October 3rd, 2012 by Macy Stoneback
Now that you’ve incorporated your emerging company, you may be wondering, “How often do I need to hold Board and shareholder meetings?” and “What decisions do I need to bring to the Board or the shareholders?” These are common questions, and the answers differ company by company, to some extent. This article is written for founders of typical early stage emerging technology companies.
Sources of Requirements for Shareholder Approval
Which corporate matters are required to be brought to shareholders for a vote is primarily statute-driven, meaning that, under law, certain actions have to be approved by shareholders in order for the corporation to take such actions. Such matters include company name changes, an increase in the number of authorized shares, the creation of a new class of stock, and certain fundamental changes such as mergers, conversions, and sales of substantially all of a corporation’s assets. The company’s investment-related agreements also may require investors’ approval in their capacity as shareholders before taking certain types of actions, like raising more capital or other significant actions. In most cases, actions of the shareholders can be taken at a meeting or by a written consent, both of which must follow the rules prescribed in the corporation’s Articles of Incorporation and Bylaws. If permitted by the Articles of Incorporation and Bylaws, in most cases the written consent of shareholders may only require consent of a certain percentage of holders of each class, as long as the company promptly notifies all shareholders of the approved action.
Sources of Requirements for Board Approval
The role of a Board in decision-making is a grayer area than the role of shareholders; it depends on a variety of factors. Statutes of the state in which the corporation was formed mandate that certain actions be approved by the Board. The company’s investment-related agreements may also require the approval of a supermajority of the directors or the investor-designated director(s) for certain types of actions, such as budgets or expenditures over a certain amount. To varying degrees depending on the relationship between the Board and management, the Board delegates some of its responsibility for the business and affairs of the company to the officers. Commonly accepted practices also factor into how company decisions are made.
Actions of the Board can be documented in one of two ways: (1) minutes of a meeting duly called at which a quorum was present, or (2) a written consent signed by all the directors.
Standard Practice for Board or Shareholder Actions for Emerging Companies
Whereas a basic family-owned or service business with no new share issuances or other key structural changes may get by with just one annual shareholder meeting or written consent reelecting directors and one Board meeting or written consent reelecting officers and ratifying actions of management over the past year, that’s typically not adequate for an emerging technology company. Such companies are often involved in bridge loans and equity investments, issuing stock options or restricted stock to employees and directors, and adding and removing officers and directors, all of which should be properly documented with meeting minutes or written consents. Below is a list of documents and actions that commonly affect an early stage company’s life and the typical approvals that are either required by law, bylaws, or an agreement, or are just good corporate practice.
|Document/Action||General Guidelines Based on Requirements or Best Practices|
|Incorporator actions (i.e., filing initial Articles of Incorporation)||Board ratification|
|Articles of Incorporation – amendments||Board approval and usually shareholder approval|
|Bylaws – initial adoption and amendments||Board or shareholder approval|
|Securities issuances and redemptions (e.g., stock, stock options, warrants, and convertible notes)||Board approval and sometimes shareholder approval, depending on the context|
|Stock transfers||Board and sometimes shareholder approval, if required by a shareholder agreement or other agreement with rights of first refusal|
|Stock Incentive Plan||Board approval and, in most contexts, shareholder approval within one year|
|Investment documents for bridge and equity financings (e.g., Stock Purchase or Subscription, Voting, Right of First Refusal, and Investors’ Rights Agreements)||Board approval and, in many contexts, shareholder approval|
|Conversion, merger, acquisition, and other key corporate restructuring events||Board and, in many contexts, shareholder approval|
|Appointment and removal of officers||Board approval|
|Election and removal of directors||Shareholder approval and, in limited contexts, director approval|
|Executive employment documents, executive compensation plan/bonuses||Usually Board approval and sometimes shareholder approval*|
|401(k) plan, profit sharing plans, and similar plans||Board approval|
|Loans, credit lines, and other bank financings, including authorized signatories||Board approval and sometimes shareholder approval*|
|Annual budget||Board approval and sometimes shareholder approval*|
|Audit firm selection||Board approval and sometimes shareholder approval*|
|Lease – new, extension, or significant amendment||Board approval|
|Arms-length agreement with related company (e.g., Intercompany Agreement, IP Licensing Agreement)||Board approval and sometimes shareholder approval*|
|Term sheets (e.g., for investor financings, joint development, licensing)||Usually Board approval|
|Important agreements with key business partners (e.g., research, development, licensing, supply, distribution, etc.)||Usually Board approval|
* in certain limited contexts involving outside investors with certain contractual rights
Routine agreements related to sales, consulting, vendors, confidentiality, and non-executive employees are typically decided on by management. Each company’s situation differs, so it is often a good idea to talk with your attorney when deciding on the parameters for proper approvals.
Consequences of Failing to Obtain Necessary Approvals
You may be asking, “Who cares anyway?” Your investors, future acquiror, regulatory agencies, and future potential disgruntled employees and business partners care. You have a vested interest because you are personally and financially vested in the company’s success. Failure to comply with appropriate approval levels and best practices can yield the following “parade of horribles,” many of which we have seen firsthand:
- Your investment deal could get unwound, requiring the company to return investment funds (now spent) to the investors.
- The Internal Revenue Service may audit the company and discover it has violated Section 409A of the Internal Revenue Code and impose taxes and penalties on the equity grant recipients.
- Your acquisition or venture capital investment could be delayed while your attorneys fix past errors and omissions.
- You could lose credibility in front of your Board members for failing to bring key information to their attention.
- Your standing in a lawsuit could be compromised because you failed to obtain adequate board and shareholder consents approving a later disputed action.
- In egregious situations, the “corporate veil” could be pierced due to this and other negligence, exposing you and others to personal liability.
While corporate governance may at times seem like self-serving fluff, it can help prevent these and other time- and money- draining problems.
Advantages of Obtaining Proper Board and Shareholder Consents
By understanding the roles and interplay between Boards, shareholders, and management, you will be in a better position to know when proposed actions are to be approved by which constituency or group. Doing so will help you gain the trust of your stakeholders and avoid problems down the road.