1002-00004 · Pinnacle Venture Fund II LP · Analyses

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MEMORANDUM

PRIVILEGED & CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION ATTORNEY WORK PRODUCT

August 8, 2022

To: Andrew Fitzpatrick, Lead Associate, Mergers & Acquisitions Practice Group Harrison Wexford, Responsible Partner, Mergers & Acquisitions Practice Group

From: Naomi Petersen, Working Associate, Mergers & Acquisitions Practice Group

Re: Delaware Law Analysis — Protective Provisions and Minority Investor Rights in Connection with Proposed Series D Investment by Pinnacle Venture Fund II LP in Verdana Software, Inc.

Matter No.: 1002-00004

Client No.: PIN-0042

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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 Delaware law framework governing minority preferred stockholder protections and to assess the legal enforceability, practical feasibility, and negotiating dynamics surrounding each of the specific protective provisions Pinnacle has proposed in the current draft transaction documents.

Following the closing of the Series D investment, Pinnacle will hold approximately 15.00% to 18.75% of Verdana's fully-diluted capitalization, depending on the final agreed-upon pre-money valuation and the treatment of the proposed option pool expansion. While Pinnacle will constitute a significant minority holder, it will not hold a controlling interest in the Company and will occupy only one of seven board seats. Accordingly, the protective provisions negotiated in the Amended and Restated Certificate of Incorporation (the "A&R Charter") and the ancillary investor agreements are of critical importance to safeguarding Pinnacle's economic interests and governance rights.

The key conclusions of this memorandum are as follows:

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 of First Refusal and Co-Sale Agreement — are generally enforceable under Delaware contract law.

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 existing preferred stock series (Series A, B, and C) rights, the board's fiduciary obligations, and the practical realities of Verdana's financial condition.

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 the existing Series A, B, and C preferred stockholders, creating asymmetry that may trigger opposition from existing investors and, potentially, class voting requirements under Section 242(b)(2) that could impede the charter amendment process.

This memorandum is intended to provide the legal framework necessary to inform the ongoing negotiations with Langford Price and the Company. It addresses each proposed protective provision in turn, analyzes the applicable Delaware statutory and case law, and provides specific structuring recommendations.

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 full $60,000,000 funded at closing, subject to customary closing conditions including the filing of the A&R Charter with the Delaware Secretary of State, the execution of all ancillary agreements, and the satisfaction of Pinnacle's due diligence requirements.

Verdana is a growth-stage enterprise software company headquartered in Austin, Texas, that provides cloud-based supply chain management solutions to mid-market and enterprise customers. The Company was founded by Raj Anand (CEO) and Lena Kovac (CTO) in 2016 and has raised three prior rounds of preferred stock financing from institutional investors.

Pre-Investment Capitalization. Prior to the Series D investment and assuming no expansion of the employee stock option pool ("ESOP"), Verdana's fully-diluted capitalization comprises approximately 80,000,000 shares, allocated as follows:

Proposed ESOP Expansion. Verdana has proposed expanding the ESOP by 5,000,000 shares prior to the Series D closing, which would bring the total ESOP to 17,000,000 shares and the pre-close fully-diluted share count to 85,000,000. This ESOP expansion is a point of ongoing negotiation, as it directly affects the dilutive impact of the Series D investment on Pinnacle's post-close ownership percentage. Verdana has indicated that the ESOP expansion is necessary to recruit and retain key engineering and product leadership talent in connection with the Company's planned expansion into European markets.

Valuation Dispute. The pre-money valuation remains under active negotiation. The two positions are as follows:

• Verdana's Position: $320,000,000 pre-money valuation, implying a per-share price of $4.00 (calculated as $320M ÷ 80M shares, or $320M ÷ 85M shares if the ESOP expansion is included pre-close). At this valuation, Pinnacle's $60M investment would yield 15,000,000 shares of Series D Preferred Stock, representing approximately 15.79% of post-close fully-diluted capitalization (without ESOP expansion) or approximately 15.00% (with ESOP expansion).

• Pinnacle's Position: $260,000,000 pre-money valuation, implying a per-share price of approximately $3.25 (calculated as $260M ÷ 80M shares). At this valuation, Pinnacle's $60M investment would yield approximately 18,461,538 shares of Series D Preferred Stock, representing approximately 18.75% of post-close fully-diluted capitalization (without ESOP expansion). Pinnacle has further taken the position that the ESOP expansion should be included in the pre-money capitalization (i.e., funded from the pre-money share count) rather than treated as an additional dilutive event post-close.

The resolution of the valuation dispute will affect not only the total number of shares issued to Pinnacle and its corresponding ownership percentage, but also the per-share conversion price that establishes the baseline for the anti-dilution calculations discussed in Section IV.C below. For purposes of this memorandum, where specific dollar amounts or share counts are referenced, we note both Verdana's proposed terms and Pinnacle's proposed terms where the distinction is material.

B. Pinnacle's Proposed Protective Provisions at Issue

In its initial term sheet dated May 18, 2022, and in subsequent markups of the draft transaction documents, Pinnacle has proposed the following protective provisions, each of which is analyzed in detail in this memorandum:

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. 1.5x Non-Participating Liquidation Preference. A preference entitling Series D holders to receive an aggregate amount equal to 1.5 times the original purchase price per share of the Series D Preferred Stock ($90,000,000 in the aggregate) plus all declared but unpaid dividends, before any distribution to the holders of common stock in connection with a Liquidation Event, without participation alongside common stockholders thereafter. This is in contrast to Verdana's offered 1.0x non-participating liquidation preference ($60,000,000).

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 fair market value per share as determined by an independent appraiser.

It should be noted that the existing Series A (Ridgeline Ventures Fund III LP), Series B (Northgate Growth Partners Fund II LP), and Series C (Brindoval Capital Group LLC) preferred stock all carry a 1.0x non-participating liquidation preference with broad-based weighted average anti-dilution protection. None of the prior series currently have redemption rights or mandatory pay-to-play provisions. The proposed Series D terms therefore represent a significant departure from the terms governing the Company's existing preferred stock in several material respects.

C. Key Documents Implicating Protective Provisions

The protective provisions at issue will be implemented through a combination of the following transaction documents, which are currently in various stages of negotiation between our firm (on behalf of Pinnacle) and Langford Price & Associates LLP (on behalf of Verdana):

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 corporate actions — will be set forth in the A&R Charter. As discussed in Section V below, charter-level protections represent the strongest form of investor protection under Delaware law.

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 objections to Pinnacle's proposed terms in the July 22, 2022 markup.

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) that will be analyzed in a forthcoming separate memorandum.

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 agreement, which provides a $10,000,000 revolving credit facility ($6,200,000 currently drawn) bearing interest at SOFR + 3.50%, maturing on June 30, 2024. This credit facility contains financial covenants (including a minimum $10,000,000 liquidity covenant and an ARR-based coverage ratio) and negative covenants restricting the incurrence of additional indebtedness, which may interact with the debt consent provisions discussed in Section IV.A below. A detailed review of the Pacific Summit Bank credit facility is set forth in the Pacific Summit Bank Credit Facility Review Memorandum dated June 28, 2022, and the Lender Consent Analysis Memorandum dated June 30, 2022, both of which should be reviewed in conjunction with this memorandum.

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. DGCL Section 151 — Authority to Create Series with Specific Rights, Preferences, and Restrictions

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 authority expressly vested in it by the certificate of incorporation. This provision is the statutory foundation upon which the entire edifice of preferred stock rights in venture capital financings is built.

The breadth of Section 151 cannot be overstated. It permits the creation of preferred stock with virtually any combination of economic and governance rights, including but not limited to:

• Dividends, whether cumulative or non-cumulative, at fixed or variable rates;

• Liquidation preferences at any multiple of the original issue price, with or without participation alongside common stockholders;

• Conversion rights, including mandatory and optional conversion into common stock at specified conversion ratios, subject to adjustment;

• Anti-dilution protection, including full-ratchet, broad-based weighted average, narrow-based weighted average, or other customized formulas;

• Voting rights, including the right to vote on an as-converted basis with common stockholders, special class voting rights, and the right to elect one or more designated directors;

• Protective provisions requiring the affirmative vote or written consent of the holders of a specified percentage of the outstanding shares of the series before the corporation may take specified actions (such as incurring debt, amending the charter, issuing senior or pari passu securities, or consummating a change-of-control transaction); and

• Redemption rights, exercisable at the option of the holder or the corporation, at specified prices, on specified dates, and subject to specified conditions.

When these rights are set forth in the certificate of incorporation (or in a certificate of designations authorized by the certificate of incorporation through so-called "blank check" authority), they become part of the corporate charter itself and are binding on the corporation and all of its stockholders as a matter of the corporation's constitutive document. This is a critical distinction from contractual rights, as discussed further in Section V below.

