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Question:  My buddy and I are launching a new venture, and we’ve read some articles on the web about incorporating in Delaware and other things we need to do from the legal side.  One issue that came up that we don’t understand is Class F stock, which we read about on a couple of blogs.  What is Class F stock and do you think we should be utilizing it?

Answer: This issue has come-up quite a bit recently with a few of my new clients.  “Class F” stock is a special class of common stock that was designed by The Founder Institute (with the assistance of Yokum Taku, a smart Silicon Valley lawyer) to protect founders.

The “F” is for “Founders” – but it really doesn’t matter what you call it: Class H, Class Q or Class X.  The key point is that a separate class of common stock is issued to the founders upon incorporation with the following special rights (as set forth in the sample certificate of incorporation on the Founder Institute’s website):

  • Super-voting rights (10 votes per share);
  • Certain protective rights similar to those that preferred stockholders are generally granted (e.g., the consent of a majority of the Class F holders is required for the company to enter into a “Liquidation Event”); and
  • The right to elect a director that has two votes on the Board (not one).

The advantage of issuing Class F Stock is that it arguably levels the playing field for founders in connection with their negotiations with investors.  When investors present their term sheets, founders will own not only typical shares of common stock (referred to as “Class A” in the certificate of incorporation), but also shares of Class F stock, which could give entrepreneurs additional negotiating leverage.

The disadvantage of Class F Stock is that it may scare investors away.  It’s tough enough for start-ups to raise capital these days; throwing Class F stock in the equation may make your company less attractive.  Moreover, the added complexity of issuing Class F stock increases your legal fees both at the incorporation stage and at the funding.

The bottom line is that the issuance of Class F Stock is relatively new and uncommon.  Accordingly, in the current economic environment (where money is scarce and investors generally have the leverage), Class F Stock probably only makes sense for successful, serial entrepreneurs who are going to have lots of investors interested in their venture.  For first-time entrepreneurs, it probably makes sense to keep it simple and just issue ordinary shares of common stock.

That being said, I tip my hat off to Adeo Ressi, the founder of the Founder Institute, for his efforts.  Having spent the bulk of my career doing large M&A transactions in New York City, I was surprised to see how complex and pro-investor the standard VC financing documents are.  Clearly, any effort to level the playing field is a net plus for entrepreneurs.

Disclaimer: This “Ask the Attorney” post discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. VentureBeat, the author and the author’s firm expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.

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