Giving access to shares of your business to the general public for the first time is called an Initial Public Offering (IPO) The best place in the USA to structure and register a business for an IPO is the state of Delaware. Almost all IPOs since the early 90’s have been launched under the legal framework of a Delaware General Corporation. There are several good reasons why Delaware holds most of this market, but attracting a large volume of investors is definitely the main one. It is important to note that most investors don’t simply invest in a good idea; rather, they invest in tangible, measurable ownership of some of the profits that originate from good ideas and savvy investors want to own part of this tangible and measurable value that is materialized through owning stock.
Blank check preferred stock is one example. You can structure a company right from the start with an optional second class of stock that gives you the latitude to offer special deals to more important investors. Preferred stock is very attractive to investors and it costs the company very little to issue them.
Preferred stock lets you negotiate dividend rights, the votes per share, the security interests in the company’s assets and the potential to convert the preferred shares into common shares at a future date. Below are two examples of how preferred stock acts in your favour during an IPO.
Suppose you have investors who, for whatever reason, hasn’t demanded stock in exchange for their investment to date. This investor has put nominal sums into the business but now, on the verge of an IPO, he wants a major percentage of the company.
You can approach these investors and offer a very attractive deal. The terms you negotiate are up to you because, under Delaware law, you have the flexibility to strike a deal on terms agreeable to both sides.
If a company has been successful in raising money before a public offering, it runs the risk of having attracted too much money meaning that founders’ ownership often shrinks to a level where they barely still control their own company.
At that point however, while founders still maintain majority control, they can issue preferred stock to themselves with the following preferred terms:
- No dividends (thus avoiding investor objections); and
- With voting rights on all matters shareholders may vote upon (thus solidifying voting power even if founders have sold more than 50% of the common stock). Furthermore, even if the company continues to attract investment that further dilute founders ownership percentage, by granting additional votes the founders can offset the voting rights of the other outstanding shares. (Note: doing all this correctly almost certainly requires the services of an attorney well-versed in all these matters)
Most IPO experts agree that, through its General Corporation provisions, Delaware offers the most versatile and functional toolbox of stock structures. Stock choices such as blank check preferred stock, super-voting powers, stock options, stock warrants and shareholder agreements give an entrepreneur a number of avenues to effectively attract investors.
How Much Stock?
A key question that needs to be resolved before one decides to form a Delaware General Corporation is the number of shares of stock that need to be issued for the company. In order to answer this two questions need to be addressed:
1) how much money needs to be raised? and
2) what percentage of the company’s stock (ownership) are the existing shareholders willing to give-up for the money needed?
Like so many other business calculations a company really needs to back into the number of shares that are evaluated using the answers obtain from the questions above.
By applying these simple calculations the company needs to figure out what percentage needs to be retained before an IPO is executed. Going public is rarely simple, one must assume that you will need to devote some stock to attract top personnel. Also very often other needs may require further stock, so these need to also be accounted for in the thought process. All this underscores the importance of blank check preferred stock. As ownership percentages of common stock diminishes, majority voting rights and control can still be maintained with the provisions set out by the preferred stock. Through this a balance can be achieved that allows to attract investors and talented employees while avoiding the prospect of being voted out and losing control of the company that the founders built. When the amount of money needed has been determined, you then need asses the number of shares and the value of each in order to reach the desired number. The calculations involved in those decisions are affected by way too many variables to be laid out in this explanation but we are happy to take you through these when needed.