Application to Verdana. The A&R Charter to be filed in connection with the Series D closing will set forth the specific rights, preferences, privileges, and restrictions of the Series D Preferred Stock. These are expected to include, among other things:

• The liquidation preference (whether 1.0x or 1.5x, as negotiated);

• The cumulative dividend right (8% per annum, non-compounding, equal to $4,800,000 per year on a $60,000,000 investment, accruing from the date of original issuance and payable when and if declared by the board);

• The conversion ratio and conversion mechanics (initially 1:1, subject to adjustment);

• The anti-dilution formula (whether full-ratchet or broad-based weighted average, as negotiated);

• The redemption right (if included, exercisable after five years); and

• The protective provisions requiring Series D class consent for specified corporate actions.

Enforceability. It is well-established under Delaware law that charter-level protections constitute the strongest form of investor protection available to preferred stockholders. Because the rights of preferred stockholders set forth in the certificate of incorporation are treated as contractual in nature — the preferred stockholder having, in effect, "bargained for" those specific rights at the time of investment — they are enforceable in accordance with their terms. Delaware courts will interpret charter provisions governing preferred stock rights using the same principles of construction applicable to contracts, looking first to the plain language of the charter and giving effect to the parties' objectively manifested intent. See Ellingwood v. Wolf's Head Oil Refining Co., 38 A.2d 743 (Del. 1944); Matulich v. Aegis Communications Group, Inc., 942 A.2d 596 (Del. 2008).

Moreover, charter-level protections cannot be amended or removed without the affirmative consent of the affected class of stockholders under Section 242(b)(2) of the DGCL, as discussed in Section III.B below. This provides an inherent structural protection that Pinnacle should leverage to the fullest extent in the ongoing negotiations.

B. DGCL Section 242 — Charter Amendments and Class Voting Protections

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 to vote separately as a class on the proposed amendment. The affirmative vote of a majority of the outstanding shares of such class or series is required to approve the amendment, unless the certificate of incorporation specifies a greater voting threshold.

This provision is of fundamental importance to preferred stockholders because it provides an inherent, statutory "veto right" against any charter amendment that would adversely affect their negotiated rights. In the context of Pinnacle's Series D investment, Section 242(b)(2) operates in two critical ways:

First, once the A&R Charter is filed and the Series D Preferred Stock is issued, Verdana will be unable to unilaterally amend the charter to strip, modify, or dilute the Series D rights, preferences, privileges, or restrictions without the affirmative vote of a majority (or such greater percentage as may be specified in the A&R Charter) of the outstanding shares of Series D Preferred Stock, voting separately as a class. This provides a structural floor of protection for Pinnacle's Series D rights that exists by operation of statute, independent of any negotiated protective provision.

Second, and of immediate practical significance to the current transaction, the filing of the A&R Charter to create the Series D Preferred Stock and authorize the Series D investment will itself constitute a charter amendment. If the terms of the Series D — including, in particular, the proposed full-ratchet anti-dilution provision and the 1.5x liquidation preference — adversely affect the powers, preferences, or special rights of the existing Series A, B, or C preferred stock, then the holders of each adversely affected series are entitled to a separate class vote on the A&R Charter amendment under Section 242(b)(2). This creates a potential structural impediment to closing, as discussed in Sections IV.C.4 and VII.C below.

We note that Section 242(b)(2) requires only a majority vote of the affected class to approve the adverse amendment — it does not require unanimity. However, the charter may specify a supermajority threshold. We recommend that Pinnacle negotiate for a higher consent threshold — such as the affirmative vote of holders of at least two-thirds (66⅔%) of the outstanding shares of Series D Preferred Stock, or, if commercially achievable, the unanimous written consent of all Series D holders — for any future charter amendment that would alter or change the powers, preferences, or special rights of the Series D Preferred Stock. In the present transaction, Pinnacle is expected to be the sole holder of Series D Preferred Stock at closing, so a majority vote and a unanimous vote would be effectively identical. However, if additional Series D shares are issued in the future to other investors (e.g., in a subsequent closing or follow-on round), a supermajority or unanimity requirement would provide Pinnacle with greater protection against modifications sought by a coalition of other Series D holders and the Company.

Interaction with prior series. As noted above, the existing Series A (Ridgeline), Series B (Northgate), and Series C (Brindoval) preferred stockholders also enjoy the protections of Section 242(b)(2). Any future charter amendment affecting their respective series would require the separate class vote of each affected series. In the current transaction, the filing of the A&R Charter will need to navigate these multi-class consent requirements, which adds complexity to the closing process and provides existing investors with leverage over the terms of the Series D.

C. DGCL Section 151(b) — Dividends and Preferences

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 an annual dividend accrual of $4,800,000.

Several points warrant attention regarding the structuring of this dividend right:

Under Section 151, the corporation may create preferences in dividends, and cumulative dividends accrue from the date of issuance regardless of whether the board has declared a dividend. However, under standard Delaware corporate law principles, even cumulative dividends are not payable until and unless the board declares them — the accrual creates an economic right that is relevant primarily in the context of a liquidation event, conversion, or redemption, rather than creating a current cash payment obligation. The charter may, of course, specify otherwise, and parties are free to negotiate mandatory dividend payment dates, but the standard venture capital convention — which the parties appear to be following here — is to treat cumulative dividends as accruing and payable only upon a Liquidation Event or when declared by the board.

We recommend specifying clearly in the A&R Charter that all accrued and unpaid cumulative dividends shall be added to and form part of the liquidation preference amount payable upon a Liquidation Event (including deemed liquidation events). This ensures that in the event of a sale, merger, or other exit transaction, the accrued dividend amount is included in the senior preference payment to Series D holders before any distribution to common stockholders. If the dividends are not explicitly added to the liquidation preference in the charter, there is a risk that they could be characterized as a separate, subordinate claim rather than as part of the senior preference stack.

Additionally, we recommend specifying in the redemption provisions (discussed in Section III.D below) that accrued and unpaid cumulative dividends are added to the redemption price upon exercise of the redemption right.

D. DGCL Section 160 and Section 151 — Redemption Rights

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 election of the holders of a majority of the outstanding Series D shares at any time after the fifth anniversary of the original issuance date.

Enforceability. Redemption rights, when set forth in the certificate of incorporation, are enforceable as charter-level provisions. Delaware courts have consistently recognized that redemption obligations are binding on the corporation once the conditions for redemption are triggered. In SV Investment Partners, LLC v. ThoughtWorks, Inc., 7 A.3d 973 (Del. Ch. 2010), the Court of Chancery addressed the enforceability of a mandatory redemption provision in a certificate of incorporation and held that the corporation's board of directors had a contractual duty to take all lawful steps to effectuate the agreed-upon redemption. The court made clear that a board cannot simply refuse to comply with a charter-mandated redemption obligation on the grounds of business judgment or competing priorities.

Surplus Limitation. However, a critical constraint on the practical enforceability of redemption rights is DGCL Section 160, which provides that a corporation may redeem or repurchase its own shares only out of surplus — defined under DGCL Section 154 as the excess of the corporation's net assets over its stated capital. If the corporation lacks sufficient surplus at the time redemption is demanded, the redemption may be legally impossible notwithstanding the charter obligation. A corporation cannot redeem stock if doing so would render it insolvent or impair its stated capital.

Practical Concern. Verdana's current financial position raises material questions about the availability of surplus for a potential redemption in five years. As of March 31, 2022, the Company reported:

• Trailing twelve-month EBITDA: negative $11,600,000

• Cash and cash equivalents: $22,400,000

• Annual recurring revenue (ARR): $47,300,000 (growing, but the Company remains cash-flow negative)

Without a significant influx of additional capital or a dramatic improvement in profitability, Verdana may not have surplus sufficient to fund a redemption of $60,000,000 or more (plus accrued dividends) five years from now. The Series D investment itself will add $60,000,000 in cash to the balance sheet, but a substantial portion of these funds will be consumed by ongoing operations and the Company's growth plan.

Recommendation. To address the surplus limitation and maximize the practical enforceability of the redemption right, we recommend the following structuring approach:

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 each installment.

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 increasing surplus. While this mechanism does not create new cash, it may eliminate the legal barrier to redemption when the corporation has sufficient net assets but insufficient "surplus" as technically defined.

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: $60,000,000 + $24,000,000 = $84,000,000

• At 1.5x preference: $90,000,000 + $24,000,000 = $114,000,000

These are significant obligations that must be carefully considered in structuring the redemption right.

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 satisfy the redemption obligation. While such a provision does not guarantee results, it creates a contractual obligation on the Company to pursue a path to liquidity and provides a basis for enforcement proceedings if the Company fails to do so.

