United States: …And The Unicorn You Rode In On (Silicon Valley – Episode 26)

Alas, poor Erlich!  We knew him; 'a fellow of infinite jest, of most excellent fancy; he hath borne us on his back a thousand times; and now,' as Jared poetically recounts, "Erlich's Bachmanity boondoggle has led to his being unceremoniously bucked off the Pied Piper unicorn, [lock-] stock-and-Board-seat-wise."  Unfortunately, Erlich's lavish over-spending of Bachmanity's capital, combined with his personal liability for Bachmanity's debts, have brought Erlich to the brink of bankruptcy.  He's so desperate for funding he's willing to sell his Pied Piper shares to dig himself out of his hole.  But yet again, the "onerous terms" that Richard accepted when he took Russ Hanneman's investment rear their ugly head.  Previously these terms enabled Raviga to take control of Pied Piper's board and fire Richard.  Now Laurie uses the terms to block Erlich from selling half his shares to Russ for $5 million, and forces Erlich to sell all his shares to Raviga Capital for the exact amount of Erlich's debts ($713,000).  This leaves Erlich with nothing except extreme public ridicule.

From Erlich's perspective, Laurie's powers must appear outrageous and ridiculous—but are they?  Well, not exactly.  It turns out that many privately-held companies have restrictions on the transfers of their shares, and there are a wide variety of possible restrictions.  One common restriction is a right of first refusal ("ROFR"). Typically,  a ROFR gives the company first, and the preferred shareholders second, the right to purchase common shares from founders, employees or other investors at the same price offered by the potential buyer.  For example, when Erlich got Russ's offer for half of his shares, a ROFR would have given Laurie the right to step in and purchase those shares from Erlich instead of Russ, provided she paid the same price Russ offered—$5 million.  Interestingly, many ROFR agreements also provide for a "co-sale" right, usually to preferred investors.  This means that the shareholders who have co-sale rights could have claimed the right to sell a pro rata portion of their shares to Russ/Raviga at the same price offered to Ehrlich for his shares.  For example, if a co-sale provision gave them co-sale rights, Richard, Monica, Dinesh, Gilfoyle and Raviga might have each had a right to sell some of their shares as part of any sale by Erlich.  This would have reduced the number of shares Erlich could sell, but maybe the others would have loaned him the proceeds of their sales to get him through his rough patch?

At any rate, clearly Laurie didn't match Russ's offer, so we most likely aren't dealing with a ROFR.  Instead, as Laurie explained, when Russ invested he obtained a restriction that allowed a majority of Pied Piper's board to vote to block any transfer of the common, "restricted" stock.  Since Raviga Capital controls Pied Piper's board, Laurie simply "voted" against the sale to Russ.  She also made it clear she would block any other sale except to Raviga, at the price Laurie dictated.  Erlich was left with no choice but to sell to Laurie at her rock-bottom price.  As unfair as it may seem to Erlich, a restriction that prohibits any transfers of stock except with approval of the company, or approval of the preferred shareholders, is usually permissible.  For example, Delaware law explicitly permits this type of restriction, as well as ROFR provisions, and provisions requiring holders of restricted stock to transfer their shares back to the company under certain conditions (like if they leave the company).

So the restrictions on Erlich's stock are not totally whacky, and are likely quite legal.  But why are they there?  Did Russ insist on the restrictions just so he could further torment Pied Piper and the team?  Maybe not; and in fact, Delaware courts generally will not enforce restrictions on stock transfers unless the restrictions were imposed for a 'reasonable corporate purpose.'  It turns out that privately-held companies (and more specifically, their VC investors) can have a variety of 'reasonable' purposes.  For one thing, companies often wish to limit the number of investors so that they stay under the threshold that would force the company to register as a public company with the SEC.  Although this threshold has been raised in recent years, it still may be a concern for mature private companies approaching, but not yet ready for IPO.  Limiting share transfers can ensure that outsiders, and even competitors, don't become disruptive shareholders with rights of access to sensitive company information.  Prohibiting founders and early employees from "cashing out early" could help keep them focused on the long-term success of the company.  Any of these are likely to satisfy the Delaware courts and permit a company to restrict the transfer of its shares.

