The chapter on Articles of Incorporation in Business Transactions Solution (BTS §§ 31:1 et seq.) covers the decisions and procedures relating to the preparation, execution and filing of the articles of incorporation of a general business corporation and amendments to such articles that may be approved by the board of directors and shareholders after the corporation is formed.
If the principals have had an opportunity to consider the structure for internal governance of the corporation, the articles of incorporation may well reflect these decisions and include detailed provisions relating to the powers and actions of the directors; the various rights and preferences of the authorized stock (e.g., terms of preferred shares); and certain matters relating to the shareholders (e.g., preemptive rights, transfer restrictions). See BTS Master Form at § 31:61.
Drafting the articles of incorporation for a corporation with a complex capital structure that includes both common and preferred shares requires a lot of care and attention. The first step is to collect certain general information relating to the preferred stock such as designating the name for each class of stock to be issued (e.g., common stock, preferred stock or class a preferred stock); determining the number of shares to be authorized in each class; determining whether any limitations will be placed on issuance of each class of stock; determining whether stock will be issued in series; determining differences among classes and series relating to rights, preferences, privileges and restrictions of each class or series; determining whether the board of directors will have the right to fix rights, preferences, privileges and restrictions of any class or series; determining whether the board of directors will have the right to increase the size of the issue; and determining whether the board of directors will have the right to issue other classes of preferred stock, junior or senior.
Once these questions have been answered attention should turn to the specific rights, preferences and privileges of each series of preferred stock, making sure that the relative rights of multiple series have been considered and balanced. Issues to consider include dividend rights, including amounts and timing of payments, whether dividends will be cumulative or noncumulative and whether a particular series will have a preference as to dividends over other series; voting rights, particularly the right to votes as a separate class or series on specific matters such as mergers, sales of assets and issuance of new shares; rights on liquidation and dissolution, including preferential rights to liquidating distributions; conversion rights, including mandatory conversion into common stock upon the occurrence of certain events (e.g., initial public offering); and redemption procedures, including the rights of the company to require redemption and/or the rights of shareholders to require the company to redeem their shares. It is customary to also include protection provisions for preferred stock such as restrictions on changing the terms of issued preferred shares with approval of a stated percentage of such shares, prohibitions on the creation of any stock issue on parity with or senior to the outstanding preferred shares, and requirements for obtaining approvals from a stated percentage of preferred shares in order to consummate specific corporate actions.
Common examples of complex capital structure include the following:
- Common shares, typically issued to the founders and employees of a corporation, and an initial series of preferred shares, typically referred to as “Series A”, to investors participating in the corporation’s initial round of outside equity financing and requiring the full range of economic and voting rights described above. See BTS Specialty Form at § 31:149.
- Common shares as above and multiple series of preferred shares (i.e., Series A and Series B) issued in multiple rounds of financing to outside investors. See BTS Specialty Form at § 31:147.
- Common shares as above and an initial series of preferred shares with limited voting rights and no special economic rights, a structure that might be used when investors have purchased convertible notes and demand the voting preferred shares as a means for participating in management control of the corporation until the notes are converted upon closure of a traditional equity financing round. See BTS Specialty Form at § 31:149.70.
- Two classes of common shares with one class being issued to the founders and having super voting rights (i.e., 10 or more votes per share) and the other class with regular voting rights (i.e., one vote per share) being issued to employees and consultants and to outside investor upon conversion of preferred shares that might be issued to them in the future, a structure that is designed to ensure that the founders maintain the right to control key decisions regarding the corporation made at the stockholder level. See BTS Specialty Form at § 31:149.30.
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