly, spells out certain limited rights that cannot be waived in such documents.
One of the primary rights of common shareholders of a Delaware corporation is the right to their pro-rata share of any dividend issued by the Board of Directors to the common shareholders.
Another basic right of all owners of shares of common stock in Delaware corporations is that they may vote one vote per share on all matters that common shareholders are allowed to vote on.
Under Delaware law, a shareholder has a to right to vote on any amendment to the corporation’s governing documents, whether such class of shares is entitled to vote or not under the governing documents, for actions that would (i) increase or decrease the number of authorized shares of such class; (ii) increase or decrease the par value of shares of such class; or (iii) adversely alter or change the powers, preferences, or special rights of the shares of such class.
Another key, unassailable right is a shareholder’s right to inspect the books and records of a corporation. This often-litigated right permits a shareholder to inspect corporate books and records for any “proper purpose,” which has been interpreted to mean a purpose reasonably related to a person’s interest as a shareholder.
For example, investigating suspected mismanagement would generally qualify as a proper purpose. A shareholder is permitted to review records that are “essential and sufficient” in order to achieve a proper purpose.
The number of authorized shares of each class of stock in a Delaware corporation is on file with the Delaware Division of Corporations; however, the names and addresses of the shareholders are not listed or recorded with the State government.
In fact, there is no public registry which lists shareholders of private Delaware corporations, and private Delaware corporations are not typically obligated to publically disclose their stock ownership records.
Corporations must hold a shareholder meeting at least once every thirteen months and must send a notice to all shareholders of the time and place of the meeting, inviting them to attend.
Shareholders who have the time should make an effort to attend a corporation’s shareholder meetings so they can stay abreast of the corporation’s activities, challenges and growth. They may also attend by conference telephone and may vote by proxy without attending if they desire.
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.
Why 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:
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 these blank checks?
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:
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.
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.
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.
Entrepreneurs are primarily concerned with running a successful company-- on a daily basis, they make myriad decisions and face constant pressure related to the operation of the company.
Often, particularly early on in a company’s existence, taking formal steps to document and track corporate actions and decisions is an afterthought, given the pace at which decisions are made and actions are taken.
Drafting corporate resolutions, recording meeting minutes and tracking stock available for issuance is sometimes seen as a distraction from the company’s primary focus of pursuing its business plan and achieving its goals.
Such a mindset, however, can ultimately prove damaging to a business’s growth and future. Mistakes or failures to monitor corporate actions can come back to haunt a company at the most inopportune times, such as when it is looking to bring aboard investors.
Take for example, a company that has issued stock to its founders and employees without documenting these grants through corporate resolutions, only to find that it has issued more shares than permitted under the company’s Certificate of Incorporation.
Such an issue is a red flag for both investors and lenders, both of whom view adherence to formalities as a sign of a company’s overall commitment to detail.
All is not lost, however, because under Section 204 of the Delaware General Corporation Law a company can retroactively ratify mistakes through action that, prior to the adoption of Section 204 of the Delaware General Corporate Law in 2013, would have been deemed invalid as well as a financial and logistical mess to correct.
Elaborating on our example, assume that a company is authorized to issue 2 million shares of stock under its Certificate of Incorporation but has inadvertently issued 2.1 million shares.
What would Section 204 require as a corrective action for the issuance of these 100,000 shares of unauthorized stock that was issued to the shareholders?
If the above actions are done in compliance with Section 204, the defective action is approved by the state of Delaware and, in our example, the 100,000 formerly invalid shares would be deemed valid stock and the amended Certificate of Incorporation would govern.
Section 204 is not the only means by which a Delaware company can give authorization to correct prior mistakes, but it is a formal means with which to deal with serious problems, such as the breach of a company’s Certificate of Incorporation, per our example.
This is unique to the state of Delaware and yet another example of how Delaware keeps the Delaware corporate law structure on the cutting edge.
A company reviewing its past or current compliance with corporate formalities should seek the assistance of counsel to ensure that any corporate clean-up is documented appropriately.