What Do Stockholders In My Startup Generally Need to Approve?

In the early stages of a startup, decisions are typically made by a small group of founders. However, as a startup grows and brings in outside investors, these investors become stockholders with a say in some key decisions.

This article discusses the various actions that stockholders in a startup generally need to approve, including changes to the company’s articles of incorporation and bylaws, issuance of new shares, major transactions, changes in the board of directors, changes to capital structure, employee stock option plans, indemnification agreements, and related party transactions. While the specific requirements for stockholder approval can vary based on the company’s bylaws, the terms of a past financing and the laws of the jurisdiction in which it’s incorporated, it is crucial for startups to keep their stockholders informed and involved in major decisions that could impact their investment.

This article will mostly focus on shareholder approvals for common shareholders. However, it’s important to remember that in many startups, especially those with significant venture capital investment, there are likely preferred shareholders with different approval rights. Some of these will be addressed at the bottom of the article.

Though this article will give you a general idea of shareholder approvals, all of this is very specific to each company, so it’s essential that you work with legal counsel to ensure compliance. If you’re looking for legal counsel, feel free to reach out to us here.

Changes To Articles of Incorporation and Bylaws

Any changes to your startup’s articles of incorporation or bylaws usually require stockholder approval. These documents outline the structure, purpose and regulations of your startup. Proposing amendments may affect the rights and obligations of stockholders, so it is important to get their input. Examples of changes that may require stockholder approval include increasing or decreasing the number of authorized shares, changing voting requirements or altering dividend policies.

Issuance of New Shares

Stockholders also need to approve any issuance of new shares or other securities. This means that if your startup wants to sell additional shares, stockholders must first approve the decision. This is important because any new shares will dilute the ownership percentage of existing stockholders. As such, it is crucial for them to have a say in whether or not your startup should proceed with the issuance.

Major Transactions

Stockholders may also need to approve any mergers, acquisitions or other major transactions involving your startup. These types of transactions can significantly impact the direction and future of your startup, so it is important for stockholders to have a say in whether or not they should proceed. For example, if your startup is considering merging with another company, stockholders will want to know how this will affect their ownership stake and what benefits the merger will bring to the company as a whole. Similarly, if your startup is considering acquiring another company, stockholders will want to know how this acquisition fits into the overall business strategy and what potential risks and rewards may come with it. In any case, it is important to keep stockholders informed and involved in major decisions that could impact their investment.

Changes In Board of Directors

Stockholders play a critical role in the direction and decision-making of a startup. Therefore, any changes in the company’s board of directors must be approved by them. Typically, stockholders approve the following:

• Election of Directors. At the annual general meeting, shareholders vote on who sits on the board of directors. Each shareholder has a certain number of votes based on the number of shares they own. These votes can be cast for different director candidates, and the candidates with the most votes will be elected to the board.
• Removal of Directors. Similarly, shareholders typically have the power to vote to remove directors from the board. The process for this can vary based on the company’s bylaws and the laws of the jurisdiction in which it’s incorporated. Sometimes, a simple majority vote is enough to remove a director, while other times, a supermajority or other specific requirements might be needed.
• Board Expansion. If a startup wants to increase the size of its board of directors, this often requires shareholder approval. The specific requirement for this can vary based on the company’s bylaws and the laws of the jurisdiction.

Changes to Capital Structure

Stockholders must approve any changes to the company’s capital structure, such as a stock split or reverse stock split. A stock split increases the number of outstanding shares and reduces their value, while a reverse stock split decreases the number of outstanding shares and increases their value. These types of changes can impact the liquidity and value of shares held by stockholders, so it is important for them to have a say in whether or not these changes should be made.

Employee Stock Option Plan

Stockholders need to approve the establishment of an employee equity plan and may also need to approve any revisions of the plan. This plan outlines the terms and conditions for granting stock options to employees, including vesting schedules, exercise prices and expiration dates. Any significant changes made to this plan could impact the value of existing stock options held by employees, as well as future grants.

Indemnification Agreements

Indemnification agreements are contracts in which a company agrees to cover certain potential losses or liabilities that its directors or officers might face as a result of their service to the company. These agreements are a common way for companies to attract high-quality candidates to these roles, as they help to mitigate the personal financial risk associated with these positions.

However, entering into such agreements can also create a significant potential liability for the company. Therefore, shareholders often need to approve these agreements.

Related Party Transactions

Related party transactions involve a deal or arrangement between two parties who have a preexisting relationship. This can include transactions between the company and its directors, executives, key employees or shareholders who own a significant stake in the company.

Related party transactions require special attention because they can create potential conflicts of interest. For example, a company might overpay in a transaction with a company owned by one of its directors, which would benefit that director at the expense of the company and its shareholders. To mitigate this risk, these transactions are often subject to a higher level of scrutiny and generally require approval from disinterested shareholders.

Typical Series A Preferred Shareholder Approvals

Different classes of shares come with different rights and privileges. Thus far, this article has been focusing on the common shareholders. Common shares are the most basic form of equity and are often held by the founders, employees and sometimes early-stage investors.

Preferred shares, on the other hand, are a type of equity typically held by venture capital investors or other later-stage investors. They come with certain “preferred” rights over common shares that are designed to protect their investment and influence strategic decision-making. One of these preferred rights is known as protective provisions, which simply means that the preferred shareholders must approve a certain set of actions.

The protective provisions will vary from deal to deal, depending on the specifics of the investment agreement and the negotiation between the company and the investors.

Below is a fairly standard set of protective provisions for a Series A financing:

1. Liquidate, dissolve or wind-up the affairs of the company.
2. Amend, alter, or repeal any provision of the charter or bylaws.
3. Create or issue any other security convertible into or exercisable for any equity security unless the same ranks junior to the Series A Preferred.
4. Create or distribute any digital tokens.
5. Purchase or redeem or pay any dividend on any capital stock prior to the Series A Preferred.
6. Adopt, amend, terminate or repeal any equity compensation plan.
7. Create or authorize the creation of any debt security over a certain amount.
8. Create or hold capital stock in any subsidiary that is not wholly owned, or dispose of any subsidiary stock or all or substantially all of any subsidiary assets.

In addition to the protective provisions above, the preferred shareholders may also have the right to elect a certain number of board seats as well as other rights.

Conclusion

In conclusion, stockholders in a startup generally need to approve a wide variety of actions, ranging from changes to the company’s articles of incorporation and bylaws to major transactions and changes in capital structure. While the specific requirements for stockholder approval can vary based on the company’s bylaws and the laws of the jurisdiction in which it’s incorporated, it is crucial for startups to keep their stockholders informed and involved in major decisions that could impact their investment. By understanding the corporate formalities required for each action, startups can ensure that they follow the necessary procedures and avoid unnecessary headaches.