Stockholders of Delaware corporations for many years have had the right to examine stock ledgers, stockholder lists and “books and records” for a “proper purpose” under Section 220 of the Delaware General Corporation Law.  Until recently, however, the concepts of “books and records” and “proper purpose” were not specifically defined in the DGCL. 

Over time, Delaware courts have broadened the scope of books and records demands, allowing stockholders to gain access not just to formal corporate records like board minutes, but also to informal documents such as emails and text messages. Courts have also lowered the threshold for demonstrating “proper purpose,” requiring only a “credible basis” to suspect corporate wrongdoing.

The expansive judicial interpretation of Section 220 has led to a surge in inspection demands, often a precursor to stockholder lawsuits, significantly increasing compliance costs and litigation risks for companies.

This led to calls for reform of the books and records inspection rules.  The calls have also come amid the backdrop of a growing debate about Delaware’s standing as the jurisdiction of choice for incorporation. Some high-profile business leaders, including Elon Musk and Mark Zuckerberg, have been upset about recent decisions in the Delaware courts and have questioned whether Delaware remains the best place to incorporate, creating speculation about companies redomiciling elsewhere or “DExit” as the threatened exodus has been nicknamed.

Responding to these concerns, the Delaware legislature recently adopted significant amendments to the DGCL, including an overhaul of Section 220.  The Section 220 amendment seeks to restore predictability and limit the scope of document production by explicitly defining “books and records”, imposing stricter conditions on stockholder requests and restrictions on how stockholders could use inspected records, while preserving the inspection rights of stockholders with a truly proper purpose.

The changes to DGCL Section 220 could be summarized as follows:

Definition of “Books and Records”.  Prior to the Amendment, Section 220 had no explicit definition for “books and records”, leading to disputes over scope.  The term “books and records” is now defined to consist of the following:

  • Certificate of incorporation and any document incorporated by reference in the certificate of incorporation;
  • By-laws and any document incorporated by reference in the bylaws;
  • Minutes of meetings and written consents of stockholders for the past three years;
  • Written or electronic communications to stockholders within the past three years;
  • Minutes of meetings and written consents of the board of directors or any board committee;
  • Materials provided to the board or any board committee regarding actions taken by the board or any such committee;
  • Annual financial statements for the last three years;
  • Any agreement entered into with a current or prospective stockholder under §122(18) of the DGCL; and
  • Director and officer independence questionnaires (listed companies only).

Court Authority to Order Production.  Previously, courts could order production of various corporate records beyond books and records.  The Amendment limits the Delaware Court of Chancery to ordering only the books and records identified above, with two exceptions: (i) if the company lacks certain records, the court may order the “functional equivalent”; and (ii) if the stockholder has a “compelling need,” the court may order additional records.

Inspection Conditions.  Previously, stockholders only needed a “proper purpose” for inspection.  The Amendment adds three new conditions: (i) the stockholder must act in “good faith” for a proper purpose; (ii) the request must be made with “reasonable particularity”; and (iii) the purpose must be “specifically related” to the requested records.

Confidentiality and Use Restrictions.  Previously, there was no explicit statutory authority for corporations to impose confidentiality restrictions.  Under the Amendment, corporations may condition production on the stockholder agreeing to “reasonable restrictions” on confidentiality, use or distribution of records. Companies may also redact information not specifically related to the stockholder’s purpose.

Compelling Need Exception.  Under the Amendment, the Court of Chancery may order a corporation to produce specific records not within the new definition of “books and records” if the stockholder otherwise satisfies the aforementioned inspection conditions (“proper purpose”, “reasonable particularity” and “specific relation”), shows a “compelling need” to further its proper purpose and demonstrates by clear and convincing evidence that specific records are necessary and essential to further such purpose.

Observations

First, the proper purpose standard under the express language of old Section 220 applied to all three categories of corporate records: stock ledgers, stockholder lists and books and records.  As amended, the conditions that stockholders must satisfy when seeking inspection – “proper purpose”, “reasonable particularity” and “specific relation” – technically only apply to books and records under the express language of Section 220.  It will be interesting to see whether stockholders seize on this inconsistency and take the position that they are entitled to inspect stock ledgers and stockholder lists without needing to satisfy the statutory conditions.

Second, books and records now explicitly includes materials provided to the board of directors or any board committee in connection with actions taken by the board or such committee.  Companies often struggle with the dilemma of whether and to what extent any materials should be sent to the directors (and any observers) in advance of board meetings, as opposed to just presenting information and perhaps a power point presentation at the meeting.  With board materials now explicitly included within the scope of books and records for the purpose of Section 220 inspections, companies should include this among the list of factors to consider when contemplating whether or not to include any particular document among board materials.

