One Reason Why Venture Capital Firms Prefer Delaware Corporations

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This difference is typically why many funds investing large amounts of money in a …

This difference is typically why many funds investing large amounts of money in a
company prefer it to be a Delaware corporation. These investment funds want to protect their
ability to control whether a merger occurs and do not want common shareholders to have the
ability to block a merger.

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  • 1. http://biztaxbuzz.com/reason-venture-capital-firms-prefer-delaware-corporations/ May 21, 2013One Reason Why Venture Capital Firms Prefer DelawareCorporations | BizTaxBuzz by Trevor Crow17thMayOne Reason Why Venture Capital FirmsPrefer Delaware CorporationsPosted by Trevor CrowThere are various structures to use when selling a company. Most privately held companies aresold through a sale of its assets or a triangular merger, where the purchaser forms a subsidiarythat then merges into the target company. State law and a company’s constituent documents(i.e., articles of incorporation and bylaws) control the requirements for a merger and for the sale ofsubstantially all of a company’s assets. In this post, I outline a comparison of the votingrequirements under Delaware law and Colorado law for a merger.DelawareUnder Delaware corporate law, a merger requires approval of a majority of the outstanding stockentitled to vote, unless there are additional approvals required under the company’s Certificate ofIncorporation (e.g. super-majority approval or approval from each series of stock). Further, theacquiring company may require other approval, like a super-majority approval, to limit the numberof stockholders that may exercise dissenter’s rights.ColoradoUnder Colorado corporate law, a merger requires the approval of a majority of the outstandingshares of each class of the corporation, unless (i) the board of directors requires a greater vote(ii) additional approvals are required under the company’s Articles of Incorporation or Bylawsadopted by the shareholders (e.g. super-majority approval) or (iii) the acquiring company requiresother approval, like a super-majority approval, to limit the number of stockholders that mayexercise dissenter’s rights. In practice, this usually means that a majority of the preferredshareholders must approve of the merger and a majority of the common shareholders mustapprove the merger.One of the biggest differences between Colorado law and Delaware law is that a majority of eachclass of shares must approve a merger under Colorado law whereas a majority of the totaloutstanding shares must approve a merger under Delaware law. To illustrate, assume that aColorado company has 50 common shares and 50 preferred shares for a total of 100 sharesoutstanding. If all 50 of the preferred shares and 20 of the common shares are voted in favor ofthe merger, the merger still fails because a majority of the common shares did not vote to approve
  • 2. the merger. Under Delaware law, this same example reaches a different result. The merger wouldbe approved under Delaware law because a majority of the outstanding shares voted to approvethe merger (i.e. 70 out of 100).Bottom Line. This difference is typically why many funds investing large amounts of money in acompany prefer it to be a Delaware corporation. These investment funds want to protect theirability to control whether a merger occurs and do not want common shareholders to have theability to block a merger.