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A Cautionary Tale For Investors

Connecticut Law Tribune

November 16, 2009

Authors: John H. Lawrence

A venture-backed company faces difficult conflict of interest issues when its investors and their board representatives lose patience with management and want to sell the company at a time when the common stockholders will get little or nothing.

 

This produces predictably strong disagreements between the investors — who are seeking an exit in short order to salvage some return for their limited partners — and the company’s founders and other common stockholders — who believe that the company will turn around with just a little more time.

 

The situation becomes especially risky for the investor-appointed directors where the preferred stockholders have no contractual right to force a sale of the company and they make the mistake of using their board positions to accomplish the sale. The recent decision of the Delaware Chancery Court in the case of In re Trados Incorporated Shareholder Litigation, 2009 WL 2225958 (Del. Ch. July 24, 2009), serves as a warning to investors who face this very common dilemma.

 

The plaintiff in Trados was a common stockholder and charged that the board, a majority of which was appointed by the preferred stockholders, had approved a sale of the company at a price that resulted in the payment of a large liquidation preference to the preferred stockholders and multi-million dollar bonuses to management, but left nothing for the common stockholders at a time when the company seemed to be turning the corner.

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