These days the Delaware C Corporation (also known as a General Corporation) is the most commonly incorporated Company type in Delaware.
Entrepreneurs are attracted by the Delaware C Corp’s ability to go public and raise capital by selling shares in the company. This type of corporation is also often used by startups looking to attract venture capital.
The Delaware C Corp has a typical Corporate/Legal structure: shareholders own the company via shareholdings, Directors run the company and are responsible for its strategic management, whilst officers (eg Managers, the CEO etc) manage the company’s day-to-day business.
Are You Thinking of Going Public?
So you market, or are about to market, a unique service or product! Your business is up and running and is growing (or is in the incubator stage). If you are in this position, you may find yourself, before too long, weighing up the option of going public.
Offering shares in your company to the general public for the first time is called an Initial Public Offering, or IPO. If you’re considering where or how to launch your IPO, look no further than Delaware. Almost all American IPOs in the last 25 years have been launched under the framework of a Delaware General Corporation (ic C Corp).
Delaware C Corp – General
So what is a Delaware General Corporation/C- Corp?
A Delaware General Corporation has three pillars of influence: shareholders, Directors and Officers. Each of these groups has different rights and responsibilities within the corporation.
Shareholders
The shareholders of a C Corp own the company, but do not manage the company. Typically, holders of common stock receive one vote for each share they own, and they have the right to elect the members of the Board of Directors. (They also have the right to vote on certain other matters of major significance to the company).
Any stockholder who holds a majority of the issued shares in a C Corp can control the company. Majority shareholders typically hold a larger amount of responsibility / power than minority shareholders.
Generally, minority shareholders hold no responsibility for, or re, the company, and are able to assign, via proxy format, their votes to anyone of their choosing. Typically minority shareholders can also sell their shares whenever they want (though this can be modified by reference to a Shareholder’s agreement).
C Corp Shareholders can/will receive 2 potential benefits: first, dividends (ie a share of the company’s profits) paid in proportion to the percentage of stock held (ie when/if the Board of Directors decided to declare a dividend); and second, by the increased value of their shares as the company grows.
Directors
The Directors run the company and are responsible for the company’s overall management/direction/results. They take responsibility for all major business actions, such as the issuance of shares, the hiring of officers, the hiring of key management, commercial decisions, the establishment of corporate policies’ and the setting of salaries and compensation packages.
The Board of Directors decides if a dividend will be paid to the shareholders and, if so, how much. Individual directors may also own shares in a C Corp.
Directors of a Delaware C Corp have certain fiduciary responsibilities to the company (known as Directors duties). They must be loyal to and not in conflict with the company; they must make informed, independent decisions; they must not act in bad faith (eg as self-dealing or fraudulent dealings); and they must act in the best interests of the company and its shareholders.
Directors may make decisions and take action in pre-schedules meetings (ie where a quorum is present, or without a meeting – by unanimous written consent of all Directors. Directors cannot donate or sell their votes to other directors, nor can they vote by proxy.
Ordinarily, Directors may be removed and replaced – with or without cause - by the majority vote of the shareholders. (This is why a majority shareholder can/does control the company).
Officers
The officers of the company work for the Board of Directors and handle the day-to-day business of the company. Officers carry out the Board’s decisions and implement the Board’s policy. Officers are usually the President, Vice President, Secretary and Treasurer. However, the Board may appoint other officers, such as a C.E.O., C.F.O., C.I.O., Sales Manager, Operations Manager or any other title ithe Board may wish to create.
Officers may be compensated with shares, or they may buy shares in the company as the Board of Directors may decide.
Why Delaware?
There are several good reasons why almost all US IPOs are Delaware general corporations/C Corps: Smart Investors don’t invest in good ideas – they prefer to invest where they can see they will receive/own a tangible, measurable proportion of the Company’s profits originating from the ideas. A shareholding offers such certainty.
Many IPO Professional Advisers would say that, through its general corporation provisions, Delaware offers the most versatile and functional toolbox of share structures. Stock choices available to a Delaware C Corp include blank check preferred stock, super-voting powers, stock options and stock warrants. With these features, + the added ability to tailor shareholders entitlements via reference to a shareholders’ agreement, a Delaware C Corp can provide entrepreneurs with a number of ways to attract investors.
Blank check preferred stock is one common example of a left field way to attract or secure an investor. You can structure your Delaware C Corp right from the start with an optional second class of stock that gives you the latitude to offer special deals to certain/significant investors.
Another such option is Preferred stock. 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. Preferred stock can be very attractive to investors, yet costs very little to issue.
Below are just two examples of how preferred stock can act in your favor in an IPO.
Using Preferred Stock to Attract an Investor
Let’s say you have an investor or interested party who, for whatever reason, hasn’t demanded shares in exchange for his or her investment, until now. To date the investor has put nominal sums into the business but now, on the verge of your IPO, wants a major percentage of the shares to be issued.
A Delaware C Corp can enable you to approach that investor and offer a very attractive deal: The terms of the deal are negotiable as, under Delaware law, you have the flexibility to reach a deal on terms agreeable to both sides.
You might, for example, offer the investor, 100,000 shares of (preferred) stock at $10 each with preferential terms, such as: 1) a guaranteed annual dividend of $1.00 per share (thus guaranteeing a 10 percent return to the investor); 2) no voting rights until the company goes public (meaning – you’re not diluting your own power); and 3) the preferred stock would be transferable to 1,000,000 shares of common stock one year after the Company goes public. The end result? You’ve delivered to the investor the prospect of a substantial return on his/her investment without diluting your ownership stake!
