The Corporate Charter (often referred to as the Articles of Incorporation), which is a state require document and varies widely by state, is part of the National Venture Capital Association’s templates for a preferred equity round for a private equity company, does exactly what it says it does. You should seek advice from your legal counsel as to the individual requirements of the state of domicile for the company under consideration.The corporate Charter defines the workings of the corporation: corporate name, corporate address, board of directors/governors (C-Corp/LLC), types and amounts of stock, actions taking place upon liquidation, voting, antidilution (if relevant), dividends, shareholder meetings, investor protections, fiscal year, type of corporation, and indemnification (if relevant). It must be updated any time a new round of capital is authorized by the shareholders. The NVCA standard terms are strongly preferred because they are regarded as industry best management practices. All changes to the Charter must be approved by the shareholders.

The important points are as follows:

  • The Charter defines the rights of classes of stock. This typically includes Common stock (“founder’s stock”) and defines the voting rights, which is typically one vote per share. If there is a preferred class of stock, it is also defined in the Charter. Preferred stock usually has an accrued dividend built into the class rights. Preferred stock generally votes one vote per share as with the Common shares.
  • The charter defines the order in which classes of stock are compensated in the event of a liquidation. Preferred stock generally receives capital back first up to the liquidation preference (typically 1x). After which the preferred stock is converted to Common, where it participates prorata with the remaining Common shares.
  • Defines the election of Directors/Governors. A preferred class of stock generally is given the right to elect one to two Directors by itself.
  • Defines certain investor protections:
    • The Board may not vote to liquidate or dissolve the corporation with out the approval of the Preferred holders.
    • The shareholders may not amend or repeal any provision of the Charter without the consent of the Preferred holders.
    • The shareholders may not authorize new shares or classes of shares and may not change the order of liquidation preference without the approval of the Preferred holders.
    • The corporation may not create an indebtedness of more than a given threshold without the consent of the Preferred holders.
    • The corporation may not create a subsidiary that is not wholly owned by the corporation with out the approval of the Preferred holders.
    • The corporation may not transfer assets of the corporation without approval of the Preferred holders. This includes sublicensing the IP of the corporation.
    • Alter the number or composition of the Board of Directors/Governors
  • Defines the process of converting Preferred to Common and when it is appropriate to do so, typically at the time of an IPO, merger, or acquisition.
  • Binds the corporation to pay taxes that are incurred in converting Preferred to Common shares.
  • Defines the terms of options and warrants on stock of the corporation.
  • Defines terms of antidilution for any given class of stock. Generally, common stock is dilutable always. In special circumstances, Preferred shares are generally adjusted to compensate the Preferred holders, such as in a down-round. Average weighted antidilution is the most common form. It essentially weights the antidilution based on the amount of time that has elapsed since the Preferred shares were issued.
  • Defines the logistics of stock splits and combinations.
  • Prevents the corporation from issuing a dividend to Common shares that is not also enjoyed by Preferred.
  • Defines the circumstances under which the corporation may force the conversion of Preferred shares to Common shares, namely an IPO.
  • Instructs the Board of Directors/Governors to create and maintain bylaws of the corporation
  • Defines the number of directors/governors.
  • Instructs the shareholders to hold one meeting each year in the state of the corporation domicile.
  • Indemnifies the Directors/Governors that act in good faith for the corporation.

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