Nasdaq 20% Rule Shareholder Approval Clause

Summary

This clause is a covenant that requires an issuer listed on The Nasdaq Stock Market (Nasdaq) to obtain shareholder approval before any issuances of securities in excess of 20% of its outstanding securities in a nonpublic offering at a below-market price. This clause is intended to be used in a transaction involving the issuance of convertible securities and should be used with the applicable operative transaction document (e.g., purchase agreement, investor rights agreement, etc.). This clause contains practical guidance, drafting notes, and an alternate clause. Nasdaq Rule 5635(d) requires listed companies to obtain shareholder approval for issuing securities representing 20% or more of the outstanding pre-transaction common stock or voting power of the company at prices below the market price of the company's shares in a transaction exempt from registration under the Securities Act of 1933, as amended (Securities Act). Companies frequently issue securities convertible into or exercisable for common stock (e.g., convertible notes, convertible preferred stock, or common stock purchase warrants) that, when converted or exercised, may result in the issuance of common stock in excess of the 20% threshold, which would violate the rule. To avoid violating the rule, companies will include a "conversion cap" clause in the appropriate transaction document (e.g., preferred share purchase agreement, warrant agreement) that provides that shares in excess of the cap, typically 19.99% of the shares issued and outstanding on the date the convertible security was issued, cannot be issued until the company obtains shareholder approval for the transaction. Alternatively, the parties may include a conversion or exercise price floor that, by limiting the amount by which the conversion or exercise price may be adjusted downwards in the absence of shareholder approval, achieves the same result. The transaction documents commonly include a covenant by the company to obtain such shareholder approval following a request to by the holders to exercise or convert their securities into such number of shares that would exceed the share cap (typically referred to as a "triggering request") at either the company's next annual shareholders meeting or a special shareholders meeting called for such purpose. For more detailed information about the Nasdaq 20% rule, see 20% Rule and Other NYSE and Nasdaq Shareholder Approval Requirements. See also NASDAQ IM 5635-2, NASDAQ IM 5635-3, and NASDAQ IM 5635-4 for guidance from Nasdaq on its interpretation of Rule 5635(d). For clauses that provide share caps and conversion floors in transactions that may trigger shareholder approval requirements under Nasdaq or New York Stock Exchange rules, see Share Caps and Conversion Floors: Clauses to Avoid Triggering 20% Shareholder Approval Rule.