By Robert Wenzel
Once your company has decided to accept investors, one of the items that must be done is to amend and restate the company’s articles of incorporation. One of the first things that need to be done is to distinguish between common stock and preferred stock.
Most companies that are traded publicly offer common stock. The rights of the common stock holder are usually to vote for the directors of the organization and certain other business transactions. In addition, common stock pays any dividend money to the investors after all company obligations have been met.
However, preferred stock is paid to the investors of the business. Some of the topics that are established in the articles of incorporation include the rights, privileges, and restrictions of the preferred stock. In order to cover these areas, the areas of the term sheet that relate to capitalization and the rights of the shareholders are usually not amended; rather, the articles are amended and restated in one document.
One option that companies sometimes pursue when amending and restating the term sheet may issue preferred stock to the investors in several series and fix the rights, preferences, privileges and restrictions. What this means is that when new individuals or companies invest money in a company, there may be changes to how the stock is paid out. This often is done to protect the business and allow them flexibility in returning capital to the investor.
There are several things that the company may want to include in the amended and restated articles of incorporation. These items include but are not limited to:
1) Dividend Preference. The term sheet should discuss any issues related to dividends such as rates, whether the dividends are cumulative and if there will be dividend preference among the investors. This will help the investor to get a better idea of what they may expect in the way of a return on their investment and what the return (if any) will be.
2) Liquidation Preference. A “liquidation event” is when a company merges with another organization, most of the voting power is disposed of, or most of the company’s assets are sold. When this happens, an investor may have leverage when and if there is a sale. (An example of this would be having preferred stock converted to common stock in the new organization.) This can be beneficial since it gives the person or company who invested the capital choices as to how or if they even want to contribute money to the new organization.
3) Voting Rights. Depending on how the term sheet was negotiated, individuals who have preferred stock may have the right to vote or serve on the company’s board of directors. In some cases, it will be required that a certain number of preferred stock shares be held in order to serve on the board of directors. While it would require the individual to contribute more money, it could also benefit the investor because they would then have a direct say in how the company is run.
4) Redemption Right. The term sheet needs to describe if the preferred stock is redeemable and if so, what the redemption terms are. Some newer companies may not have redemption rights since it may hinder their ability to raise money in the future. However, more established companies may have redemption rights. This allows the investor to redeem their money out of the company at a specific time, which can be useful if the investor needs the capital for another reason.