We often hear about how majority shareholders have the power to make big decisions, including who might sit on the board of directors. And while that is true, under California law, for non-publicly traded companies, cumulative voting is required and can impact an important vote.
At its basic level, cumulative voting provides that the number of votes available to a shareholder is equal to the number of votes owned by the shareholder multiplied by the number of positions up for a vote. Therefore, if multiple positions are up for a vote, a shareholder may cast all or most of his or her votes for a signal nominee, making a minority share a lot more powerful.
To show how this might play out, let’s assume that Alex owns 600 shares, Bill owns 250, and Catherine owns 250. Under a conventional structure, if there were three board seats available the board would be compromised of board members Alex chose, as he out-votes the other two shareholders 600 to 500 every time, even if we assume Bill and Catherine are voting together.
Now lets look at cumulative voting. Assume there are three board positions available and six candidates (Dave, Erin, Frank, George, Hilary and Ian). Because each shareholder is able to cast his or her total number of votes (remember: number of shares x positions up for vote) towards one nominee, the result could be as follows:
Dave: 750 (all of Bill’s Votes)
Erin: 600 (one third of Alex’s votes)
George: 750 (all of Catherine’s votes)
Hilary: 1200 (two third’s of Alex’s votes)
Under cumulative voting, even though Alex was the majority shareholder, he would only be successful in bringing on board Hilary, as he would need to use up his votes to win one seat and then would be out-voted for the other positions. The best-case scenario for Alex would be if he strategized and casted 900 votes each towards two candidates, but even then Bill or Catherine would be successful in bringing on at least one of the board members if they decided to use all of their votes on one board seat.
Per California law, cumulative voting is a statutory right provided to shareholders in a non-publicly traded company that cannot be taken away (See Corp. Code 708(a)). However, a shareholder is only entitled to cumulate their votes if the candidate name has been placed in nomination, and the shareholder has given their intention to cumulate their shareholder votes prior to the vote. Furthermore, it only takes one shareholder to give notice to allow all shareholders to cumulate their votes in a nomination (See Corp. Code 708(b)). Another important consideration is that cumulative voting can apply to your corporation even if you’re a foreign corporation conducting business in California if you are considered a “pseudo-foreign” corporation under California Corporate Law (see Corp. Code Section 2115).
As a founder or a minority shareholder it’s important to know your rights when it comes to corporate actions. If you have questions or concerns about your setup, don’t hesitate to give us a call at 415 633 6841, or email us at email@example.com.
Disclaimer: This article discusses general legal issues, but it does not constitute legal advice. 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. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.