Meaning
Constitutional documents establish the foundational governance rules, share classes, and corporate powers of a business entity being evaluated for investment or acquisition. The target company charter defines the primary governance rules and the rights of different classes of stock. Reviewing this document during due diligence is necessary to identify any protective provisions or transfer restrictions.
Amendments to the charter must be executed at the closing of a transaction to reflect the rights of the new investors.
Due Dilution Review
Legal teams scrutinize the target company’s governance documents to ensure there are no hidden obstacles to the transaction. When analyzing the target company charter, lawyers check for any supermajority voting requirements that could block a merger or asset sale. They must also identify any right of first refusal or co-sale rights that affect the transfer of shares.
Discovering these provisions early allows the deal team to negotiate necessary waivers before the transaction goes too far.
Protective Provisions
Preferred shareholders often negotiate protective provisions that give them veto power over specific corporate actions. Under the target company charter, the company cannot issue senior equity, change board size, or sell the business without the approval of a majority of the preferred shares. Such covenants protect the investors’ financial interest from being diluted by the founders or majority common shareholders.
If a transaction requires these actions, the target must obtain a formal consent from the preferred holders. This ensures that the majority cannot make fundamental changes to the business without investor alignment.
Post Closing Amendment
Amending the constitutional documents is a standard condition precedent to closing any major equity investment. The newly amended target company charter incorporates the liquidation preferences, anti-dilution protections, and dividend rights negotiated in the term sheet. Filing this document with the state registry makes these rights binding on all current and future shareholders.
It creates a new governance structure that protects the incoming investors’ capital.
