Taking Advantage Of The Golden Window Before An IPO

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As companies prepare to go public and draft bylaws, there is an opportunity to put in place a series of provisions that can give newly public companies significant degrees of autonomy from their shareholder base. This is a “golden window” of opportunity when companies can include specific language in their bylaws that are advantageous to the founders/management, which gives the company more maneuverability.

So what are these provisions and how do they work?

Evergreen provision: An evergreen provision in a company’s bylaws is a clause that automatically renews the terms of the bylaws at the end of their term unless either party gives written notice of termination. This means that the bylaws will continue in effect indefinitely unless someone takes action to terminate them

An evergreen equity grant replenishment provision is a provision in a company’s equity plan that automatically replenishes the pool of shares available for grants each year.

This means that the company does not need to go through the process of shareholder approval each year in order to have a new pool of shares for employee grants.

Evergreen equity grant replenishment provisions are often used by high-growth companies that want to be able to attract and retain top talent. By having a steady supply of shares available for grants, companies can make sure that they are able to reward their employees with equity compensation, even if the company’s stock price is not rising.

A so-called evergreen provision can only be put in place before you are public. The evergreen provision creates an automatic equity replenishment capability.

Typically, an evergreen provision might give a company 3 -4 % equity pool replenishment option each year that might last 4-6 years. This means the company would not have to go back each year in the annual proxy and request more equity from the shareholders.

Dual Class Shares: Dual-class shares are a type of corporate structure that gives different classes of shareholders different voting rights. This means that a shareholder with a small number of shares in one class may have more voting power than a shareholder with a large number of shares in another class.

Dual-class shares are often used by companies that want to give founders or other insiders more control over the company without giving up too much ownership. For example, a company might issue two classes of shares: Class A shares with one vote per share and Class B shares with 10 votes per share. This would mean that a shareholder with 100 Class B shares would have the same voting power as a shareholder with 1,000 Class A shares.

Dual-class shares can have both advantages and disadvantages. On the one hand, they can allow founders or other insiders to maintain control of the company even as it grows and becomes more widely held. This can be important for companies that want to pursue a long-term vision or that are in industries that are subject to rapid change. Additionally, it often allows for a strategy of growth and investment with a longer horizon time to profitability.

On the other hand, dual-class shares can give insiders too much power and make it difficult for shareholders to hold them accountable. This can lead to poor decision-making and a lack of transparency.

In recent years, there has been growing scrutiny of dual-class shares. Some investors and regulators have argued that they are unfair to minority shareholders and that they should be banned. However, other investors and companies have argued that dual-class shares can be a valuable tool for promoting long-term growth and innovation.

Here are some examples of companies that have dual-class share structures:

  • Alphabet
  • Facebook
  • Alibaba
  • Tencent
  • SoftBank

These companies all have very strong founders or other insiders who hold a significant number of shares with multiple voting rights. This gives them a great deal of control over the company, even though they may not own a majority of the shares.

Dual-class share structures are controversial, and there is no consensus on whether they are good or bad for shareholders. However, they are becoming increasingly common, especially with strong founders.

Super Majority Voting: A supermajority-voting bylaw gives extra corporate protections. A supermajority proposal requires a higher-than-normal majority of shareholder votes to pass. This is typically set at a threshold of 67% – 95%; it can vary depending on the company’s charter or bylaws.

There are a few reasons why companies might implement supermajority voting bylaws for shareholder proposals. When a company is preparing to go public, it is standard corporate governance practice to implement supermajority voting as it can be protective for the company. Companies that are newly public may be seen as financially attractive targets for hostile takeovers. For this reason, typically companies who are 6+ years past IPO will typically review and consider sunsetting supermajority provisions. In 2022 Netflix
finally removed its supermajority provision after being public for 10 years.

It is interesting to note that supermajority voting is becoming more common and that 51% of all public companies now have supermajority clauses.

Supermajority voting shareholder proposals are often used to approve changes to a company’s charter or bylaws, or to merge with another company. They can also be used to approve other major decisions, such as a change in the company’s business strategy or the sale of a significant asset.

Additionally, supermajority voting allows companies to have continuity of their board of directors. Based on supermajority voting requirements, it would be very difficult for shareholders to remove a board member. This means that directors are not at risk of being removed from the board if they do not follow institutional shareholder recommendations.

However, there are also some potential drawbacks to using supermajority voting shareholder proposals. First, they can make it more difficult to make decisions, as they require a higher level of support. Second, they can give more power to a small group of shareholders, as they may be able to block a decision even if it is supported by the majority. Supermajority voting is very difficult to achieve as there are typically a low number of voters at shareholder meetings.

For example, Tesla
has previously attempted to pass 2 shareholder-friendly proposals but given there was only 52% total shareholder turnout for voting, there was no way for the proposals to pass.

Here are some examples of supermajority voting shareholder proposals:

  • In 2018, shareholders of Alphabet approved a supermajority voting shareholder proposal that required 75% of shareholder votes to approve any future changes to the company’s dual-class share structure.
  • In 2019, shareholders of Facebook approved a supermajority voting shareholder proposal that required 67% of shareholder votes to approve any future mergers or acquisitions.
  • In 2020, shareholders of Alibaba approved a supermajority voting shareholder proposal that required 75% of shareholder votes to approve any future changes to the company’s corporate governance structure.

I think that boards will need to be sensitive to the institutional investor community’s reactions and once companies put in place these bylaws they should expect that over a period of time, there will be significant pressure to begin to sunset some of these provisions. Sunset timeframes for each provision anecdotally vary. They are often along the lines of about 4-6 years. After 7-12 years expect significant pressure to sunset.

Reflecting on some of the provisions that are potentially available to private boards, I think they merit discussion and consideration. I think it can be very advantageous to put many of these types of protective provisions in place if you are a private company preparing to go public.

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