This doesn't mean a company, or VCs, can impose restrictions willy-nilly.  For example, Delaware law states that restrictions will not be binding on shares issued prior to the imposition of the restriction, unless the holders of those shares vote for or agree to the restrictions.  Other states' courts impose similar rules.  Erlich received his shares in exchange for hosting Pied Piper in his incubator even before Pied Piper had any investors.  Russ required the transfer restrictions as a condition of his later investment, and to make the restrictions iron-clad and unchallengeable by Erlich, Russ would have obtained Erlich's consent.  Russ could have required the restrictions as part of his "protective provisions," which are provisions that give the holders of the preferred stock, or a series of preferred stock, the ability to block/veto certain company actions. In other words, the restriction could have required that the majority of the preferred shareholders would need to consent to any transfer of the restricted stock, or conversely, would have the right to block any sale (even if the board had approved the sale). Instead, Russ apparently demanded the right of a majority of the board to vote to block any transfers.  Either way, Erlich almost certainly agreed to the restrictions by voting in favor of them and/or signing on to an amendment of Pied Piper's certificate of incorporation when Russ made his investment.  From then on, the fate of his shares was sealed.

Even though there's nothing inherently wrong with Pied Piper's board having the right to block Erlich's sale to Russ, Laurie may have violated her fiduciary duties in taking advantage of that right. While shareholders generally have a right to vote their shares in their (self) interest, directors must act in the best interests of the company.  Specifically, directors must act to maximize the long term value for the common shareholders.  Here, Laurie's actions may have depressed the value of the common shares, at least in the short term (e.g., she set an actual price that was far below what Russ offered).  Even worse, Laurie appears to have engaged in "self-dealing"—using the votes of Raviga's directors to give Raviga a benefit (the ability to acquire additional shares dirt cheap) that was not provided to the other shareholders.  This would be even more egregious if there had been other preferred investors who were denied the opportunity to participate in the deal.  Self-dealing transactions may be void or voidable under Delaware law where an action is approved by interested directors and their financial interest was not disclosed to the rest of the Board or approved by impartial directors.  Here Richard was the lone uninterested director and he was completely unaware of Erlich's sale until after it happened, so he wasn't informed and certainly didn't vote to approve it!

Erlich's situation should be a wake-up call to the other Pied Piper guys about Raviga's power over them, and a good lesson on how "onerous" terms can continue to haunt a company for years despite its overall performance and reputation.  Even though Russ no longer holds any Pied Piper shares, the terms he negotiated will likely be difficult to get rid of.  Investors who negotiate the terms usually make sure the terms can't be eliminated without those investors' consent.  And future investors are likely to demand the same rights.  Thus, even though Pied Piper is now the hottest company in Silicon Valley, Richard, Erlich and the rest of the team are stuck under the thumb of Raviga and Laurie because their stock is subject to the same onerous terms they accepted during their darkest days.

Erlich definitely got a raw deal, but as we've seen over the past few episodes, he set himself up for this fall.  Let's hope he brings some hard-won wisdom to his new role as "CEO."

With special thanks to corporate attorney Kevin Rogan for his insights.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Events from this Firm
13 Sep 2018, Other, Los Angeles, United States

Liisa will be giving opening remarks and presenting, "Big Data and Online Behavioral Advertising (OBA): An Advertiser’s Perspective Origins of big data and how to legally acquire data."

20 Sep 2018, Seminar, Los Angeles, United States

The annual seminar addressing changes and developments in state and federal wage and hour laws is a unique one-day program and hundreds of California employers, personnel managers, controllers, attorneys, payroll managers, and supervisors attend each year.

26 Sep 2018, Seminar, San Francisco, United States

Please join us for Sheppard Mullin's Labor & Employment Law Update & Happy Hour Seminar Series.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions