Private Company Financings: Delaware Court Provides Guidance for Boards and Venture Funds
A common fact pattern for venture-backed companies is the emergency “inside round”: the company is running out of cash, new investors have not been found, and therefore the current backers - that is, the venture funds that likely control a majority of the company’s stock and a majority of its board seats - agree to invest additional capital. This used to be a fact pattern that was well known in the market, but had rarely been seen in the Delaware courts. That has changed in recent years, as the Delaware courts have by now decided several notable cases concerning inside rounds - and in particular the fiduciary duties of boards in approving them.
The recent decision of the Delaware Court of Chancery in In re Nine Systems Corporation Shareholders Litigation, Consol. C.A. No. 3940-VCN (Del. Ch. Sept. 4, 2014), is especially instructive for private company directors, investors, and the lawyers who advise them.
The case was highly critical of the process followed by directors and their VC affiliates in connection with an inside round. However, by pointing out in detail the defects in the process, the court also created a road map for running a better process and protecting directors and VCs in the future. The court also showed once again that Delaware courts are sophisticated in their analysis of valuation questions and willing to recognize that an inside round, particularly for a struggling company, may have been priced fairly even though the directors and VCs faced conflicts.
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Jeffrey R. Wolters, “Delaware Insider: Private Company Financings: Delaware Court Provides Guidance for Boards and Venture Funds,” ABA’s Business Law Today, October 2014.