Contract analysis

I. Executive Summary This memorandum analyzes the enforceability and optimal structuring of the protective provisions proposed by Pinnacle Venture Fund II LP ("Pinnacle") in connection with its contemplated $60,000,000 investment in Series D Preferred Stock of Verdana Software, Inc. ("Verdana" or the "Company"), a Delaware C-corporation (DE SOS File No. 6274913). Pinnacle has retained our firm to advise on the Delawa

1. Delaware law provides substantial flexibility to craft preferred stock rights through the certificate of incorporation pursuant to Section 151 of the Delaware General Corporation Law (the "DGCL"), and contractual protections in ancillary investor agreements — including the Amended and Restated Investors' Rights Agreement (the "A&R IRA"), the Amended and Restated Voting Agreement, and the Amended and Restated Right

2. All six of Pinnacle's proposed protective provisions — (a) debt consent, (b) budget deviation consent, (c) full-ratchet anti-dilution protection, (d) a 1.5x non-participating liquidation preference, (e) mandatory pay-to-play, and (f) five-year redemption rights — are legally permissible under the DGCL. However, certain provisions require careful structuring to ensure enforceability and to avoid conflicts with exis

3. Charter-level protections are the strongest form of investor protection under Delaware law because they bind the corporation and all stockholders, render non-compliant corporate actions voidable, and cannot be amended without the affirmative class vote of the affected series under DGCL Section 242(b)(2). Pinnacle should insist on embedding its core economic protections in the A&R Charter.

4. Practical obstacles are significant. Langford Price & Associates LLP ("Langford Price"), acting as counsel to Verdana under the direction of Jonathan Hale, has pushed back on several of Pinnacle's proposed protective provisions in their July 22, 2022 markup of the A&R IRA. Additionally, certain provisions — notably full-ratchet anti-dilution and the 1.5x liquidation preference — deviate from the terms granted to t

II. Background and Transaction Context A. The Parties and Investment Structure Pinnacle Venture Fund II LP, a Delaware limited partnership whose general partner is Pinnacle Capital Management LLC, proposes to invest $60,000,000 in Verdana Software, Inc., a Delaware C-corporation, through the purchase of shares of Series D Preferred Stock. The Series D investment is expected to be a single-tranche closing, with the fu

1. Consent Right Over New Indebtedness. A requirement that the Company obtain the affirmative vote or written consent of the holders of a majority of the outstanding shares of Series D Preferred Stock before incurring, guaranteeing, or otherwise becoming liable for indebtedness in excess of $5,000,000 in the aggregate (other than under existing credit facilities).

2. Consent Right Over Budget Deviations. A requirement that the Company obtain the affirmative vote or written consent of the holders of a majority of the outstanding shares of Series D Preferred Stock before approving or implementing any annual operating budget that deviates by more than 15% from the board-approved annual plan.

3. Full-Ratchet Anti-Dilution Protection. A provision that upon the issuance of shares at a price below the Series D original issue price (a "down round"), the Series D conversion price shall be adjusted downward to the price per share at which such new shares were issued, without regard to the number of shares involved. This is in contrast to Verdana's proposed broad-based weighted average anti-dilution mechanism. 4

5. Mandatory Pay-to-Play. A provision requiring all holders of preferred stock (Series A, B, C, and D) to participate on a pro rata basis in any future qualified equity financing round, with failure to participate resulting in the automatic conversion of such non-participating holder's preferred stock into common stock.

6. Redemption Rights. A right, exercisable at the election of the holders of a majority of the outstanding shares of Series D Preferred Stock at any time after the fifth anniversary of the original issuance date, to require the Company to redeem all outstanding shares of Series D Preferred Stock at the greater of (a) the original purchase price per share plus all accrued and unpaid cumulative dividends or (b) the fai

1. Amended and Restated Certificate of Incorporation. The A&R Charter will be the primary vehicle for establishing the Series D Preferred Stock's rights, preferences, privileges, and restrictions. Charter-level protections — including the liquidation preference, anti-dilution formula, dividend rights, conversion mechanics, redemption provisions, and protective provisions requiring Series D class consent for specified

2. Amended and Restated Investors' Rights Agreement. The A&R IRA will govern the contractual rights of Pinnacle and the other preferred stockholders, including information rights, registration rights (demand and piggyback), inspection rights, and additional contractual consent rights that supplement the charter-level protective provisions. It is in this agreement that Langford Price has raised the most significant ob

3. Amended and Restated Voting Agreement. This agreement will govern the election of directors and the exercise of drag-along rights. The proposed seven-member board composition, including Pinnacle's right to designate one director, will be established in this agreement. The drag-along provisions are the subject of a separate ongoing dispute (regarding the founders' insistence on a $500,000,000 enterprise value floor

4. Series D Preferred Stock Purchase Agreement. The purchase agreement will contain representations and warranties, covenants, closing conditions, and indemnification provisions specific to the Series D investment.

5. Amended and Restated Right of First Refusal and Co-Sale Agreement. This agreement will govern transfer restrictions on the Company's equity securities, including rights of first refusal in favor of the Company and the investors, and co-sale (tag-along) rights in favor of the investors with respect to transfers by the founders. Additionally, we note the existence of the Company's Pacific Summit Bank, N.A. credit ag

III. Delaware General Corporation Law Framework for Preferred Stock Rights This Section provides an overview of the DGCL statutory provisions that govern the creation, enforcement, and modification of preferred stock rights, preferences, and protections. Understanding this statutory framework is essential to analyzing the enforceability and optimal structuring of each of Pinnacle's proposed protective provisions. A.

Section 151(a) of the DGCL grants broad authority to Delaware corporations to issue shares of stock with such voting powers, designations, preferences, and relative, participating, optional, or other special rights, and such qualifications, limitations, or restrictions thereof, as shall be stated in the corporation's certificate of incorporation or in a resolution adopted by the board of directors pursuant to authori

Section 242(b)(2) of the DGCL provides that if any proposed amendment to the certificate of incorporation would alter or change the powers, preferences, or special rights of the shares of any class or series so as to affect them adversely, then the holders of the outstanding shares of that class or series, regardless of whether they are otherwise entitled to vote under the certificate of incorporation, are entitled t

Section 151 of the DGCL expressly permits the creation of preferred stock with preferential dividend rights. Verdana and Pinnacle have agreed in principle on an 8% cumulative, non-compounding dividend accruing from the date of original issuance, payable when and if declared by the board of directors. On a $60,000,000 aggregate investment (regardless of whether the per-share price is $4.00 or $3.25), this equates to a

Section 151(b) of the DGCL expressly permits shares of stock to be made redeemable at the option of the holder or the corporation, or both, at such price or prices, or at such rate or rates, and with such adjustments, as shall be stated in the certificate of incorporation or in the resolution providing for the issuance of such shares. Pinnacle has proposed that the Series D Preferred Stock be redeemable at the electi

1. Installment Redemption. Draft the redemption provision to require redemption in three equal annual installments, with the first installment payable on the fifth anniversary of the original issuance date, the second on the sixth anniversary, and the third on the seventh anniversary. This mitigates the single-year cash burden on the Company and increases the likelihood that sufficient surplus will be available for e

2. Board Obligation to Create Surplus. Include a covenant requiring the board of directors, upon receipt of a redemption notice, to take all lawful action reasonably necessary to generate sufficient surplus to fund the redemption, including, without limitation, effecting a reduction of capital under DGCL Section 244. Section 244 permits the board, by resolution, to reduce the corporation's stated capital, thereby inc

3. Accrued Dividends. Specify that accrued and unpaid cumulative dividends are added to the redemption price. Based on an 8% annual accrual on a $60,000,000 investment, after five years the accrued dividend amount would be approximately $24,000,000 (assuming no interim dividend declarations by the board). The total potential redemption obligation at the fifth anniversary would therefore be: • At 1.0x preference: $60,

4. Fallback Liquidity Mechanism. Include a provision stating that if, upon exercise of the redemption right, the Company lacks sufficient surplus to effect the redemption (even after taking all lawful steps to create surplus), the Company shall use commercially reasonable efforts to consummate a liquidity event (defined to include a sale, merger, IPO, or other transaction) that would generate sufficient proceeds to s

Section 202 of the DGCL permits the imposition of restrictions on the transfer of securities, provided that such restrictions are noted conspicuously on the face or back of the certificate (or, in the case of uncertificated shares, contained in a notice sent to the holder). Transfer restrictions are a standard feature of venture capital preferred stock and are relevant here primarily in the context of the right of fi

IV. Enforceability of Specific Proposed Protective Provisions This Section analyzes each of Pinnacle's six proposed protective provisions in detail, addressing the legal framework, enforceability under Delaware law, practical considerations, and specific structuring recommendations. A. Consent Right Over New Debt Exceeding $5,000,000

