For those doing venture financing, a recent Delaware court decision1 ("Moelis"), which effectively invalidated certain parts of a company's stockholder agreement, is of considerable interest. At issue in this case were certain provisions in the stockholder agreement pertaining to requirements for pre-approval of certain board actions, board composition, and board committee composition.
Specifically, these provisions required the board to obtain the founder's consent before taking certain actions, limited the board's ability to alter the board's size and composition, and required the board to put a founder representative on all board committees. The court ruled that these provisions unlawfully constrained the board's discretion under Section 141(a) of the Delaware General Corporation Law (the "DGCL"); and that the board's ability to exercise its discretion may only be implemented through amendments to the company's Certificate of Incorporation.
Moelis has resulted in some anxiety within the venture community as to its impact on the stockholder agreements commonly used in venture financings. The following points are offered as an initial assessment of Moelis' impact on privately held venture-backed companies:
- It is important to recognize that Moelis is a lower court decision and therefore is subject to appeal (in other words, it's not necessarily the final word).
- Proposed amendments to the DGCL in reaction to Moelis have already been approved by the Delaware Bar and are expected to be introduced to the Delaware General Assembly for action this year. If enacted, these amendments will, among other things, amend the DGCL to explicitly authorize the type of provisions that were held to be invalid in Moelis. With the Moelis decision impacting such a large number of Delaware companies, it would be reasonable to expect that Delaware will amend the DGCL to minimize, if not largely negate, the impact of Moelis.
- Moelis is a publicly traded company, and it is unclear to what extent the analysis used by the court in Moelis would apply to a privately held venture-financed corporation, in which all of the investors and founders agreed to the provisions.
- The stockholder agreement at issue in Moelis deviates significantly from the current model National Venture Capital Association ("NVCA") documents, which are used in most venture financing deals.
- To the extent Moelis (if affirmed on appeal and if the DGCL is not amended to authorize the relevant provisions) does impact the model NVCA docs, then many VC-financed companies will be similarly impacted and it is likely that a consensus, and compliant amended language, will emerge from the NVCA and venture legal community.
Additionally, it is worthwhile to highlight several points in the current NVCA document templates (most updated in January 2024):
- The updated NVCA Investor Rights Agreement template already provides that "stockholder veto rights" are in fact board decisions. That is, it's not the preferred stockholder(s) whose approval is required, it's the board member nominated by the preferred stockholders (the "Preferred Director"). This structure would appear to be permissible under Moelis.
- The updated NVCA Certificate of Incorporation template already includes language (suggested in Moelis as a fix for some of the problematic provisions in the Moelis stockholders agreement) that the Preferred Director vote requirement modifies the general "one person, one vote" rule found in standard Certificates of Incorporation.
For venture-backed companies and investors that use NVCA model documents, it may be advisable not to act until things have settled and a consensus among the venture community emerges, which should occur fairly quickly after the case is appealed or the DGCL amended. That way the community is implementing the same, agreed-upon fixes (no-one wants to be the "odd person out"). These companies should discuss this possible approach with legal counsel.
Footnote
1. West Palm Beach Firefighters' Pension Fund v. Moelis & Co., No. 2023-0309-JTL (Del. Ch. Feb. 23, 2024)
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