Mr. Muchnikoff is a Partner with the Washington, D.C. law firm Silver, Freedman & Taff, L.L.P. He specializes in public and private offerings of common and preferred stock, mergers and acquisitions, and the preparation of public disclosure documents. Previously, he was a Senior Attorney and Assistant Branch Chief with the Division of Corporation Finance at the U.S. Securities and Exchange Commission. Mr. Muchnikoff is also a Certified Public Accountant.

The conqueror, Frederick the Great, an outstanding military strategist, said "It is pardonable to be defeated, but never to be surprised." This military wisdom applies equally well in today's business world. Now is the time to strategically plan the direction your company should take in order to access the capital markets and/or position itself for an acquisition, either as the acquirer or as the target. The most successful companies are those that have already developed a competitive strategy so that they can move quickly as opportunities present themselves.

Frequently, founders of closely held companies find themselves questioning whether or not to issue additional stock. When considering equity financing opportunities, such as by offering common or preferred stock to angel investors and/or to venture capital funds, a major consideration is the possible loss or dilution of control. The loss of control by founders of a company is also a consideration in the issuance of equity to directors, officer and employees of the company, which many companies are required to do in order to retain, attract and motivate these individuals in the competitive marketplace.

While there are real economic disadvantages to founders issuing additional stock that need to be considered, the dilution of a founders voting power in the company can be minimized by experienced counsel who can provide protections in the corporate governance documents. These protective devices can usually assure that effective control can be maintained even if the founder does not own a majority of the outstanding shares. For example, common stock can be structured to permit two classes of voting stock, thus permitting an owner to retain common stock with increased voting rights. Of course, during the course of negotiating equity financing an investor may want to remove some or all anti-takeover provisions. Investors generally want some control and/or an exit strategy. Both of these issues can usually be dealt with in a "stockholders" or "exit rights" agreement governing voting rights and dispositions of the stock. By implementing some of these protective provisions in the corporate governing documents prior to financing, however, your negotiating position can be strengthened.

Some anti-takeover devices, which generally may be utilized in a company's certificate of incorporation, are as follows:

Staggered terms for Board of Directors

Electing directors to different terms can make it more difficult and time consuming to change majority control of the Board. This eliminates the chance of a sudden change in the majority of the Board and encourages any person seeking control of the company to negotiate first with the Board of Directors.

Super-majority vote to reduce or increase the number of directors

Increasing the vote required to change the size of the Board to 75% or 80% of the outstanding shares makes it more difficult for an insurgent to change the Board's membership to gain control through appointing new members and undercutting the effect of having staggered terms for directors.

Longer notice period requirements for the nomination of directors and proposals for new business by persons other than management.

This provision eliminates the possibility of unanticipated Board nominations or proposals from the floor at an annual meeting and provides the existing Board with a meaningful opportunity to consider the qualifications of nominees and the benefits of any proposal prior to a stockholder vote.

Elimination of the right of stockholders to call a special meeting of stockholders

This provision limits the opportunity for changes to the Board or consideration of proposals affecting the business of the company to once a year-at the annual meeting

Elimination of cumulative voting

Under this procedure stockholders may cast a number of votes equal to the number of shares they own multiplied by the number of directors to be elected in a particular class. To elect a director, minority stockholders would cumulate their votes and cast them for less than the total number of directors to be elected. Eliminating this procedure makes it more difficult for minority stockholders to successfully elect a director loyal to them when a majority of stockholders oppose the election.

Authorization of "blank check" preferred stock

This authorization permits the Board to issue preferred stock into friendly hands with terms as determined by the Board that may make it more difficult to obtain control of the company, such as providing for new directors or conversion of the preferred into common stock.

Any business combination with a 10% or more stockholder (other than 10% or stockholders as of the date this provision is adopted) would generally require a vote of eighty percent of the total number of outstanding voting shares or a vote of two-thirds of the Board of Directors unless the consideration to be paid for the stock is not lower than the highest price paid by the offeror in purchasing his initial block of stock or the book value of the company, whichever is higher.

This provision increases the cost to acquire a company by precluding an "interested stockholder" from paying a premium to obtain majority control and forcing a merger where minority shareholders would receive a lower price. It encourages persons seeking control of the company to negotiate with the company's Board.

Amendment of certificate of incorporation provisions requires a super majority vote of the shares outstanding

This provision ensures that the number of votes required to amend anti-takeover provisions requiring a super majority vote cannot be changed to a lower vote requirement by amending the provision itself.

Many other corporate actions such as a removal of a director or sale of the company can be structured to require the approval of a super majority vote of the outstanding stock. Additional provisions in the company's governing documents can provide indemnification of officers and directors of the company for costs incurred as a result of their good faith actions, including anti-takeover related actions, protecting them against the potential costs and risks of legal proceedings.

In addition to anti-takeover provisions in the certificate of incorporation or corporate by-laws, providing stock based incentive compensation plans, such as a stock option plan, a management recognition and retention plan or an employee stock ownership plan will assist in attracting and retaining directors, officers and employees and placing stock in friendly hands. Among the types of awards that may be granted to the Board, management and employees under a stock compensation plan are stock options and restricted stock (i.e. bonus stock subject to designated performance or length of service restrictions). In addition, many companies may establish a Management Recognition and Retention Plan ("MRP") to grant either newly issued or repurchased shares for the benefit of designated key employees. Both the options awarded under the stock option plan and the shares granted by a MRP are also generally subject to performance or length of service conditions and are often subject to three to five year vesting schedules (with immediate vesting in the event of a takeover attempt.).

One caveat in issuing stock under a stock based compensation plan is concern over the "cheap stock" issue currently being raised by the U.S. Securities and Exchange Commission ("SEC"). Companies considering implementing stock based compensation plans and conducting an initial public offering within one year of implementation should be aware of potential "cheap stock" issues. "Cheap Stock" refers to the issuance of stock at a substantial discount from its fair market value at the date of issuance. As part of its review process, the SEC reviews grants made within the year prior to filing with the SEC to determine if additional compensation expense should be recorded. The amount of compensation expense is based on the difference between the value of the common stock award at the time of grant and its fair market value at the time of the offering, i.e., the offering price. If the difference is significant, the argument can be made that the fair market value on the date of grant is understated. Careful planning is required to establish that the fair market value at the time of grant is less than the offering price to avoid a restatement of the companies income statement to reflect reduced earnings as a result of the additional expense.

David Rockefeller once said, "Success in business requires training and discipline and hard work. But if you're not frightened by these things, the opportunities are just as great today as they ever were." As a founder, issuing additional stock to finance the company or reward employees while maintaining control of the direction of the company permits you to achieve the success you envision.

Opinions expressed in this article do not necessarily reflect the views of the Foundation for Enterprise Development.