The ThoughtWorks line of cases provides strong support for the enforceability of both the redemption obligation itself and the ancillary covenant requiring the board to take lawful steps to effectuate the redemption. This is an area where Pinnacle can take comfort that Delaware law is favorable to the investing stockholder's position.

E. DGCL Section 202 — Transfer Restrictions

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 first refusal ("ROFR") and co-sale (tag-along) rights that Pinnacle has proposed.

Pinnacle's proposed co-sale/tag-along rights provide that if either founder (Raj Anand or Lena Kovac) proposes to transfer shares of common stock representing more than 1% of the Company's total outstanding shares, the holders of preferred stock (including Pinnacle as the holder of Series D) shall have the right to participate in such transfer on a pro rata basis, selling their shares (or shares into which their preferred stock is convertible) on the same terms and conditions as the founders.

These co-sale rights can be structured either as charter provisions (set forth in the A&R Charter) or as contractual obligations in the A&R ROFR and Co-Sale Agreement. The standard venture capital practice is to include co-sale rights in the contractual agreement rather than the charter, because charter-level transfer restrictions are relatively inflexible and may complicate future corporate transactions. However, including a reference to the transfer restrictions in the charter (with the detailed mechanics in the contractual agreement) is advisable for maximum enforceability.

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, assume, guarantee, or otherwise become liable for indebtedness for borrowed money in excess of $5,000,000 in the aggregate, other than amounts outstanding under the existing Pacific Summit Bank, N.A. revolving credit facility (currently carrying a $10,000,000 facility limit with $6,200,000 drawn as of the date of this memorandum).

This type of debt consent provision is a standard protective provision in venture capital preferred stock terms and is widely used in Series A through later-stage financings. It is squarely within the scope of the powers that Section 151 of the DGCL authorizes the certificate of incorporation to confer upon a class or series of preferred stock. The consent right operates as a condition precedent to the valid corporate action of incurring debt: if the Company purports to incur indebtedness exceeding the threshold without obtaining the requisite Series D consent, such action would be voidable at the instance of the Series D holders. This is a significantly stronger remedy than a mere breach of contract claim.

Delaware courts have recognized that protective provisions requiring class consent for specified corporate actions are valid exercises of the corporation's authority under Section 151 and are enforceable according to their terms. See Glenrock Partners IV, L.P. v. Vague, 2002 WL 1732423 (Del. Ch. July 15, 2002) (analyzing protective provisions in the context of preferred stock rights and acknowledging the enforceability of charter-level consent requirements).

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 independent bases for challenging unauthorized debt incurrence: (a) a challenge to the corporate action itself as voidable under the charter, and (b) a breach of contract claim under the IRA.

The distinction between these two remedies is significant. A charter-level violation renders the corporate action voidable — meaning that if the Company incurs debt without Series D consent, the debt obligation itself may be challenged (subject to equitable considerations, including whether the lender had notice of the charter restriction). A contractual violation, by contrast, gives rise to a claim for damages or, if available, specific performance — but the underlying corporate action (the debt incurrence) is not itself voidable on the basis of a breach of the IRA.

Recommendation: We recommend including the debt consent right in both the A&R Charter (as a protective provision binding on the corporation and enforceable against the world) and the A&R IRA (as a contractual covenant providing a supplemental remedy). The charter-level provision should be treated as the primary protection.

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 restrictive covenants, including negative covenants that may already limit the Company's ability to incur additional indebtedness.

If the Series D protective provision requires consent for new debt exceeding $5,000,000, and the Pacific Summit Bank credit agreement also restricts additional indebtedness (as is typical for bank revolving credit facilities), the Company would face dual consent requirements for any new debt — one from the Series D holders and one from the bank. While this provides additional protection for Pinnacle, it also creates a risk of operational paralysis if the Company needs to act quickly to secure debt financing for legitimate business purposes.

To address this concern, and to avoid the argument that the protective provision is impractical or unduly burdensome, we recommend including the following carve-outs in the debt consent provision:

(a) Amounts outstanding under the existing Pacific Summit Bank revolving credit facility, and any amendments, extensions, renewals, or refinancings thereof, up to an aggregate principal amount not exceeding $12,500,000 (providing reasonable headroom above the current $10,000,000 facility limit);

(b) Equipment financing or capital lease obligations incurred in the ordinary course of business in an aggregate principal amount not exceeding $1,500,000 at any time outstanding;

(c) Trade payables and other current liabilities incurred in the ordinary course of business consistent with past practice; and

(d) Intercompany indebtedness among the Company and its wholly-owned subsidiaries (if applicable).

These carve-outs are market-standard and provide the Company with adequate operational flexibility while preserving the Series D holders' consent right over material new indebtedness that could impair the Company's financial position.

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 financing.

This objection has some merit as a practical matter, but is not legally dispositive. The debt consent threshold is a negotiated commercial term, not a legal requirement, and Delaware law does not prescribe any minimum or maximum threshold. That said, the appropriateness of the threshold should be evaluated in the context of the Company's size, growth trajectory, and financing needs.

Based on our review of comparable venture capital transactions in the growth-stage enterprise software sector, we observe the following:

• For companies with ARR in the $30M–$75M range, debt consent thresholds in the range of $5,000,000 to $10,000,000 are common.

• A $5,000,000 threshold is at the lower end of the market range and is more typical of earlier-stage investments.

• A $15,000,000 threshold, as proposed by Langford Price, is at the upper end of the market range and may not provide sufficient protection for a minority investor committing $60,000,000.

Recommendation: A compromise at $7,500,000 to $10,000,000 may be appropriate, preserving meaningful protection for Pinnacle while providing the Company with adequate operational flexibility. We recommend proposing a threshold of $7,500,000 in the next markup, with the carve-outs described above.

B. Consent Right Over Annual Budgets Deviating More Than 15% from Board-Approved Plan

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 a stockholders' agreement) rather than at the charter level, though charter-level implementation is also permissible.

A provision requiring the affirmative vote or written consent of the holders of a majority of the outstanding shares of Series D Preferred Stock before the board may approve or the Company may implement any annual operating budget (or any modification thereto) that deviates by more than 15% from the annual operating budget most recently approved by the board of directors is enforceable under Delaware law as either a charter provision (under Section 151) or a contractual covenant (under the IRA).

If implemented at the charter level, the budget consent right would function as a protective provision within the meaning of the A&R Charter's Series D designation, and any budgetary action taken in violation of the provision would be voidable. If implemented at the contractual level, a violation would give rise to a breach of contract claim.

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 corporation's certificate of incorporation. The proviso "except as may be otherwise provided in the certificate of incorporation" is critical: it expressly authorizes the certificate of incorporation to impose restrictions on the board's authority, including restrictions that condition certain corporate actions on stockholder approval.

Delaware courts have recognized that protective provisions requiring stockholder consent for specified corporate actions do not constitute an impermissible delegation of board authority. Rather, they operate as negotiated restrictions on the scope of board authority, which the corporation is free to establish in its charter. The rationale is that the corporation voluntarily accepted these restrictions as a condition of the preferred stockholder's investment, and the preferred stockholder's consent right is part of the bargained-for exchange.

However, we note a potential concern if the budget consent right is structured too broadly. If the provision effectively prevents the board from taking action necessary to preserve the business in exigent circumstances — for example, if the Company faces an emergency requiring immediate expenditures that exceed the 15% deviation threshold, and the Series D holders are unable or unwilling to provide timely consent — the provision could be challenged as an impermissible restraint on the board's ability to fulfill its fiduciary duties. While we are not aware of a Delaware case that has invalidated a budget consent right on this ground, the risk should be mitigated through careful drafting.

Recommendation: Include a carve-out for emergency expenditures that are necessary to preserve the business, protect the Company's assets, or comply with applicable law, provided that the board provides prompt written notice to the Series D holders of any such emergency expenditure and the reasons therefor. This carve-out preserves the board's ability to act in a crisis while ensuring transparency and accountability to Pinnacle.

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., marketing spend) could occur while total operating expenditures remain well within the threshold, or vice versa.

• Baseline: What is the reference point — the annual operating budget as approved by the board at the beginning of each fiscal year? If the board approves mid-year revisions (with Series D consent), does the revised budget become the new baseline?

• Measurement Period: Is the 15% deviation measured on an annual basis (cumulative year-to-date), quarterly, or at any point in time?

Recommendation: Define the threshold as a 15% deviation from the aggregate annual operating expense budget as approved by the board of directors at the beginning of each fiscal year (the "Approved Budget"). Specify that if the board approves a mid-year revision to the Approved Budget with Series D consent, the revised budget becomes the new baseline. Include a mechanism for quarterly reporting of actual expenditures versus the Approved Budget, with a requirement that the Company's Chief Financial Officer certify to the Series D holders (and the board) within 30 days after the end of each fiscal quarter whether expenditures are tracking within the 15% threshold. Additionally, include a provision for interim board approval of budget adjustments with Series D observer notification for deviations between 10% and 15% (as an early warning mechanism), with Series D written consent required only for deviations exceeding 15%.

