By: Nam Jun Park

In September of 2020, Peter Thiel’s secretive project of nearly two decades, Palantir, had its direct listing on the New York Stock Exchange. While news of hiccups during the direct listing have received most media attention, some may be more interested in what the Wall Street Journal has called “one of the most aggressive governance structures ever seen.” According to the Journal, one of the three founders could effectively control the company by owning just 0.5% of the shares. How does the law allow this kind of corporate governance structure?

 

Palantir is incorporated in Delaware. The Delaware General Corporation Law (DGCL) permits corporations to issue classes or series of stock in a variety of ways. For example, corporations can issue stock with or without par value; with voting powers or not; with different amounts of voting powers; with special designations; with preferences on liquidation; or with other special advantages or disadvantages. The corporate charter or board resolutions of the corporation can give effect to these kinds of arrangements. Absent specific contractual provisions addressing traits of a share class, however, the DGCL’s default terms are what have force, in which case one common stock would have one vote and all the other default privileges of common stock of a Delaware corporation.

 

One example of use of different class of stock is the use of nonvoting common stock. Snap Inc. chose to utilize this method when they offered only nonvoting common shares in their initial public offering (IPO). This meant that buyers of Snap IPO stock could not participate in director elections, votes on major transactions (like mergers, significant asset sales, dissolutions), amendments to the certificate of incorporation, conversions of corporate form, or other corporate governance matters (e.g. say-on-pay, bylaw amendment). Despite this seeming imbalance in power, certain legal duties and responsibilities cannot be contracted away by stockholders nor corporate managers, however – for example, corporate managers still owe fiduciary duties to holders of both voting common stock and nonvoting common stock. Another example of a nonvoidable right would be inspection rights (holders of nonvoting common stock are still entitled to the right to examine the books of records of the corporation in their capacity as stockholders) and appraisal rights (holders are still entitled to have the fair value of their holdings estimated in the event of a merger or other major transaction).

 

Another possible use of stock class differentiation is the use of preferred stock. One of the most common ways this is used is in granting preferred holders priority in the distribution of dividends and possible liquidation. Often, these priority grants are accompanied by the relinquishment of voting rights. Preferred stockholders often also have the right to convert into common stock (Investopedia – Difference between Preferred and Common). Holders of preferred often end up in tricky situations if the interests of common holders and preferred holders suddenly come into conflict. Delaware courts have often held that corporate managers must prefer the interests of common stockholders to those of preferred stockholders should the interests of the two classes become orthogonal (ABA – Words that Matter). At issue often are “no impairment” clauses, which provide that a company may not do anything to “impair” the rights, powers, preferences, etc. of preferred holders. Without voting rights, however, preferred holders are sometimes left with no recourse but costly litigation after their statutory or common law rights have been violated (ABA – Words that Matter).

 

Then there are companies like Palantir. The company’s S-1 (an SEC filing required when a company is about to go public) lays out a 3-class voting structure: classes A, B, and F of common stock. One class A stock has 1 vote per share; one B class stock has 10 votes per share; and one class F stock has a variable number of votes per share. The S-1 reads that class F shares in combination with the Founder Voting Agreement will ensure that the Founders will maintain “up to 49.999999% of the Company’s voting power” so long as certain other minor conditions are met. The filing also reads that the Founders would “effectively control all matters submitted to the stockholders for the foreseeable future” including significant corporate control events like director elections. In addition, under the Founder Voting Agreement, even if one of the Founders were to leave the company, sell their shares, or die, a proxy voting arrangement contained in the Founder Voting Agreement would allow the remaining Founder(s) to vote with the class F common stock regardless of whom those shares had passed to. This arrangement is possible precisely because the DGCL allows creative ways to arrange just about any aspect of corporate governance – including stock class differentiation.

 

In sum, the DGCL allows entrepreneurs and business entities unbelievable freedom in shaping corporate equity structure. While some core aspects of corporate stock cannot be voided by contract between stockholders and the corporation, many aspects of a stock class can be altered through contract. Entrepreneurs and startups seeking to utilize equity issuance to fund operations and growth would do well be cognizant and perhaps even utilize nonvoting, preferred, or multiple classes of stock.

 

 

SOURCES

  • Palantir S-1 (page 69)
  • WSJ – Palantir Expected to be Valued at Nearly $22BN in Trading Debut (https://www.wsj.com/articles/palantir-expected-to-be-valued-at-nearly-22-billion-in-trading-debut-11600990739)
  • Tech Crunch – Palantir targeting 3 class voting structure (https://tcrn.ch/31g7dmy)
  • ABA – Words that Matter: Considerations in Drafting Preferred Stock Provisions (https://www.americanbar.org/groups/business_law/publications/blt/2014/01/04_bigler/)
  • Hunton & Williams – Nonvoting Common Stock: A Legal Overview (https://www.huntonak.com/images/content/3/4/v2/34138/nonvoting-common-stock.pdf)
  • Simplified Codes DGCL § 151 (https://simplifiedcodes.com/?page_id=135)
  • DGCL § 151 (https://delcode.delaware.gov/title8/c001/sc05/index.shtml)
  • https://www.investopedia.com/ask/answers/difference-between-preferred-stock-and-common-stock/