The sale of a venture-backed company is typically structured as triangular merger, where the acquiror forms a merger sub that merges into the target company. The stockholder vote requirements for a merger are governed by state law and the company’s charter (Certificate of Incorporation in Delaware or Articles of Incorporation in California) and bylaws. (Occasionally, the company’s charter will need to be amended in connection with the merger to change the flow of merger consideration or other reasons. In this situation, the stockholder approval to amend the Company’s charter is also relevant.) The stockholder vote requirements under Delaware law and California law for a merger are outlined below.
Delaware
General. Delaware corporate law provides that a merger requires the approval of a majority of the outstanding stock entitled to vote. Companies cannot “contract out” of the Delaware law requirement. (In order to address the minimum vote requirements, some venture funds insist on drag-along provisions, which require stockholders to vote in favor of a merger if certain conditions are met.)
Practical answer. Generally, the necessary stockholder approval for a merger of a Delaware corporation will be (i) a majority of all shares on an as converted to common basis, (ii) any other approval required by the protective provisions in the Certificate of Incorporation, such as a separate series approval or super-majority approval, and (iii) any other approval requested by the acquiror in the merger, such as a super-majority approval in order to limit the number of stockholders that may exercise dissenters rights (to be covered in a future post). Acquirors asking for an extremely high percentage, such as 90% or 95% approval, is not particularly unusual in the sale of a private company, especially if there may be dissenting stockholders.
California
General. California corporate law provides that a merger requires the approval of a majority of the outstanding shares of each class of the corporation. This means preferred stock as a class and common stock as a separate class. Companies cannot “contract out” of the California law requirement. (In order to address the minimum vote requirements, some venture funds insist on drag-along provisions.)
Practical answer. Generally, the necessary shareholder approval for a merger of a California corporation will be (i) a majority of all common stock, (ii) a majority of all preferred stock on an as converted to common basis, (iii) any other approval required by the protective provisionsin the Articles of Incorporation, such as a separate series approval or super-majority approval, and (iv) any other approval requested by the acquiror in the merger, such as a super-majority approval in order to limit the number of shareholders that may exercise dissenters rights (to be covered in a future post). Acquirors asking for an extremely high percentage, such as 90% or 95% approval, is not particularly unusual in the sale of a private company, especially if there may be dissenting shareholders.
The fact that holders of common need to approve a merger of a California corporation is one reason why venture funds prefer Delaware. Venture funds don’t want common holders to have the ability to block a merger.
Section 2115 of California General Corporation Law and Examen, Inc. v. VantagePoint Venture Partners 1996
Section 2115 of California General Corporation Law (CGCL) provides that certain sections of the CGCL apply to non-California incorporated corporations if: (i) more than 50 percent of the corporation’s business is conducted in California; and (ii) more than 50 percent of their outstanding voting securities are held of record by persons having addresses in California. Except for corporations that are exempt (such as public companies), Section 2115 provides that California law supersedes the law of the jurisdiction of incorporation with respect to various matters including:
• the annual election of directors;
• removal of directors for cause or by court proceedings;
• a director’s standard of care;
• officers and directors indemnification;
• the liability of directors and shareholders for unlawful distributions;
• cumulative shareholder voting;
• class votes with respect to the approval of mergers;
• dissenters’ rights; and
• shareholders rights of inspection.
Section 2115 makes the merger approval provisions under California law applicable to “quasi-California corporations.” This means that a merger must be approved by the outstanding shares of each class, which means a class vote for preferred stock and a class vote for common stock.
However, the Delaware Supreme Court decided against the preferred stock having a class vote pursuant to Section 2115 in a case called Examen, Inc. v. VantagePoint Venture Partners 1996. Examen was incorporated in Delaware, privately owned and headquartered in California. Examen entered into a merger agreement with Reed Elsevier, Inc. Although Examen’s board of directors approved the merger, VantagePoint, holder of 83% of Examen’s preferred stock, claimed that it was entitled to a separate class vote on the merger pursuant to Section 2115.
Under California law, VantagePoint would be entitled to vote as a separate vote on the merger, which would have given VantagePoint a veto over the merger with Reed Elsevier. The Delaware Supreme Court held that Delaware law should be respected and VantagePoint would not receive a separate class vote, even though Examen qualified to be treated as a California corporation for the purposes of CGCL Section 2115. However, California courts are not obligated to follow the decision of the Delaware Supreme Court, so most attorneys still advise companies to obtain a separate common class vote and preferred class vote to be cautious.