C. Full-Ratchet Anti-Dilution vs. Broad-Based Weighted Average

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 economic term that is left entirely to the parties.

Anti-dilution provisions function by adjusting the conversion ratio at which preferred stock converts into common stock, such that if the corporation issues common stock (or common stock equivalents) at a price below the preferred stock's original issue price (or then-current conversion price), the preferred stockholders' conversion price is adjusted downward, entitling them to a greater number of common shares upon conversion. The purpose is to protect the preferred stockholders against economic dilution resulting from subsequent issuances at lower prices — commonly referred to as "down rounds."

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 aggressive form of anti-dilution protection available to preferred stockholders.

To illustrate the mechanics with a concrete example: Assume a Series D conversion price of $4.00 per share (under Verdana's proposed valuation), with 15,000,000 shares of Series D outstanding. If Verdana subsequently issues shares at $2.00 per share in a down round, the Series D conversion price would be adjusted to $2.00 under a full-ratchet provision. The number of common shares issuable upon conversion of the Series D would increase from 15,000,000 to 30,000,000 (calculated as $60,000,000 aggregate original issue price ÷ $2.00 adjusted conversion price), thereby doubling Pinnacle's share count upon conversion and dramatically increasing its ownership percentage. This adjustment occurs regardless of whether the down round involves the issuance of 1,000 shares or 10,000,000 shares — the full-ratchet mechanism looks only to the price per share of the new issuance, not its magnitude.

Full-ratchet anti-dilution provisions are fully enforceable under Delaware law when set forth in the certificate of incorporation. The certificate need only state the formula clearly and specify the conversion price adjustment mechanism, the types of issuances that trigger the adjustment (and any customary exceptions, such as employee equity plan issuances, strategic partnership issuances, and the like), and the calculation methodology.

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 prior to the new issuance

• A = the total number of shares of common stock outstanding immediately prior to the new issuance (on a fully-diluted basis, including all shares issuable upon conversion of all outstanding convertible securities and exercise of all outstanding options and warrants — the "broad base")

• B = the number of shares of common stock that the aggregate consideration received by the corporation for the new issuance would purchase at the then-current conversion price (i.e., aggregate consideration ÷ CP)

• C = the number of shares of common stock actually issued (or issuable upon conversion of convertible securities issued) in the new issuance

The effect of this formula is to produce a smaller conversion price adjustment than full-ratchet, because it proportionally weights the dilutive impact of the new issuance against the total outstanding capitalization. A small dilutive issuance results in a small adjustment; a large dilutive issuance results in a larger adjustment. This is widely regarded as a fairer mechanism that avoids the punitive effects of full-ratchet, particularly in situations involving small dilutive issuances.

This is the mechanism used in Verdana's existing Series A (Ridgeline), Series B (Northgate), and Series C (Brindoval) preferred stock. All three prior rounds employ broad-based weighted average anti-dilution with the same general formula, as set forth in the current certificate of incorporation.

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 (and correspondingly more common shares upon conversion) than the Series A, B, and C holders with broad-based weighted average protection. This differential treatment means that in a down round, Pinnacle's ownership percentage increases more rapidly than the earlier investors' ownership percentages, resulting in disproportionate dilution of the founders and earlier-series investors. This creates a misalignment of incentives: Pinnacle, protected by full-ratchet, has less economic exposure to a down round than the earlier-series investors, and arguably less incentive to resist or mitigate the pricing in a down round.

Governance Implications. Brindoval Capital Group LLC, acting through Diana Chen (Brindoval's board designee), has specifically and forcefully objected to full-ratchet anti-dilution for the Series D as inconsistent with the terms granted to prior series. Brindoval's position is that granting more favorable anti-dilution protection to a later series undermines the principle of parity among preferred stockholders and creates a precedent that could be cited by future investors to demand even more aggressive terms. Ridgeline (Series A) and Northgate (Series B) have not yet formally taken a position on this issue but may be expected to align with Brindoval.

Legal Analysis. As a matter of Delaware law, there is no requirement that all series of preferred stock carry identical anti-dilution protection. The corporation is free to grant different anti-dilution mechanisms to different series — each series is a separate contractual bargain between the corporation and the holders of that series, and there is no statutory or common-law principle requiring inter-series parity. See generally Glenrock Partners IV, L.P. v. Vague, 2002 WL 1732423 (Del. Ch. July 15, 2002) (recognizing that different classes and series of stock may have different rights and that the validity of such differences is assessed under the charter and the DGCL).

However, this legal flexibility does not eliminate the practical obstacle. The charter amendment required to create the Series D with full-ratchet anti-dilution will require the affirmative vote of the board and a majority of the outstanding voting shares. Critically, under Section 242(b)(2), if the charter amendment adversely affects the rights of the existing preferred series — and a strong argument can be made that granting full-ratchet to a new series adversely affects the earlier series by increasing the dilution they face in a down round (relative to what their dilution would be if the new series also had broad-based weighted average) — then each affected series would be entitled to a separate class vote on the amendment. If Ridgeline (Series A), Northgate (Series B), or Brindoval (Series C) exercise their class voting rights to block the charter amendment, the Series D closing cannot proceed on these terms.

Recommendation. We advise Pinnacle that full-ratchet anti-dilution is legally permissible and enforceable under Delaware law, and there is no legal impediment to granting Series D more favorable anti-dilution protection than the prior series. However, the practical risk that existing investors will exercise their class voting rights to block the charter amendment is significant and may represent the most material impediment to achieving full-ratchet terms in this transaction.

As a potential compromise, Pinnacle may wish to consider the following alternatives:

(a) Narrow-Based Weighted Average. A narrow-based weighted average formula uses a smaller denominator (typically only the outstanding shares of the affected series or all preferred stock, rather than the full fully-diluted capitalization) in the anti-dilution formula. This produces a larger adjustment than broad-based weighted average but a smaller adjustment than full-ratchet, and may be viewed as a middle ground.

(b) Full-Ratchet with a Sunset. Grant full-ratchet anti-dilution for a limited period (e.g., 18 to 24 months from closing), after which the anti-dilution mechanism automatically converts to broad-based weighted average. This provides Pinnacle with enhanced protection during the period of greatest risk (the near-term) while eventually harmonizing the anti-dilution treatment across all series.

(c) Full-Ratchet with a Threshold. Grant full-ratchet anti-dilution only if the down-round issuance price is below a specified threshold (e.g., less than 75% of the Series D original issue price), with broad-based weighted average applying to issuances at prices between 75% and 100% of the Series D original issue price. This limits the punitive effect of full-ratchet to significant down rounds.

Any of these alternatives may be more achievable in negotiations while still providing Pinnacle with meaningfully enhanced anti-dilution protection relative to the broad-based weighted average standard.

D. 1.5x Non-Participating Liquidation Preference

1. Legal Framework

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 preference, as proposed by Pinnacle, means that in connection with any Liquidation Event (typically defined to include a dissolution or winding up of the Company, as well as deemed liquidation events such as mergers, acquisitions, consolidations, and sales of all or substantially all of the Company's assets), the holders of Series D Preferred Stock are entitled to receive, prior to and in preference to any distribution to the holders of common stock, an amount per share equal to 1.5 times the Series D original issue price, plus all declared but unpaid dividends. On Pinnacle's proposed $60,000,000 aggregate investment, this equates to a $90,000,000 aggregate liquidation preference (before accrued dividends). The "non-participating" element means that after receipt of the preference amount, the Series D holders do not participate alongside common stockholders in any remaining distribution — they receive only their preference amount and nothing more (unless they elect to convert to common stock and participate pro rata with common, which they would do only if the per-share common distribution exceeds the per-share preference).

By contrast, Verdana has offered a 1.0x non-participating liquidation preference, which would entitle Series D holders to receive $60,000,000 in the aggregate (plus declared but unpaid dividends) before any distribution to common stockholders.

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 preferred stock liquidation rights as stated in the charter); In re Trados Inc. Shareholder Litigation, 73 A.3d 17 (Del. Ch. 2013) (analyzing the interplay between liquidation preferences and the board's fiduciary duties in a change-of-control transaction).

