Question

What provisions are available to protect a preferred stockholder?

Answer 1

Following are thr provisions to protect the right of preferred stock holders

1) Liquidation preference : In event of liquidation preference shares are paid ahead of equity share holders

2) Dividend : Regardless of profit , preference share holder will get fixed dividend. In absence of profit, dividend will accumulate and paid in year of profit

3) Voting right :

A) Board Composition
The composition of the board of directors post-financing is almost always a highly negotiated term. Because the board of directors oversees management and determines the company’s major strategic decisions, control of the board is important to both investors and founders.

The composition of the board of directors post-financing is almost always a highly negotiated term. Because the board of directors oversees management and determines the company’s major strategic decisions, control of the board is important to both investors and founders.

In connection with a preferred stock financing, the lead investor typically seeks to obtain one or more board seats that will be elected by only the holders of preferred stock. This right typically is implemented in the company’s certificate of incorporation. The investors will often require that the company and its stockholders execute a voting agreement, which further provides that a specific investor has the right to designate the individual that will represent the holders of preferred stock on the board of directors. Common stockholders continue to be represented on a board of directors following a financing; however, depending on the number of board seats that preferred investors demand, founders may find that they no longer control the company’s board of directors following the first or second round of financing.

B) Protective Provisions
Preferred stockholders often negotiate for protective provisions, which are provisions in the company’s certificate of incorporation that require certain decisions or transactions can only be approved by a certain percentage of the holders of the preferred stock, voting alone. These preferred stockholder votes typically cover transactions that already require approval of all stockholders, such as a sale of the company or amendments to the company’s certificate of incorporation. In many cases, however, protective provisions also require approval of transactions that do not otherwise require stockholder approval, such as the incurrence of debt, new rounds of financing and increasing the size of the board of directors. These provisions effectively give preferred stockholders significant control over major corporate decisions even if, as a class, they own less than a majority of the company’s outstanding shares.