Third, while new Section 220 generally limits the scope of books and records demands to those documents listed in the definition of books and records, the exception for such other records for which a stockholder can show a “clear and compelling” need creates the potential for the courts to interpret this broadly.  If so, stockholders may be able to gain access to some of the same informal types of records that the Amendment was ostensibly seeking to restrict, such as emails and texts.  It may also open the door for stockholders to demand more than three years of those books and records that are otherwise limited to the past three years under the new definition, namely minutes of stockholder meetings, stockholder consents, communications with stockholders and annual financials.  This could potentially weaken the practical value of the Amendment in a significant way.

Before 2013, issuers were prohibited from using any means of general solicitation or advertising when raising capital in the private markets.  The prohibition was perceived by many to be the single biggest impediment to raising capital privately, particularly since it foreclosed the use of perhaps the greatest capital raising tool ever created: the Internet.

That all changed in 2013 when the Securities and Exchange Commission created new Rule 506(c) under the JOBS Act of 2012, which allowed companies for the first time ever to seek investors through general solicitation and advertising without registering with the SEC, so long as they sold only to accredited investors and used reasonable methods to verify accredited investor status. 

So what are reasonable methods of verification?  It clearly involves something more than what would meet the “reasonable belief” standard for determining accredited investor status for purposes of the 35 non-accredited investor cap for Rule 506(b) offerings, which as a practical matter means self-attestation through an investor questionnaire. That would not fly under Rule 506(c)’s reasonable verification method standard.

Continue Reading (Minimum Investment) Size Matters, When it Comes to Rule 506(c) Verification

According to crypto platform Kraken, the aggregate market cap for all meme coins is over $70 billion.  Five meme coins would be considered unicorns (market cap over $1 billion) if they were startups.  Dogecoin’s market cap is $35 billion.  Social media influencers, celebrities and high-profile politicians have either launched their own meme coin or endorsed others, including Caitlyn Jenner (JENNER), Iggy Azalea (MOTHER) and Donald Trump (MAGA).  Meme coins are not backed by any real-world assets, not even virtual assets. In fact, many meme coins originate as internet jokes.  

Meme coins lack any inherent utility and function primarily as speculative gambling vehicles.  Given the speculative nature of meme coins, they tend to experience significant market price volatility.  

But are they securities?  The answer is generally no, according to a staff statement released by the Securities and Exchange Commission’s Division of Corporation Finance on February 27, 2025. 

Continue Reading Crypto Collectibles: Meme Coins Deemed Not Securities by SEC Staff
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When negotiating convertible notes, parties typically focus on the terms of conversion upon an equity financing, most notably the discount and valuation cap.  This is understandable inasmuch as the not-so-hidden secret of convertible notes is that no one wants the notes to ever get paid.  The investors are not seeking interest on their investment.  The goal is for the company to attract venture capital investors in the near future, do a priced round and then to have the notes convert into that round at a discount.

Not enough attention, however, is paid to what happens upon maturity, assuming a qualified financing, non-qualified financing or corporate transaction has not occurred that would result in conversion prior to maturity.  As a general matter, three possible scenarios could occur upon maturity of a convertible note: conversion into common, repayment of the note and extension of the maturity date. 

A recent case in Delaware involves a dispute between a company and its convertible note investors over the noteholders’ rights upon maturity.  The case serves as a cautionary tale to investors and companies alike as to the importance during the negotiation process of paying close attention to what happens upon maturity. At the risk of getting tedious, the background details are worth reviewing.

Continue Reading Beyond the Discount: Why Maturity Terms Matter in Convertible Notes
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I’m often asked whether employees should have access to the company’s cap table.  The cap table is one of the most sensitive and critical documents in any startup.  At its most basic level, it lays out who owns what – founders, investors, employees, consultants. It typically contains information about outstanding shares, convertible instruments, pricing, valuation and ownership dilution. More complex cap tables may include formulas that model out various hypothetical transactions such as new funding rounds, sales of the company or public offerings, and may provide details on the holdings of each individual owner and each individual type of security.

Traditionally, access to the cap table is tightly controlled, with only a select few in the company being privy to its contents. However, as demands are made for more transparency, the question arises as to whether employees should have access to the cap table.

Continue Reading Cap Table Confidential: Should Startup Employees Get a Peek?
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The Wall Street Journal recently reported that xAI, the artificial intelligence startup founded by Elon Musk, completed a funding round of $5 billion at a pre-money valuation of $45 billion ($50 billion post-money). Rumored to participate in the round according to the Journal were Sequoia Capital, a16z and Valor Equity Partners.  One could hardly blame these Silicon Valley heavyweights for wanting to make a big bet on artificial intelligence and Elon Musk’s record of success.  But one may wonder whether in their eagerness to do so, they’ve overlooked xAi’s corporate structure as a benefit corporation, which allows it to pursue stated societal goals in addition to purely financial returns.

xAI’s structure as a benefit corporation is noteworthy, but far from unusual for an AI startup.  xAI typifies a growing trend of AI startups adopting governance frameworks that prioritize societal impact alongside profit.  For example, Anthropic organized as a public benefit corporation with a stated purpose of “the responsible development and maintenance of advanced AI for the long-term benefit of humanity”.   Similarly, OpenAI has reportedly adopted plans to restructure itself as a benefit corporation. 