The preference must be stated in connection with a "Liquidation Event," which is a defined term in the A&R Charter. We recommend defining "Liquidation Event" broadly to include not only a statutory dissolution or winding up but also any of the following deemed liquidation events:

(a) Any merger, consolidation, or similar transaction in which the Company's stockholders immediately prior to the transaction hold less than 50% of the voting power of the survi

MEMORANDUM
PRIVILEGED & CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION ATTORNEY WORK PRODUCT
August 8, 2022
To: Andrew Fitzpatrick, Lead Associate, Mergers & Acquisitions Practice Group Harrison Wexford, Responsible Partner, Mergers & Acquisitions Practice Group
From: Naomi Petersen, Working Associate, Mergers & Acquisitions Practice Group
Re: Delaware Law Analysis — Protective Provisions and Minority Investor Rights in Connection with Proposed Series D Investment by Pinnacle Venture Fund II LP in Verdana Software, Inc.
Matter No.: 1002-00004
Client No.: PIN-0042
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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 Delaware law framework governing minority preferred stockholder protections and to assess the legal enforceability, practical feasibility, and negotiating dynamics surrounding each of the specific protective provisions Pinnacle has proposed in the current draft transaction documents.
Following the closing of the Series D investment, Pinnacle will hold approximately 15.00% to 18.75% of Verdana's fully-diluted capitalization, depending on the final agreed-upon pre-money valuation and the treatment of the proposed option pool expansion. While Pinnacle will constitute a significant minority holder, it will not hold a controlling interest in the Company and will occupy only one of seven board seats. Accordingly, the protective provisions negotiated in the Amended and Restated Certificate of Incorporation (the "A&R Charter") and the ancillary investor agreements are of critical importance to safeguarding Pinnacle's economic interests and governance rights.
The key conclusions of this memorandum are as follows:
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 of First Refusal and Co-Sale Agreement — are generally enforceable under Delaware contract law.
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 existing preferred stock series (Series A, B, and C) rights, the board's fiduciary obligations, and the practical realities of Verdana's financial condition.
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 the existing Series A, B, and C preferred stockholders, creating asymmetry that may trigger opposition from existing investors and, potentially, class voting requirements under Section 242(b)(2) that could impede the charter amendment process.
This memorandum is intended to provide the legal framework necessary to inform the ongoing negotiations with Langford Price and the Company. It addresses each proposed protective provision in turn, analyzes the applicable Delaware statutory and case law, and provides specific structuring recommendations.
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 full $60,000,000 funded at closing, subject to customary closing conditions including the filing of the A&R Charter with the Delaware Secretary of State, the execution of all ancillary agreements, and the satisfaction of Pinnacle's due diligence requirements.
Verdana is a growth-stage enterprise software company headquartered in Austin, Texas, that provides cloud-based supply chain management solutions to mid-market and enterprise customers. The Company was founded by Raj Anand (CEO) and Lena Kovac (CTO) in 2016 and has raised three prior rounds of preferred stock financing from institutional investors.
Pre-Investment Capitalization. Prior to the Series D investment and assuming no expansion of the employee stock option pool ("ESOP"), Verdana's fully-diluted capitalization comprises approximately 80,000,000 shares, allocated as follows:
Proposed ESOP Expansion. Verdana has proposed expanding the ESOP by 5,000,000 shares prior to the Series D closing, which would bring the total ESOP to 17,000,000 shares and the pre-close fully-diluted share count to 85,000,000. This ESOP expansion is a point of ongoing negotiation, as it directly affects the dilutive impact of the Series D investment on Pinnacle's post-close ownership percentage. Verdana has indicated that the ESOP expansion is necessary to recruit and retain key engineering and product leadership talent in connection with the Company's planned expansion into European markets.
Valuation Dispute. The pre-money valuation remains under active negotiation. The two positions are as follows:
•  Verdana's Position: $320,000,000 pre-money valuation, implying a per-share price of $4.00 (calculated as $320M ÷ 80M shares, or $320M ÷ 85M shares if the ESOP expansion is included pre-close). At this valuation, Pinnacle's $60M investment would yield 15,000,000 shares of Series D Preferred Stock, representing approximately 15.79% of post-close fully-diluted capitalization (without ESOP expansion) or approximately 15.00% (with ESOP expansion).
•  Pinnacle's Position: $260,000,000 pre-money valuation, implying a per-share price of approximately $3.25 (calculated as $260M ÷ 80M shares). At this valuation, Pinnacle's $60M investment would yield approximately 18,461,538 shares of Series D Preferred Stock, representing approximately 18.75% of post-close fully-diluted capitalization (without ESOP expansion). Pinnacle has further taken the position that the ESOP expansion should be included in the pre-money capitalization (i.e., funded from the pre-money share count) rather than treated as an additional dilutive event post-close.
The resolution of the valuation dispute will affect not only the total number of shares issued to Pinnacle and its corresponding ownership percentage, but also the per-share conversion price that establishes the baseline for the anti-dilution calculations discussed in Section IV.C below. For purposes of this memorandum, where specific dollar amounts or share counts are referenced, we note both Verdana's proposed terms and Pinnacle's proposed terms where the distinction is material.
B. Pinnacle's Proposed Protective Provisions at Issue
In its initial term sheet dated May 18, 2022, and in subsequent markups of the draft transaction documents, Pinnacle has proposed the following protective provisions, each of which is analyzed in detail in this memorandum:
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.  1.5x Non-Participating Liquidation Preference. A preference entitling Series D holders to receive an aggregate amount equal to 1.5 times the original purchase price per share of the Series D Preferred Stock ($90,000,000 in the aggregate) plus all declared but unpaid dividends, before any distribution to the holders of common stock in connection with a Liquidation Event, without participation alongside common stockholders thereafter. This is in contrast to Verdana's offered 1.0x non-participating liquidation preference ($60,000,000).
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 fair market value per share as determined by an independent appraiser.
It should be noted that the existing Series A (Ridgeline Ventures Fund III LP), Series B (Northgate Growth Partners Fund II LP), and Series C (Brindoval Capital Group LLC) preferred stock all carry a 1.0x non-participating liquidation preference with broad-based weighted average anti-dilution protection. None of the prior series currently have redemption rights or mandatory pay-to-play provisions. The proposed Series D terms therefore represent a significant departure from the terms governing the Company's existing preferred stock in several material respects.
C. Key Documents Implicating Protective Provisions
The protective provisions at issue will be implemented through a combination of the following transaction documents, which are currently in various stages of negotiation between our firm (on behalf of Pinnacle) and Langford Price & Associates LLP (on behalf of Verdana):
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 corporate actions — will be set forth in the A&R Charter. As discussed in Section V below, charter-level protections represent the strongest form of investor protection under Delaware law.
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 objections to Pinnacle's proposed terms in the July 22, 2022 markup.
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) that will be analyzed in a forthcoming separate memorandum.
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 agreement, which provides a $10,000,000 revolving credit facility ($6,200,000 currently drawn) bearing interest at SOFR + 3.50%, maturing on June 30, 2024. This credit facility contains financial covenants (including a minimum $10,000,000 liquidity covenant and an ARR-based coverage ratio) and negative covenants restricting the incurrence of additional indebtedness, which may interact with the debt consent provisions discussed in Section IV.A below. A detailed review of the Pacific Summit Bank credit facility is set forth in the Pacific Summit Bank Credit Facility Review Memorandum dated June 28, 2022, and the Lender Consent Analysis Memorandum dated June 30, 2022, both of which should be reviewed in conjunction with this memorandum.
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. DGCL Section 151 — Authority to Create Series with Specific Rights, Preferences, and Restrictions
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 authority expressly vested in it by the certificate of incorporation. This provision is the statutory foundation upon which the entire edifice of preferred stock rights in venture capital financings is built.
The breadth of Section 151 cannot be overstated. It permits the creation of preferred stock with virtually any combination of economic and governance rights, including but not limited to:
•  Dividends, whether cumulative or non-cumulative, at fixed or variable rates;
•  Liquidation preferences at any multiple of the original issue price, with or without participation alongside common stockholders;
•  Conversion rights, including mandatory and optional conversion into common stock at specified conversion ratios, subject to adjustment;
•  Anti-dilution protection, including full-ratchet, broad-based weighted average, narrow-based weighted average, or other customized formulas;
•  Voting rights, including the right to vote on an as-converted basis with common stockholders, special class voting rights, and the right to elect one or more designated directors;
•  Protective provisions requiring the affirmative vote or written consent of the holders of a specified percentage of the outstanding shares of the series before the corporation may take specified actions (such as incurring debt, amending the charter, issuing senior or pari passu securities, or consummating a change-of-control transaction); and
•  Redemption rights, exercisable at the option of the holder or the corporation, at specified prices, on specified dates, and subject to specified conditions.
When these rights are set forth in the certificate of incorporation (or in a certificate of designations authorized by the certificate of incorporation through so-called "blank check" authority), they become part of the corporate charter itself and are binding on the corporation and all of its stockholders as a matter of the corporation's constitutive document. This is a critical distinction from contractual rights, as discussed further in Section V below.
