The National Venture Capital Association (NVCA) publishes model legal documents for venture capital financings, including a Certificate of Incorporation, Preferred Stock Purchase Agreement and Investors Rights Agreement. These documents enjoy wide industry acceptance as baseline agreements that parties and their counsel can tailor for each deal. They also include commentary on East and West Coast practice and bracketed alternative provisions to insert/omit depending on the deal terms. Perhaps most attractive to the parties, starting from a standardized form can decrease legal hours (and, more importantly, fees) from term sheet to closing.

Venture capital
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Recently, NVCA updated the model legal documents for the first time since 2014. Considering the wide use of these documents, these revisions are likely to impact future VC financings. Here are some of the key changes:

Certificate of Incorporation

  • Protective Provision for Cryptocurrency/Blockchain Issuances: VCs typically negotiate for veto rights over a company issuing additional equity and debt securities. Now, the model Certificate includes a protective provision giving investors the right to veto token, cryptocurrency and blockchain-related offerings.
  • Redemption Rights: VCs might negotiate for a redemption right, which requires the company to repurchase their preferred stock under certain conditions.  If the company does not fulfill a redemption request, the model Certificate now includes a high rate of interest on the redemption price of any shares not redeemed “for any reason”. Recent case law suggests that a board may be protected by the business judgment rule if it determines not to use funds to redeem preferred stock despite an obligation to do so.  (See e.g., TCV VI, L.P.  Trading Screen, Inc., Case No. C.A. 10164-VCN (Del Ch. Ct. Feb. 26, 2015); SV Investment Partners, LLC v. Thoughtworks, Inc., Case No. C.A. 2724 (Del. Ch. Ct. Nov. 10, 2010). Triggering an interest payment “for any reason” gives investors increased leverage and some compensation.

Stock Purchase Agreement

  • Provisions for Life Science Transactions: Life science companies are attractive to VCs due to their potential for rapid growth and significant ROI. The updated Stock Purchase Agreement includes provisions specific to life science transactions.  These include more robust treatment of milestone closings, including undersubscription procedures and penalties for an investor’s failure to close, and new reps and warranties related to government and university sponsored research, clinical trials and FDA approvals.

Investors Rights Agreement

  • Anti-Harassment Covenant: In a timely addition, the Investor Rights Agreement now includes a covenant requiring the company to adopt an anti-harassment policy and a code of conduct governing appropriate workplace behavior. NVCA recently published a set of model documents and resources addressing harassment and discrimination.

Voting Agreement

  • Drag Along Rights: A drag along provision can permit VCs to “drag” the junior preferred and common holders into a sale of the company.  Under certain circumstances, dragged shareholders can receive little or no compensation in a drag sale, which may prompt a legal challenge.  The updated drag provision is intended to more effectively implement drag transactions and reduce the likelihood of a minority stockholder claim.

Users already familiar with NVCA’s model documents will be glad to see the revisions are not extensive.  However, given the wide acceptance of these forms, it’s safe to say that the updates will be impactful. This is especially true with respect to anti-harassment policies, which is both a high-profile issue and has obvious benefits for all parties.  Stay tuned to Emerging Companies Insider for a follow-up blog addressing NVCA’s new model documents addressing harassment and discrimination.

Investment
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Investors typically do not finance an early stage or middle market company with the intent to ultimately call for a redemption of the preferred shares that it receives from the company in connection with the original financing.  Such a situation signals a failed investment, as the return of the original purchase price for the investor’s preferred shares represents zero appreciation on the original investment.  However, there are circumstances where redemption is appropriate as a last option.

A recent Delaware Chancery Court decision in TCV v. TradingScreen provided some insights into Delaware’s approach to determining the circumstances under which a corporation is legally permitted to fulfill a demand for redemption, meshing the statutory concept of “surplus”, as such term is used in the Delaware General Corporation Law, and the common law concept of “funds legally available.”  The Delaware courts had previously left unanswered the question of whether the statutory standard of “surplus” was somehow different than the common law standard of “funds legally available.”  According to the Chancery Court in TCV v. TradingScreen, there is a difference.  While a calculation of “surplus” basically consists of net assets in excess of capital, “funds legally available” is to be determined on the basis of a “going concern/insolvency” analysis (i.e., would the company’s payment of the redemption amount to the investor impair the company’s ability to continue as a going concern and pay its debts when due?).  The risk to investors is that the viability of a contractual redemption right with respect to its preferred shares may be closely tied to the timing of the demand for redemption of those shares.

Final word on the matter will be provided by the Delaware Supreme Court, as the Chancery Court decision in TCV v. TradingScreen has been appealed.  In the meantime, companies and investors should be cognizant of the implications of the Chancery Court’s decision when negotiating the terms of a redemption provision and the remedies available to the preferred stockholders if the company is not able to satisfy a mandatory right of redemption.