We’re Not Rolling the Dice in Nevada

As General Counsel of a life sciences investment fund, I’m routinely asked by company founders if they should incorporate somewhere in the US other than Delaware. That is not a question I really had to think about until a couple of years ago, when the “Dexit” crusade really got started. And it accelerated when a very prominent venture capital firm announced last year that it had moved its management company to Nevada and urged others to follow in its footsteps.

Our answer remains: Delaware – without any disclaimers or reservations. Our management company is domiciled in Delaware, and we still think Delaware is the best place for high growth, venture-backed companies to incorporate.

Let’s First Set the Record Straight

The primary rationale for leaving Delaware has been the concern about a runaway judiciary that has created intolerable uncertainty for corporations and their directors, officers, and controlling shareholders. That critique carried real weight coming out of the Musk compensation case [1] and the initial Tripadvisor redomiciliation decision [2]. It started to feel like the solid ground we thought Delaware corporate law stood on was starting to quake.

That is, until Delaware responded exactly in the way it long has:  by addressing head-on the concerns around the standard of review courts should apply to conflicted party transactions, in this case by amending the corporate statute. The Delaware legislature effectively codified the deferential “business judgment rule” as a safe harbor for transactions involving conflicted directors or controlling stockholders – if specific (and generally quite reasonable) procedural steps are met.

The procedural steps essentially require the good faith approval of constituencies (nonconflicted directors and/or stockholders) who aren’t potentially tainted by the pull of self-interest. The more stringent “entire fairness standard” only applies if the corporation fails to follow one of the other prescribed cleansing mechanisms. To move to a legal structure that doesn’t encourage companies to proactively deal with conflicts seems to throw overboard bedrock fiduciary concepts, in the name of expediency and certainty for the fiduciaries themselves. [3]

It has been posited that the recent amendments don’t matter to private tech companies because the safe harbors they enacted don’t apply to them.  That is a misconception: the amendments apply to private companies and are very useful in the types of totally justifiable and fair but conflicted transactions that venture-backed companies engage in regularly, to give both the conflicted and unconflicted stakeholders comfort that the company and its managers are protected and acting in their best interests.

As a result, we view the current situation in Delaware to be better than it was before the Musk and Tripadvisor brouhahas. What practitioners previously understood as the law around conflicted transactions in Delaware has now been codified. And they even threw in some real improvements over the prior law! [4]

Side Note: Delaware has Long Had an Option for Folks that Don’t Want the Corporate Law Fiduciary Standards

A sometimes-overlooked fact is that managers of Delaware limited liability companies are not, by default, subject to the same fiduciary duties as directors and officers of Delaware corporations. There has long been a path to having a Delaware entity avoid of the types of issues raised by the faction calling for Dexit – specifically, using an LLC and deciding the extent of the fiduciary duties (if any) you want to apply to your company. Of course, there are separate challenges to utilizing LLCs (for example, they can’t go public and can’t grant standard employee stock options). Many if not most venture capital funds’ management companies are structured as LLCs, so there is truly no point for them to move out of Delaware — none of the fiduciary duties that discomfit Musk need apply to an LLC in the first place.

Delaware Has the Corporate Law Infrastructure, Nevada has…Other Cool Stuff

There’s a key difference between writing laws and living them for decades. Delaware’s advantage isn’t just its corporate statue, it’s:

– A hundred years of corporate case law precedent;
– A judiciary staffed with corporate law experts;
– A responsive legislature and executive that appreciate the importance to the state of remaining a leader in corporate law (so they actually listen to the market); and
– An extensive, professional corporate bar, ready and able to advise on the huge variety of issues that can arise in the corporate context.

Nevada should rightly be praised for modernizing its statute and promising to create specialized courts, and time will tell if it can build a similar corporate legal community to Delaware. But it also can’t be ignored that Nevada has a lot of other things going on (have you seen the Sphere?) and one could easily see a scenario where it loses its interest in the hard steps necessary to create a vibrant corporate ecosystem and keep it thriving.

As players in the innovation economy, at my firm we try hard to challenge ourselves when we lean towards sticking with the status quo. We fear we could be prioritizing short-term comfort at the expense of long-term benefit. But in this case, we think it is hard to overestimate the loss of experience and efficiency that would be caused if a significant number of companies were to pack up for what they hope will be a greener pasture.

In Our World, One Party Rarely Calls the Shots, and We Like it That Way

In much of our private portfolio, institutional investors control the board and majority of the stock. And we can thankfully count on one hand the times we’ve seen “super voting” structures implemented to give founders control over the company’s critical decisions. So, in that sense, we’re not too concerned if founders inclined to pursue those types of governance structures head to other states that give them more flexibility to create corporate monarchies.

We will continue to seek governance structures that promote reasonable consensus (we find investors rarely agree on everything), not tyranny of any party or parties without accountability. That means visionary founders and directors can take bold shots – but also be held accountable if they cause the company to take actions that advance their individual interests to the detriment of the company’s other stakeholders.

We also take great pride in helping our companies prepare to go, and actually go, public. This process is a win-win for the companies and the public. The company has access to a broader pool of capital and the public has a way to get economic exposure to cutting edge technology.  However, the securities laws and regulations and stock exchange listing requirements that apply to public companies do not fit comfortably onto companies that are accustomed to acting with relative impunity. So we have some concerns that companies that have developed their corporate practices under less stringent laws may not be best prepared to enter the public markets. Given the trend of vast amounts of private capital in certain segments of the market and high-flying private tech companies staying private longer and longer, we are not sure that public company readiness is a factor that has much influence over the Dexit crowd. While it certainly isn’t the obligation of an individual company to strive to allow the public to acquire its equity, public access to high quality investment opportunities is an apt legislative goal.

Our Refrain: Remain

We’ll be the first to acknowledge that Delaware isn’t perfect. But it has proven it can evolve in dialogue with the needs of the market. That’s why, even after all the noise, the overwhelming majority of public companies and venture-backed private companies – including our own portfolio companies – still call it home.

We hope many stick with the system that has proven itself to be testable, fixable, and accountable to its various stakeholders. We are.