Application to Verdana. The A&R Charter to be filed in connection with the Series D closing will set forth the specific rights, preferences, privileges, and restrictions of the Series D Preferred Stock. These are expected to include, among other things:
•  The liquidation preference (whether 1.0x or 1.5x, as negotiated);
•  The cumulative dividend right (8% per annum, non-compounding, equal to $4,800,000 per year on a $60,000,000 investment, accruing from the date of original issuance and payable when and if declared by the board);
•  The conversion ratio and conversion mechanics (initially 1:1, subject to adjustment);
•  The anti-dilution formula (whether full-ratchet or broad-based weighted average, as negotiated);
•  The redemption right (if included, exercisable after five years); and
•  The protective provisions requiring Series D class consent for specified corporate actions.
Enforceability. It is well-established under Delaware law that charter-level protections constitute the strongest form of investor protection available to preferred stockholders. Because the rights of preferred stockholders set forth in the certificate of incorporation are treated as contractual in nature — the preferred stockholder having, in effect, "bargained for" those specific rights at the time of investment — they are enforceable in accordance with their terms. Delaware courts will interpret charter provisions governing preferred stock rights using the same principles of construction applicable to contracts, looking first to the plain language of the charter and giving effect to the parties' objectively manifested intent. See Ellingwood v. Wolf's Head Oil Refining Co., 38 A.2d 743 (Del. 1944); Matulich v. Aegis Communications Group, Inc., 942 A.2d 596 (Del. 2008).
Moreover, charter-level protections cannot be amended or removed without the affirmative consent of the affected class of stockholders under Section 242(b)(2) of the DGCL, as discussed in Section III.B below. This provides an inherent structural protection that Pinnacle should leverage to the fullest extent in the ongoing negotiations.
B. DGCL Section 242 — Charter Amendments and Class Voting Protections
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 to vote separately as a class on the proposed amendment. The affirmative vote of a majority of the outstanding shares of such class or series is required to approve the amendment, unless the certificate of incorporation specifies a greater voting threshold.
This provision is of fundamental importance to preferred stockholders because it provides an inherent, statutory "veto right" against any charter amendment that would adversely affect their negotiated rights. In the context of Pinnacle's Series D investment, Section 242(b)(2) operates in two critical ways:
First, once the A&R Charter is filed and the Series D Preferred Stock is issued, Verdana will be unable to unilaterally amend the charter to strip, modify, or dilute the Series D rights, preferences, privileges, or restrictions without the affirmative vote of a majority (or such greater percentage as may be specified in the A&R Charter) of the outstanding shares of Series D Preferred Stock, voting separately as a class. This provides a structural floor of protection for Pinnacle's Series D rights that exists by operation of statute, independent of any negotiated protective provision.
Second, and of immediate practical significance to the current transaction, the filing of the A&R Charter to create the Series D Preferred Stock and authorize the Series D investment will itself constitute a charter amendment. If the terms of the Series D — including, in particular, the proposed full-ratchet anti-dilution provision and the 1.5x liquidation preference — adversely affect the powers, preferences, or special rights of the existing Series A, B, or C preferred stock, then the holders of each adversely affected series are entitled to a separate class vote on the A&R Charter amendment under Section 242(b)(2). This creates a potential structural impediment to closing, as discussed in Sections IV.C.4 and VII.C below.
We note that Section 242(b)(2) requires only a majority vote of the affected class to approve the adverse amendment — it does not require unanimity. However, the charter may specify a supermajority threshold. We recommend that Pinnacle negotiate for a higher consent threshold — such as the affirmative vote of holders of at least two-thirds (66⅔%) of the outstanding shares of Series D Preferred Stock, or, if commercially achievable, the unanimous written consent of all Series D holders — for any future charter amendment that would alter or change the powers, preferences, or special rights of the Series D Preferred Stock. In the present transaction, Pinnacle is expected to be the sole holder of Series D Preferred Stock at closing, so a majority vote and a unanimous vote would be effectively identical. However, if additional Series D shares are issued in the future to other investors (e.g., in a subsequent closing or follow-on round), a supermajority or unanimity requirement would provide Pinnacle with greater protection against modifications sought by a coalition of other Series D holders and the Company.
Interaction with prior series. As noted above, the existing Series A (Ridgeline), Series B (Northgate), and Series C (Brindoval) preferred stockholders also enjoy the protections of Section 242(b)(2). Any future charter amendment affecting their respective series would require the separate class vote of each affected series. In the current transaction, the filing of the A&R Charter will need to navigate these multi-class consent requirements, which adds complexity to the closing process and provides existing investors with leverage over the terms of the Series D.
C. DGCL Section 151(b) — Dividends and Preferences
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 an annual dividend accrual of $4,800,000.
Several points warrant attention regarding the structuring of this dividend right:
Under Section 151, the corporation may create preferences in dividends, and cumulative dividends accrue from the date of issuance regardless of whether the board has declared a dividend. However, under standard Delaware corporate law principles, even cumulative dividends are not payable until and unless the board declares them — the accrual creates an economic right that is relevant primarily in the context of a liquidation event, conversion, or redemption, rather than creating a current cash payment obligation. The charter may, of course, specify otherwise, and parties are free to negotiate mandatory dividend payment dates, but the standard venture capital convention — which the parties appear to be following here — is to treat cumulative dividends as accruing and payable only upon a Liquidation Event or when declared by the board.
We recommend specifying clearly in the A&R Charter that all accrued and unpaid cumulative dividends shall be added to and form part of the liquidation preference amount payable upon a Liquidation Event (including deemed liquidation events). This ensures that in the event of a sale, merger, or other exit transaction, the accrued dividend amount is included in the senior preference payment to Series D holders before any distribution to common stockholders. If the dividends are not explicitly added to the liquidation preference in the charter, there is a risk that they could be characterized as a separate, subordinate claim rather than as part of the senior preference stack.
Additionally, we recommend specifying in the redemption provisions (discussed in Section III.D below) that accrued and unpaid cumulative dividends are added to the redemption price upon exercise of the redemption right.
D. DGCL Section 160 and Section 151 — Redemption Rights
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 election of the holders of a majority of the outstanding Series D shares at any time after the fifth anniversary of the original issuance date.
Enforceability. Redemption rights, when set forth in the certificate of incorporation, are enforceable as charter-level provisions. Delaware courts have consistently recognized that redemption obligations are binding on the corporation once the conditions for redemption are triggered. In SV Investment Partners, LLC v. ThoughtWorks, Inc., 7 A.3d 973 (Del. Ch. 2010), the Court of Chancery addressed the enforceability of a mandatory redemption provision in a certificate of incorporation and held that the corporation's board of directors had a contractual duty to take all lawful steps to effectuate the agreed-upon redemption. The court made clear that a board cannot simply refuse to comply with a charter-mandated redemption obligation on the grounds of business judgment or competing priorities.
Surplus Limitation. However, a critical constraint on the practical enforceability of redemption rights is DGCL Section 160, which provides that a corporation may redeem or repurchase its own shares only out of surplus — defined under DGCL Section 154 as the excess of the corporation's net assets over its stated capital. If the corporation lacks sufficient surplus at the time redemption is demanded, the redemption may be legally impossible notwithstanding the charter obligation. A corporation cannot redeem stock if doing so would render it insolvent or impair its stated capital.
Practical Concern. Verdana's current financial position raises material questions about the availability of surplus for a potential redemption in five years. As of March 31, 2022, the Company reported:
•  Trailing twelve-month EBITDA: negative $11,600,000
•  Cash and cash equivalents: $22,400,000
•  Annual recurring revenue (ARR): $47,300,000 (growing, but the Company remains cash-flow negative)
Without a significant influx of additional capital or a dramatic improvement in profitability, Verdana may not have surplus sufficient to fund a redemption of $60,000,000 or more (plus accrued dividends) five years from now. The Series D investment itself will add $60,000,000 in cash to the balance sheet, but a substantial portion of these funds will be consumed by ongoing operations and the Company's growth plan.
Recommendation. To address the surplus limitation and maximize the practical enforceability of the redemption right, we recommend the following structuring approach:
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 each installment.
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 increasing surplus. While this mechanism does not create new cash, it may eliminate the legal barrier to redemption when the corporation has sufficient net assets but insufficient "surplus" as technically defined.
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: $60,000,000 + $24,000,000 = $84,000,000
•  At 1.5x preference: $90,000,000 + $24,000,000 = $114,000,000
These are significant obligations that must be carefully considered in structuring the redemption right.
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 satisfy the redemption obligation. While such a provision does not guarantee results, it creates a contractual obligation on the Company to pursue a path to liquidity and provides a basis for enforcement proceedings if the Company fails to do so.
