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Words that Matter: Considerations in Drafting Preferred Stock Provisions

January 2014

Pursuant to Delaware law, all capital stock, by default, is created equal unless the company’s certificate of incorporation provides for certain classes or series of preferred stock that enjoy special contractual rights, powers, and preferences over shares of another class or series of capital stock. While the General Corporation Law of the State of Delaware (the DGCL) permits a company to create preferred stock, it provides drafters of preferred stock provisions with no specific guidance as to the nature or form of the preferred stock’s rights and obligations. Similarly, Delaware case law imposes few express mandates other than to require that shares of preferred stock have preference over shares of common stock (which typically takes the form of a preference as to dividends and/or distributions upon liquidation of the company).

With few requirements from the DGCL and Delaware case law, it is up to the drafter to set forth the particular terms, including the rights, powers, and preferences of the preferred stock. The terms of the preferred stock, particularly the economic rights, powers, and preferences, will be influenced by the context in which the preferred stock is being issued and the relative bargaining power of the company and its investors. The special rights, powers, and preferences typically associated with preferred stock consist of some combination of special dividends, liquidation, voting, redemption and/or conversion rights, and such rights, powers, and preferences must be clearly and specifically set forth in the company’s certificate of incorporation or in a certificate of designation (which has the effect of amending the company’s certificate of incorporation). For purposes of this article, a certificate of incorporation and a certificate of designation are referred to collectively as a “certificate of incorporation.”

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