So why are AI startups like xAI embracing the benefit corporation structure, and are investors overlooking the risks?

Continue Reading From Algorithms to Altruism: Risks and Rewards of xAI’s Benefit Corporation Strategy
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I’m often asked by clients whether startups should have a separate stockholders’ agreement among the founders.  The answer largely depends on whether they have or will have certain other startup documents in place. 

First, some background on stockholders’ agreements.  These are contracts entered into by owners of privately held companies to manage the following governance and ownership issues:

  • Board Composition:  Every corporate statute provides that the business affairs of a corporation are to be managed by a board of directors, which sets policy, makes major decisions and appoints officers to whom the day-to-day management of the company is delegated.  So it makes sense to determine in advance the size of the board, who the directors will be and how those directors could be removed and replaced.  Without an agreement, the default standard would be majority rule, meaning that one or more stockholders with a majority of the outstanding shares would be able to elect the entire board.  A stockholders’ agreement ensures board participation in the manner envisioned by the founders.
Continue Reading Stockholders’ Agreements for Startups: When to Sign, When to Skip
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The board of directors of any Delaware corporation proposing to merge is required under Delaware law to adopt a resolution approving the merger agreement.  In the real world of M&A practice, however, the version of the merger agreement presented to and approved by the board is typically still in draft or nearly-final draft form but not yet final.  Does this practice violate Delaware law?

A recent amendment to the Delaware General Corporation Law (“DGCL”) provides that any agreement that must be approved by the board under Delaware law must be in “final or substantially final” form when approved.  The DGCL amendment was adopted in reaction to an earlier Delaware Chancery Court ruling in favor of a stockholder that claimed that the board violated Delaware law when it approved only a draft version of the merger agreement.  These developments underscore the need for boards to consider whether a merger agreement draft submitted for approval is substantially final before approving it.

Continue Reading “Draft Dodging”:  Approving “Nearly Final” Merger Agreement Becomes Dangerous in Delaware
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In the world of early stage investing, there exists a range of structures from the most founder friendly to the most investor friendly. 

The most investor-friendly structure involves some type of a priced round in which the investor receives shares of a class of preferred stock with a negotiated set of enhanced economic, management and exit rights.  These rights and other terms are memorialized in a group of governance documents and agreements among the company, the investors and the founders.

On the other hand, the most founder-friendly investment structure is the simple agreement for future equity, or SAFE, which is similar to a convertible note but notably lacks an interest component and a maturity date.  Next along the range of investor friendliness is the convertible note, which contains several investor protections, including interest, maturity, some reps and warranties and (sometimes) security.  In the real world, however, more sophisticated investors routinely augment their protection under both SAFEs and convertible notes by negotiating side letters that provide them with more enhanced rights.

Documentation for priced rounds and SAFEs have benefited from standardization.  The National Venture Capital Association website open sources a set of standard Series A documents which are a convenient starting point for initial VC rounds.  Ted Wang of Fenwick & West developed a set of standard Series Seed documents in 2010 for use in lower dollar amount priced rounds.  Gust Launch, a SaaS platform for founding, operating and investing in startups open sources a slightly more elaborate set of Series Seed documents.  And Y Combinator, which created the SAFE, open sources its several varieties of the SAFE on its website.  Only convertible notes have lacked standardization and the efficiencies that come with it.

Continue Reading Planting Seeds:  New Standard Convertible Note Could Disrupt Angel Investing

I had a chance to sift through Pitchbook’s U.S. VC Valuations Report for the first quarter of 2024.  The data point that really jumped out at me was the increase in down rounds.  The number of flat and down rounds as a proportion of all VC deals has been rising consistently since the first quarter of 2022, reaching 27.4% of all VC deals in Q1 2024, the highest level in ten years. 

Startling, but predictable.  Companies raised capital during the venture frenzy of 2020 and 2021 at high valuations.  Many startups that had since failed to reduce their cash burn when the fundraising market turned sour in mid-2022 are now facing the prospect of having to raise capital at a discount to their last valuation.

This trend has implications for founders, investors and companies, as down rounds can trigger anti-dilution provisions, dilute existing shareholders and create challenges for companies seeking to raise additional funding.  And there’s reason to believe the worst is not yet behind us.  The incidence of down rounds during historic bear markets indicates there is still plenty of room for valuations of venture-backed companies to fall further.  The rate of down rounds in the aftermath of the 2008 financial crisis rose to nearly 36% of venture deals, which was actually dwarfed by the 58% of deals during the dot-com bust.

Continue Reading Navigating the Downside: The Rise of Down Rounds in 2024 VC Deals