The ThoughtWorks line of cases provides strong support for the enforceability of both the redemption obligation itself and the ancillary covenant requiring the board to take lawful steps to effectuate the redemption. This is an area where Pinnacle can take comfort that Delaware law is favorable to the investing stockholder's position.
E. DGCL Section 202 — Transfer Restrictions
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 first refusal ("ROFR") and co-sale (tag-along) rights that Pinnacle has proposed.
Pinnacle's proposed co-sale/tag-along rights provide that if either founder (Raj Anand or Lena Kovac) proposes to transfer shares of common stock representing more than 1% of the Company's total outstanding shares, the holders of preferred stock (including Pinnacle as the holder of Series D) shall have the right to participate in such transfer on a pro rata basis, selling their shares (or shares into which their preferred stock is convertible) on the same terms and conditions as the founders.
These co-sale rights can be structured either as charter provisions (set forth in the A&R Charter) or as contractual obligations in the A&R ROFR and Co-Sale Agreement. The standard venture capital practice is to include co-sale rights in the contractual agreement rather than the charter, because charter-level transfer restrictions are relatively inflexible and may complicate future corporate transactions. However, including a reference to the transfer restrictions in the charter (with the detailed mechanics in the contractual agreement) is advisable for maximum enforceability.
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, assume, guarantee, or otherwise become liable for indebtedness for borrowed money in excess of $5,000,000 in the aggregate, other than amounts outstanding under the existing Pacific Summit Bank, N.A. revolving credit facility (currently carrying a $10,000,000 facility limit with $6,200,000 drawn as of the date of this memorandum).
This type of debt consent provision is a standard protective provision in venture capital preferred stock terms and is widely used in Series A through later-stage financings. It is squarely within the scope of the powers that Section 151 of the DGCL authorizes the certificate of incorporation to confer upon a class or series of preferred stock. The consent right operates as a condition precedent to the valid corporate action of incurring debt: if the Company purports to incur indebtedness exceeding the threshold without obtaining the requisite Series D consent, such action would be voidable at the instance of the Series D holders. This is a significantly stronger remedy than a mere breach of contract claim.
Delaware courts have recognized that protective provisions requiring class consent for specified corporate actions are valid exercises of the corporation's authority under Section 151 and are enforceable according to their terms. See Glenrock Partners IV, L.P. v. Vague, 2002 WL 1732423 (Del. Ch. July 15, 2002) (analyzing protective provisions in the context of preferred stock rights and acknowledging the enforceability of charter-level consent requirements).
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 independent bases for challenging unauthorized debt incurrence: (a) a challenge to the corporate action itself as voidable under the charter, and (b) a breach of contract claim under the IRA.
The distinction between these two remedies is significant. A charter-level violation renders the corporate action voidable — meaning that if the Company incurs debt without Series D consent, the debt obligation itself may be challenged (subject to equitable considerations, including whether the lender had notice of the charter restriction). A contractual violation, by contrast, gives rise to a claim for damages or, if available, specific performance — but the underlying corporate action (the debt incurrence) is not itself voidable on the basis of a breach of the IRA.
Recommendation: We recommend including the debt consent right in both the A&R Charter (as a protective provision binding on the corporation and enforceable against the world) and the A&R IRA (as a contractual covenant providing a supplemental remedy). The charter-level provision should be treated as the primary protection.
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 restrictive covenants, including negative covenants that may already limit the Company's ability to incur additional indebtedness.
If the Series D protective provision requires consent for new debt exceeding $5,000,000, and the Pacific Summit Bank credit agreement also restricts additional indebtedness (as is typical for bank revolving credit facilities), the Company would face dual consent requirements for any new debt — one from the Series D holders and one from the bank. While this provides additional protection for Pinnacle, it also creates a risk of operational paralysis if the Company needs to act quickly to secure debt financing for legitimate business purposes.
To address this concern, and to avoid the argument that the protective provision is impractical or unduly burdensome, we recommend including the following carve-outs in the debt consent provision:
(a) Amounts outstanding under the existing Pacific Summit Bank revolving credit facility, and any amendments, extensions, renewals, or refinancings thereof, up to an aggregate principal amount not exceeding $12,500,000 (providing reasonable headroom above the current $10,000,000 facility limit);
(b) Equipment financing or capital lease obligations incurred in the ordinary course of business in an aggregate principal amount not exceeding $1,500,000 at any time outstanding;
(c) Trade payables and other current liabilities incurred in the ordinary course of business consistent with past practice; and
(d) Intercompany indebtedness among the Company and its wholly-owned subsidiaries (if applicable).
These carve-outs are market-standard and provide the Company with adequate operational flexibility while preserving the Series D holders' consent right over material new indebtedness that could impair the Company's financial position.
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 financing.
This objection has some merit as a practical matter, but is not legally dispositive. The debt consent threshold is a negotiated commercial term, not a legal requirement, and Delaware law does not prescribe any minimum or maximum threshold. That said, the appropriateness of the threshold should be evaluated in the context of the Company's size, growth trajectory, and financing needs.
Based on our review of comparable venture capital transactions in the growth-stage enterprise software sector, we observe the following:
•  For companies with ARR in the $30M–$75M range, debt consent thresholds in the range of $5,000,000 to $10,000,000 are common.
•  A $5,000,000 threshold is at the lower end of the market range and is more typical of earlier-stage investments.
•  A $15,000,000 threshold, as proposed by Langford Price, is at the upper end of the market range and may not provide sufficient protection for a minority investor committing $60,000,000.
Recommendation: A compromise at $7,500,000 to $10,000,000 may be appropriate, preserving meaningful protection for Pinnacle while providing the Company with adequate operational flexibility. We recommend proposing a threshold of $7,500,000 in the next markup, with the carve-outs described above.
B. Consent Right Over Annual Budgets Deviating More Than 15% from Board-Approved Plan
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 a stockholders' agreement) rather than at the charter level, though charter-level implementation is also permissible.
A provision requiring the affirmative vote or written consent of the holders of a majority of the outstanding shares of Series D Preferred Stock before the board may approve or the Company may implement any annual operating budget (or any modification thereto) that deviates by more than 15% from the annual operating budget most recently approved by the board of directors is enforceable under Delaware law as either a charter provision (under Section 151) or a contractual covenant (under the IRA).
If implemented at the charter level, the budget consent right would function as a protective provision within the meaning of the A&R Charter's Series D designation, and any budgetary action taken in violation of the provision would be voidable. If implemented at the contractual level, a violation would give rise to a breach of contract claim.
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 corporation's certificate of incorporation. The proviso "except as may be otherwise provided in the certificate of incorporation" is critical: it expressly authorizes the certificate of incorporation to impose restrictions on the board's authority, including restrictions that condition certain corporate actions on stockholder approval.
Delaware courts have recognized that protective provisions requiring stockholder consent for specified corporate actions do not constitute an impermissible delegation of board authority. Rather, they operate as negotiated restrictions on the scope of board authority, which the corporation is free to establish in its charter. The rationale is that the corporation voluntarily accepted these restrictions as a condition of the preferred stockholder's investment, and the preferred stockholder's consent right is part of the bargained-for exchange.
However, we note a potential concern if the budget consent right is structured too broadly. If the provision effectively prevents the board from taking action necessary to preserve the business in exigent circumstances — for example, if the Company faces an emergency requiring immediate expenditures that exceed the 15% deviation threshold, and the Series D holders are unable or unwilling to provide timely consent — the provision could be challenged as an impermissible restraint on the board's ability to fulfill its fiduciary duties. While we are not aware of a Delaware case that has invalidated a budget consent right on this ground, the risk should be mitigated through careful drafting.
Recommendation: Include a carve-out for emergency expenditures that are necessary to preserve the business, protect the Company's assets, or comply with applicable law, provided that the board provides prompt written notice to the Series D holders of any such emergency expenditure and the reasons therefor. This carve-out preserves the board's ability to act in a crisis while ensuring transparency and accountability to Pinnacle.
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., marketing spend) could occur while total operating expenditures remain well within the threshold, or vice versa.
•  Baseline: What is the reference point — the annual operating budget as approved by the board at the beginning of each fiscal year? If the board approves mid-year revisions (with Series D consent), does the revised budget become the new baseline?
•  Measurement Period: Is the 15% deviation measured on an annual basis (cumulative year-to-date), quarterly, or at any point in time?
