Using NVCA Model Documents in Cannabis Industry Financings
By Charles Alovisetti
Jul 29, 2020
Since 2014, the National Venture Capital Association (NVCA) has provided a free set of model legal documents that can be used in venture capital financings. These documents can save time and reduce associated costs, but not all Series A or subsequent financings use the NVCA forms. Some firms and investors still prefer to use their propriety forms because they feel compromises had to be made in order to get a group to approve the NVCA form agreements.
Though there are clear advantages to using these forms—lawyers are familiar with them and using them as a base can reduce the time and cost needed to close a financing—they do present some challenges. A common critique of the NVCA forms is that the documents were drafted by a committee and therefore contain faults common to products designed by a group. Additionally, no model documents currently exist for LLCs raising capital. However, in many cannabis financings, parties will often agree to use the model NVCA documents.
Another challenge of working with the NVCA forms is that terms that might otherwise all be contained in the same document are spread out over a set of documents. When a financing has a shareholder’s agreement, or in the case of an LLC, an operating agreement, all the terms are in one place. Because the NVCA spreads these provisions out amongst a series of documents, it can be helpful to understand where the provisions are in the suite of forms.
The NVCA provides a form sheet that aligns with their form documents. For convenience, the terms are grouped according to the relevant NVCA document (e.g., the term sheet has a section dedicated to the Investor Rights Agreement).
This agreement sets out the composition of the board and obligates the signatories to vote their shares to appoint the designated board members. It also contains the drag-along right.
Stock Purchase Agreement
This agreement sets out the terms of the actual sale of stock (e.g., the sale price of the shares and how many shares can be sold). It also will include the closing mechanics, such as if there will be closings after the initial closing. In addition, the bulk of the agreement consists of representations and warranties made by the company about its business and by the purchasers. Sometimes representations from the founders individually are included. These representations play a critical role in the diligence process and serve as an allocation of risk between the investors and the company.
Investor Rights Agreement
The Investor Rights Agreement covers a wide range of provisions. The most important are pre-emptive rights (i.e., the right to invest in subsequent financing of the company), registration rights (i.e., certain rights to force the company to register your stock for public sale with the SEC), and information rights (e.g., delivery of financial statements or the right to have someone observe board meetings).
Right of First Refusal and Co-Sale Agreement
The Right of First Refusal and Co-Sale Agreement, unsurprisingly, contains both a right of first refusal (i.e., initially the company, and then major investors, have the first chance to buy stock to be transferred by certain, or all, founders and employees) and a co-sale right (i.e., the right to force a founder or employee to give an investor the ability to sell their shares alongside the founder or employee if they are transferring their shares).
Other Documents and Ancillary Agreements
In addition to the main transaction documents, the NVCA also provides several other form documents:
- Model Legal Opinion (which would be delivered at closing by the issuer’s lawyer)
- Management Rights Letter (necessary for certain venture funds with pension fund investors)
- Indemnification Agreement (to be provided to directors of the company)
- Life Science Confidential Disclosure Agreement
- LPA Insert Language on CFIUS (which is only relevant for venture funds themselves)
- Sample conduct of conduct
- HR policies addressing harassment and diversity
Updates to NVCA Forms
The NVCA updates its form documents from time to time. The agreements were just updated on July 28, 2020. Prior to that, the last round of updates occurred in 2018. Here is a high-level summary of what was changed in 2018:
- Drafting options specific to the life sciences industry were added
- A provision was added to the Certificate of Incorporation that provides a veto over token related offerings
- Investor Rights Agreement has a new convent requiring the adoption of a code of conduct and a policy prohibiting discrimination and harassment (the NVCA provides sample versions on its website)
- Drafting options were added to allow modification of dispute resolution provisions to benefit from the Delaware Rapid Arbitration Act of 2015.
- Drag-along provisions in the Voting Agreement were improved
- Redemption right in the Certificate of Incorporation was modified to create a high accruing interest rate if the stocks to be redeemed have not been redeemed by the company
Cannabis Industry Issues with NVCA Forms
Unsurprisingly, NVCA forms do not consider any of the complexities inherent in cannabis transactions. For one, the definitions and drafting of the documents do not contemplate that most cannabis companies will be in violation of federal law. This would make the federal court a poor choice of venue and will also complicate various representations made in the agreements. Second, there are no mechanisms for getting regulatory approvals, which may be necessary to obtain, either in advance of or after closing, depending on the amount of investment and states where licenses are held.
Though not perfect for every situation, the NVCA model documents do have their advantages. These standard forms can save you time and money, and because they are widely used, most attorneys are familiar with them. If you’re in the cannabis industry, however, be aware that there are some substantial gaps in the model documents. The drafters of the NVCA were not considering cannabis-specific issues when they created these forms. For example, there is no consideration of the fact that cannabis businesses are in violation of federal law or that significant equity holders may be subject to regulatory approval and background checks.