Keeping Control
If you’ve been unusually successful at raising investor capital before the public offering, it’s possible that your share of ownership has shrunk (or is in danger of shrinking) to close to 51 percent (at which level you only just have control of the company).
To ensure you retain control well into the future, at that point, (ie while you still retain majority control of the company), what you could do is you could issue 100,000 shares of preferred stock to yourself with certain special terms eg: 1) no dividend entitlements (thus eliminating potential investor objections); and 2) voting rights of 100 votes per share on all matters shareholders might vote on (thus maintaning your voting power notwithstanding that you may have divested yourself of more than 50% of the common stock).
Even if you continue to attract investment money that further dilutes your ownership percentage, in this scenario you have delivered yourself 10,000,000 extra votes, which is more than enough to offset the voting rights of the other outstanding shares.
Stock Offerings
The issuing of Common stock in the case of a Delaware C Corp is governed by law; each share of common stock in a Delaware C Corp is entitled to one vote, and common shareholders are entitled to a proportionate share of common stock dividends (if a dividend is declared) ie in proportion to the percentage of shares they hold.
Contrast that with Preferred stock which has no set prescription or formula under Delaware law. Preferred stock in a Delaware C Corp can be issued with or without voting rights and the Stocks’ terms are open and limited only by what the Board of Directors and Investors negotiate. In short Preferred stock in a Delaware C Corp can be structured in such a way as to offer the investors preferential financial assurances without the investors receiving voting rights.
A Delaware C Corp does not have to issue Preferred stock or Common stock – they can be deployed in tandem. In fact, one common method of preserving insider voting control when raising investment capital is to use preferred stock in addition to common stock.
In some preferred stock designs, certain stockholders may be entitled to superior dividends and/or liquidation rights (ie in the event that the company files for bankruptcy protection) and/or afforded other considerations. Additionally, a Delaware C Cop can retain the right to buy out preferred stockholders at a given price, or at a certain date in the future for a price based upon a particular formula. The flexibility and adaptability of the preferred stock model truly represents one of the prime advantages of the Delaware C Corp legislation.
Preferred Stock – Other Key Elements
Some corporate lawyers refer to Delaware C Corp stock as “blank check preferred stock” because the scenarios described above are both possible with the same class of preferred stock. So, too, are other scenarios if you have issued enough preferred stock – you simply classify the stock into different series and make arrangements with investors as circumstances dictate.
If the preferred stock has already been authorized, you can issue it to the investor on a same-day basis and complete the deal without a lengthy escrow period (ie/eg if doing so is to your advantage). The “blank check” reference arises from the fact that in effect you are issuing pieces of paper as you proceed, as many as required (providing investors accept them) in order to generate capital.
Another important thing for IPOs to be aware of is a basic principle of Delaware company law, ie in a Delaware general corporation/C- Corp, the Directors set the price of the stock. What this means is that the price of your stock is set by what the Directors say it is worth and/or by what investors believe it is worth (ie regardless of what the actual value of capital or assets held by the Company may be). The investors are in effect gambling on the future viability of your company – their judgment as to the future value of your company is what determines the share price, both when you sell it initially and when it sells on the open market.
How Much Stock?
A key matter you will need to resolve before you form your Delaware general corporation/C-Corp is what is the quantum of shares of stock to issue?
In arriving at the conclusion of that conundrum you will firstly need to ask yourself these two questions:
1. How much capital do I/we need to raise? &
2. What percentage of the company am I willing to forsake for that amount of money?
Let’s assume you plan to raise, via private offering, (a) $100,000 in year 1, then (b) a further $1,000,000 via a second private offering in year 2, then (c) an additional $25 million via an IPO after three or four years.
Say for the first offering ($100,000), you’ve decided you’ll give up 10% of the company, and then another 25% for the second offering of $1 million (which means you will have parted with 35% of the Company all up before you go public).
In this scenario, you would own 65% of the Company at the time of your IPO. However, going public is rarely that straight forward. Let’s assume (a) you’ll need to set aside some stock, or stock options, to attract gun staff and (b) you’ll probably need to assume that other needs will also eat into your ownership stake.
This is when blank check preferred stock can come into play: As your ownership percentage of common stock shrinks, you can retain majority voting rights (and control of the Company) via issuance of preferred stock as you may specify. This will enable you to achieve a balance between attracting investors (along with productive coworkers) while avoiding the prospect of being voted out and losing control of your company.
Once you’ve decided the quantum of capital you want/need to raise, you’ll then need to decide the number of shares and the value of each in order to reach that figure.
In many situations, a general corporation (often referred to as a stock corporation, open corporation or C corporation), is recommended, especially when a Company goes public or plans a private Offering of Stock.
General corporations are also typically used when a company wants to attract Venture Capital Funding.
A cautionary note: Anyone can own part of a Delaware C-Corp, but there are a limited number of owners you can take in before the SEC potentially gets involved. Moreover you can’t advertise the sale without the SEC getting involved ie you can’t offer the investment online (hey, want to invest in my company? ads are not allowed). That said, if you know someone that wants to invest in your company it’s fine to sell them stock (ie private equity rounds are fine).
Before you incorporate a Delaware C Corp you should look up the SEC minimums and regulations to make sure you are following them.
Local laws can have an impact. Hence you should also seek appropriate legal financial and tax advice before committing to commit a Delaware C Corp.
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