1. Charter-Level Implementation The A&R Charter can include, as a protective provision applicable to the Series D Preferred Stock, a requirement that the Company shall not, without the prior affirmative vote or written consent of the holders of a majority (or such other specified percentage) of the outstanding shares of Series D Preferred Stock, voting separately as a single class, directly or indirectly incur, assum

2. Contractual-Level Implementation (Investors' Rights Agreement) In addition to the charter-level protective provision, the A&R IRA can include a parallel contractual covenant under which the Company agrees not to incur indebtedness exceeding the specified threshold without the written consent of Pinnacle (or holders of a specified percentage of the Series D). This "belt-and-suspenders" approach provides two indepen

3. Interaction with Pacific Summit Bank Credit Facility The interaction between Pinnacle's proposed debt consent provision and Verdana's existing Pacific Summit Bank credit facility requires careful attention. The Pacific Summit Bank facility is a $10,000,000 revolving credit facility with $6,200,000 currently drawn, bearing interest at SOFR + 3.50% and maturing on June 30, 2024. The credit agreement contains its own

4. Langford Price's Objection and Analysis In their July 22, 2022 markup of the A&R IRA, Langford Price sought to increase the debt consent threshold from $5,000,000 to $15,000,000, arguing that a $5,000,000 threshold is too low for a company at Verdana's stage and scale — with $47,300,000 in ARR — and would impair the Company's operational flexibility and ability to pursue growth opportunities that may require debt

1. Legal Framework Budget consent rights are somewhat less common than debt consent rights in venture capital protective provision packages, but they are not unusual in later-stage investments where the investor is committing a significant amount of capital and has a legitimate interest in monitoring how that capital is deployed. Budget consent rights are typically implemented at the contractual level (in the IRA or

2. Fiduciary Duty Considerations A budget consent right that conditions certain budgetary decisions on the consent of a class of stockholders raises a potential tension with the board's fiduciary obligations. Under DGCL Section 141(a), the business and affairs of every corporation shall be managed by or under the direction of its board of directors, except as may be otherwise provided in the DGCL or in the corporatio

3. Practical Considerations The 15% deviation threshold must be clearly defined to avoid ambiguity and potential disputes over whether the threshold has been triggered. Key drafting questions include: • Metric: Is the 15% deviation measured against total operating expenditures, total revenue, cash burn (net cash outflow), individual line items, or some other metric? A 15% deviation in a single line item (e.g., market

1. Legal Framework Under DGCL Both full-ratchet and broad-based weighted average anti-dilution provisions are permissible under Section 151 of the DGCL as terms of preferred stock set forth in the certificate of incorporation. The DGCL does not prescribe or favor any particular anti-dilution mechanism; the choice between full-ratchet and broad-based weighted average (or any other formula) is a purely negotiated econo

2. Full-Ratchet Mechanics and Enforceability Under a full-ratchet anti-dilution provision, if the Company issues common stock (or common stock equivalents) at a price per share below the Series D conversion price, the Series D conversion price is adjusted downward to the price per share at which the new shares were issued — irrespective of the number of shares involved in the dilutive issuance. This is the most aggre

3. Broad-Based Weighted Average Mechanics Under a broad-based weighted average anti-dilution provision, the conversion price is adjusted based on a formula that takes into account not only the price per share of the new issuance but also the number of shares involved. The standard broad-based weighted average formula is: Adjusted CP = CP × (A + B) / (A + C) Where: • CP = the conversion price in effect immediately pri

4. Analysis of Internal Consistency with Prior Series Granting full-ratchet anti-dilution to the Series D while the earlier series (A, B, and C) carry broad-based weighted average creates an asymmetry that has significant economic and governance implications. Economic Implications. In a down-round scenario, Series D holders with full-ratchet protection would receive a significantly larger conversion price adjustment

Section 151 of the DGCL permits the creation of preferred stock with any liquidation preference amount negotiated by the parties. There is no statutory maximum or minimum. The certificate of incorporation need only clearly state the preference amount, the priority of payment relative to other classes and series, and whether the preference is participating or non-participating. A 1.5x non-participating liquidation pre

2. Enforceability. A 1.5x non-participating liquidation preference is fully enforceable under Delaware law. The certificate of incorporation need only clearly state the preference amount and the payment priority. Delaware courts will enforce the liquidation preference according to its terms as a contractual right of the preferred stockholders. See Kaiser Aluminum Corp. v. Matheson, 681 A.2d 392 (Del. 1996) (enforcing