Venture preferred stock typically has voting rights, computed based on the number of shares of common stock into which the preferred stock can be converted. In addition, the preferred shareholders will be entitled to a class vote as a matter of corporation law under certain circumstances, such as certain merger situations.
What are typical voting rights that investors will receive?
The investors will typically negotiate for veto rights over certain actions of the corporation. These veto rights are also known as protective provisions, approval rights or negative covenants. Usually, the investors will negotiate for the right to approve:
(1) any merger or acquisition of the company irrespective of whether state corporation law grants them such a right;
(2) the creation of any new securities senior to or on a parity with their preferred stock;
(3) any amendment to the articles of incorporation that would affect the rights of the preferred stock; or
(4) changes to any of the rights and preferences agreed to in the preferred stock sale.
While the protective provisions mentioned above are usually included in the transaction agreements, both parties may disagree on the addition of other provisions such as those discussed below.
What are other common voting rights that investors will request?
The investors will likely want a separate vote of the preferred stockholders on some matters where such a vote is not required by law. In situations where the investors are acquiring a minority position in the company, and as such cannot control the board of directors, the investors may also attempt to negotiate the right to approve:
o any sale, merger or acquisition of the company;
o purchasing stock of another business;
o certain other corporate transactions, such as the sale of a product line;
o the sale or an exclusive license of significant technology;
o purchase of assets over a certain dollar threshold;
o incurring debt;
o the issuance of any new securities senior to or equal to the preferred stock;
o redemption of stock;
o increases in management's cash compensation beyond historical practice;
o additional stock or option grants to management; or
o other points negotiated by the parties.
How common are these voting rights?
These items listed above are typically more negotiable than items (1) through (4) in the preceding paragraph. Therefore, these provisions tend to be more negotiated by the parties. Some of these items may tend to fall into the traditional decision-making realm of management and the board of directors. In the event these veto rights encroach too far into management's responsibilities, you should attempt to negotiate those provisions away.
These veto rights in the event of specified events or protective provisions in the form of special voting rights of preferred stock holders are often (but not always) included in the term sheet. From the company's perspective, it is preferable to have a class vote (e.g., Series A and B voting together) rather than a series vote.