ACTIVIST VC BLOG

Crossing the Delaware: Legal Differences

We’ve discussed the reasons for and legal mechanisms of turning a foreign company into a Delaware corporation in previous blog entries. However, one needs to understand the differences between a Nordic company and a Delaware company in order not to make potentially costly mistakes. The same applies when someone familiar with Nordic regulations and practices invests in a US company or when a US investor invests in the Nordics.

We have seen dozens of international deals on the Nexit Transatlantic Bridge and a few expensive, hard-to-fix mistakes. Some anonymous examples will follow – luckily, they are not from Nexit portfolio…

Laws, laws, everywhere

Growth companies in the Nordics have it easy: the legislature is primarily national in scope and it is enough to understand and follow one set of rules.

In the USA, things are often quite a bit different. If you’ve set up a Delaware Corporation, you are subject to Delaware law, Federal law, and common law rules. The legal systems in the USA and the Nordics are fundamentally rather different, the US system relying much more extensively on common law and resulting case law.

Furthermore, if your company’s operation is based outside of Delaware, you also need to know and follow the laws of the States you operate in. To put it succinctly, when doing an agreement in the USA, one of the first questions your lawyer should answer for you is: which laws apply?

Nasty Surprises

If you are heading to Delaware, you should study the differences between the legal entities to avoid nasty surprises later on, below some samples:

  • Decision-making: Is a decision on some topic done by board vs. stockholders’ meeting?
  • Voting: Is each share class voting separately or are the votes from all share classes combined together?

In the following examples, we contrast a Delaware corporation to a Finnish osakeyhtiö or aktiebolaget (corporation).

Who’s the boss?

The general roles of the Board of Directors and the stockholders are not too different in Finland and in Delaware. There is, however, at least one major difference that might come as a surprise to a Finnish entrepreneur.

  • In Finland, issuing new stock must be authorized by the stockholders – the Board must always have an explicit authorization of the stockholders (in the form of a resolution by a General Meeting or a unanimous decision of the stockholders).
  • In Delaware, the Board has the authority to issue shares that dilute existing stockholders without any involvement of the stockholders if the company’s certificate of incorporation has a sufficient number of the right kind of authorized shares available. This gives the Board of Directors a fair bit more power than you might be used to. An example: the board decided on a major stock issuance without consulting the majority owner…

If, however, the certificate of incorporation does not have enough authorized shares available, stockholder approval is required to increase the number of authorized shares.

There are no default preemptive rights in Delaware companies unless the certificate of incorporation includes them. But be aware that there are US states that have default preemptive rights in their corporate laws.

My vote is better than yours

It is permissible to have different share classes with different rights both in Finland and Delaware – some shares may have more voting power than others and some may have no voting power at all. Some shares may have an anti-dilution right or a liquidation preference, others may not. In Delaware, a share class may also have multiple series of that class.

But there is a fundamental difference that can come as a surprise:

  • In Finland, if there is a vote in the General Meeting, all votes are tallied together, and decisions are made based on this total.
  • In Delaware, however, a class vote is required to approve certain decisions by stockholders, such as to increase the authorized number of shares of that class or to change the rights of that class adversely. The company’s certificate of incorporation may also require that a series of a class (such as Series B Preferred Stock) must separately agree to a corporate action. Yes, there are exceptions and yes, it is complicated.

As a result, even if the vast majority of the total votes support a decision, not having a majority in a single share class (or a series of a class) can scuttle the decision. An example: in connection with a US Flip, several share classes were created, one for the original early investors in the company. Even though this share class only constituted a few percents of the all the shares, it could still block certain key decisions…

Not to make this too easy, if you have a company incorporated in California, California corporate law has its own rules on class voting.

…and yes, then there’s California…

As a surprise to many, even if your company is incorporated in Delaware, your company might also have to comply with certain California corporate laws. If your company has sufficient financial interests in California (property, payroll or sales) and if more than half your stockholders are in California, you will need to comply with both Delaware and California corporate laws on various corporate matters.

And remember the US stock options I talked about in my last blog?  California also has some specific laws that your company must comply with when issuing options to California.

Ain’t that grand.

Nexit’s take

  1. The vast majority of our investments are in some form transatlantic of nature and we are very happy with the outcome:  a dozen highly successful international exits.
  2. Doing transatlantic transactions is a bit more complex than a domestic deal in the Nordics. Trying to do it on the cheap, without proper understanding and professional help is simply stupid.

PS. This blog entry has been written in cooperation with and using the ample experience of Sari Laitinen – a good friend of ours and a trusted advisor to many Finnish businesses and management in their US legal questions. Thanks once again, Sari!

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