Recommendation: Define the threshold as a 15% deviation from the aggregate annual operating expense budget as approved by the board of directors at the beginning of each fiscal year (the "Approved Budget"). Specify that if the board approves a mid-year revision to the Approved Budget with Series D consent, the revised budget becomes the new baseline. Include a mechanism for quarterly reporting of actual expenditures versus the Approved Budget, with a requirement that the Company's Chief Financial Officer certify to the Series D holders (and the board) within 30 days after the end of each fiscal quarter whether expenditures are tracking within the 15% threshold. Additionally, include a provision for interim board approval of budget adjustments with Series D observer notification for deviations between 10% and 15% (as an early warning mechanism), with Series D written consent required only for deviations exceeding 15%.
C. Full-Ratchet Anti-Dilution vs. Broad-Based Weighted Average
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 economic term that is left entirely to the parties.
Anti-dilution provisions function by adjusting the conversion ratio at which preferred stock converts into common stock, such that if the corporation issues common stock (or common stock equivalents) at a price below the preferred stock's original issue price (or then-current conversion price), the preferred stockholders' conversion price is adjusted downward, entitling them to a greater number of common shares upon conversion. The purpose is to protect the preferred stockholders against economic dilution resulting from subsequent issuances at lower prices — commonly referred to as "down rounds."
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 aggressive form of anti-dilution protection available to preferred stockholders.
To illustrate the mechanics with a concrete example: Assume a Series D conversion price of $4.00 per share (under Verdana's proposed valuation), with 15,000,000 shares of Series D outstanding. If Verdana subsequently issues shares at $2.00 per share in a down round, the Series D conversion price would be adjusted to $2.00 under a full-ratchet provision. The number of common shares issuable upon conversion of the Series D would increase from 15,000,000 to 30,000,000 (calculated as $60,000,000 aggregate original issue price ÷ $2.00 adjusted conversion price), thereby doubling Pinnacle's share count upon conversion and dramatically increasing its ownership percentage. This adjustment occurs regardless of whether the down round involves the issuance of 1,000 shares or 10,000,000 shares — the full-ratchet mechanism looks only to the price per share of the new issuance, not its magnitude.
Full-ratchet anti-dilution provisions are fully enforceable under Delaware law when set forth in the certificate of incorporation. The certificate need only state the formula clearly and specify the conversion price adjustment mechanism, the types of issuances that trigger the adjustment (and any customary exceptions, such as employee equity plan issuances, strategic partnership issuances, and the like), and the calculation methodology.
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 prior to the new issuance
•  A = the total number of shares of common stock outstanding immediately prior to the new issuance (on a fully-diluted basis, including all shares issuable upon conversion of all outstanding convertible securities and exercise of all outstanding options and warrants — the "broad base")
•  B = the number of shares of common stock that the aggregate consideration received by the corporation for the new issuance would purchase at the then-current conversion price (i.e., aggregate consideration ÷ CP)
•  C = the number of shares of common stock actually issued (or issuable upon conversion of convertible securities issued) in the new issuance
The effect of this formula is to produce a smaller conversion price adjustment than full-ratchet, because it proportionally weights the dilutive impact of the new issuance against the total outstanding capitalization. A small dilutive issuance results in a small adjustment; a large dilutive issuance results in a larger adjustment. This is widely regarded as a fairer mechanism that avoids the punitive effects of full-ratchet, particularly in situations involving small dilutive issuances.
This is the mechanism used in Verdana's existing Series A (Ridgeline), Series B (Northgate), and Series C (Brindoval) preferred stock. All three prior rounds employ broad-based weighted average anti-dilution with the same general formula, as set forth in the current certificate of incorporation.
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 (and correspondingly more common shares upon conversion) than the Series A, B, and C holders with broad-based weighted average protection. This differential treatment means that in a down round, Pinnacle's ownership percentage increases more rapidly than the earlier investors' ownership percentages, resulting in disproportionate dilution of the founders and earlier-series investors. This creates a misalignment of incentives: Pinnacle, protected by full-ratchet, has less economic exposure to a down round than the earlier-series investors, and arguably less incentive to resist or mitigate the pricing in a down round.
Governance Implications. Brindoval Capital Group LLC, acting through Diana Chen (Brindoval's board designee), has specifically and forcefully objected to full-ratchet anti-dilution for the Series D as inconsistent with the terms granted to prior series. Brindoval's position is that granting more favorable anti-dilution protection to a later series undermines the principle of parity among preferred stockholders and creates a precedent that could be cited by future investors to demand even more aggressive terms. Ridgeline (Series A) and Northgate (Series B) have not yet formally taken a position on this issue but may be expected to align with Brindoval.
Legal Analysis. As a matter of Delaware law, there is no requirement that all series of preferred stock carry identical anti-dilution protection. The corporation is free to grant different anti-dilution mechanisms to different series — each series is a separate contractual bargain between the corporation and the holders of that series, and there is no statutory or common-law principle requiring inter-series parity. See generally Glenrock Partners IV, L.P. v. Vague, 2002 WL 1732423 (Del. Ch. July 15, 2002) (recognizing that different classes and series of stock may have different rights and that the validity of such differences is assessed under the charter and the DGCL).
However, this legal flexibility does not eliminate the practical obstacle. The charter amendment required to create the Series D with full-ratchet anti-dilution will require the affirmative vote of the board and a majority of the outstanding voting shares. Critically, under Section 242(b)(2), if the charter amendment adversely affects the rights of the existing preferred series — and a strong argument can be made that granting full-ratchet to a new series adversely affects the earlier series by increasing the dilution they face in a down round (relative to what their dilution would be if the new series also had broad-based weighted average) — then each affected series would be entitled to a separate class vote on the amendment. If Ridgeline (Series A), Northgate (Series B), or Brindoval (Series C) exercise their class voting rights to block the charter amendment, the Series D closing cannot proceed on these terms.
Recommendation. We advise Pinnacle that full-ratchet anti-dilution is legally permissible and enforceable under Delaware law, and there is no legal impediment to granting Series D more favorable anti-dilution protection than the prior series. However, the practical risk that existing investors will exercise their class voting rights to block the charter amendment is significant and may represent the most material impediment to achieving full-ratchet terms in this transaction.
As a potential compromise, Pinnacle may wish to consider the following alternatives:
(a) Narrow-Based Weighted Average. A narrow-based weighted average formula uses a smaller denominator (typically only the outstanding shares of the affected series or all preferred stock, rather than the full fully-diluted capitalization) in the anti-dilution formula. This produces a larger adjustment than broad-based weighted average but a smaller adjustment than full-ratchet, and may be viewed as a middle ground.
(b) Full-Ratchet with a Sunset. Grant full-ratchet anti-dilution for a limited period (e.g., 18 to 24 months from closing), after which the anti-dilution mechanism automatically converts to broad-based weighted average. This provides Pinnacle with enhanced protection during the period of greatest risk (the near-term) while eventually harmonizing the anti-dilution treatment across all series.
(c) Full-Ratchet with a Threshold. Grant full-ratchet anti-dilution only if the down-round issuance price is below a specified threshold (e.g., less than 75% of the Series D original issue price), with broad-based weighted average applying to issuances at prices between 75% and 100% of the Series D original issue price. This limits the punitive effect of full-ratchet to significant down rounds.
Any of these alternatives may be more achievable in negotiations while still providing Pinnacle with meaningfully enhanced anti-dilution protection relative to the broad-based weighted average standard.
D. 1.5x Non-Participating Liquidation Preference
1. Legal Framework
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 preference, as proposed by Pinnacle, means that in connection with any Liquidation Event (typically defined to include a dissolution or winding up of the Company, as well as deemed liquidation events such as mergers, acquisitions, consolidations, and sales of all or substantially all of the Company's assets), the holders of Series D Preferred Stock are entitled to receive, prior to and in preference to any distribution to the holders of common stock, an amount per share equal to 1.5 times the Series D original issue price, plus all declared but unpaid dividends. On Pinnacle's proposed $60,000,000 aggregate investment, this equates to a $90,000,000 aggregate liquidation preference (before accrued dividends). The "non-participating" element means that after receipt of the preference amount, the Series D holders do not participate alongside common stockholders in any remaining distribution — they receive only their preference amount and nothing more (unless they elect to convert to common stock and participate pro rata with common, which they would do only if the per-share common distribution exceeds the per-share preference).
By contrast, Verdana has offered a 1.0x non-participating liquidation preference, which would entitle Series D holders to receive $60,000,000 in the aggregate (plus declared but unpaid dividends) before any distribution to common stockholders.
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 preferred stock liquidation rights as stated in the charter); In re Trados Inc. Shareholder Litigation, 73 A.3d 17 (Del. Ch. 2013) (analyzing the interplay between liquidation preferences and the board's fiduciary duties in a change-of-control transaction).
The preference must be stated in connection with a "Liquidation Event," which is a defined term in the A&R Charter. We recommend defining "Liquidation Event" broadly to include not only a statutory dissolution or winding up but also any of the following deemed liquidation events:
(a) Any merger, consolidation, or similar transaction in which the Company's stockholders immediately prior to the transaction hold less than 50% of the voting power of the survi

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