Insights

The Underrated Value of a Company Board

By Steven Keeler

Many small businesses have elected directors only because the law may require it, and they may not hold regular board meetings or have major company actions like stock option grants, electing officers, amending their articles or company borrowings approved at a board meeting or in a written board consent. But when a company raises capital or is preparing for a sale, this may change depending on the requirements of an investor or buyer. More important, having and using a board of directors (corporation) or a board of “managers” (limited liability company) can add real value to a business both today and when a major capital raise or sale is contemplated.

Benefits of a Board

• Company founders and management can receive invaluable advice and support by having a board that includes investor representatives and “independent”, non-employee directors with business and industry experience and contacts. These directors are often well worth the expense reimbursements, director fees or stock options the company may provide to them.
• Founder directors have a “duty of loyalty” and “duty of care” which requires that they act in the best interests of all stockholders. Independent directors provide both a sounding board and check on major decisions. So founders also gain some legal protections from stockholder claims for breach of fiduciary duties by having independent board members who can assess and approve major decisions and transactions that might benefit the founders.
• The best board members can occasionally participate in capital raises and introduce the company to business and professional contacts. This gives the company more credibility and professionalism in the eyes of lenders, investors, vendors, customers and buyers.
• When a company raises capital or conducts a sale process, a history of sound review and decisions by a board that does not just include the controlling owners makes investors and buyers more comfortable and their due diligence easier.

Board Best Practices

• Make sure the company’s articles or governing documents provide directors with personal liability limitation and indemnification protection from stockholder and third party claims, and consult with a reputable insurance company to purchase effective director and officer (“D&O) insurance coverage.
• To obtain the benefits of a board, provide legal protections and make future financing or sale transactions more smooth, hold regular board meetings, provide directors with written materials (key financial, budgetary and business information, updates and reports) in advance of meetings, and have someone take minutes of the meeting (taking care not to include confidential or sensitive information in the minutes), or when more convenient, have board members sign a written consent authorizing major actions such as option grants, major hires and major contracts. Major actions such as the election of officers, amendments to company governing documents, grants of options or equity, and major financings or sales should be reviewed, discussed and approved by the board.
• Create committees of the board to investigate, analyze and report back to the board in areas such as compensation, audits and major transactions.
• Always have legal counsel present, and no non-board members (i.e., go into “executive session” without non-director management personnel), when sensitive legal matters need to be discussed. This will help protect those board discussions from later discovery in the event of a dispute or litigation. To avoid a negative impression to non-director meeting participants, plan an executive session break-out at the end of each meeting to provide an opportunity for board members to discuss any personnel or sensitive matters.
• Manage meeting time and view the board as part of the team, not the enemy. Share bad news along with the good, and avoid late-breaking bad-news surprises. Directors want the company to succeed, and they expect to have to deal with some bad events.

Board Process for Capital Raise or Sale

• When working through a capital raise or company sale, always remember to check the company’s governing documents for any special stockholder or member rights (e.g., the right to approve the transaction or to exercise preemptive rights to invest or tag-along or drag-along rights sell shares in a company sale). These owner rights must be honored in addition to board approval.
• Avoid rash or rushed decisions. Prepare for and hold one or more board meetings to discuss any major transaction, the company’s options and the best path forward. Seek the advice of legal, financial and accounting advisers to protect the board members. If possible, consider having major transactions researched and reviewed by a special committee of independent directors to provide the founders and management with additional director protections. Disclose all (and even obvious) conflicts of interest (i.e., any personal interest of any director in the transaction or “side deals” such as employment agreements or equity incentives).
• Remember that, in considering and approving a major company transaction such as a capital raise or a sale, the board’s actions may come under increased after-the-fact legal scrutiny. The board should consider whether bids or offers of capital or for an acquisition should be solicited from multiple parties to obtain the best price and terms (i.e., a limited or broad “auction” process). Directors must consider the interests of all common stockholders as well as any preferred stockholders in approving a transaction.
• The process with which the board approves a major transaction is more important than the board’s approval or decision itself. Hold special meetings and discuss the pros and cons of the transaction, and consider the fairness of the transaction to all stockholders. Consider engaging an investment banker and certainly seek the advice of the company’s attorneys and accountants. If a majority of the directors are conflicted, consider a special committee of independent directors to review and make recommendations regarding the transaction.

Take Aways

A board of directors which includes non-employee and non-owner members can provide invaluable experience, advice and support to a company, its management and founders. Using the board with a focus on good process and best practices will not only avoid potential legal disputes and investor or buyer questions down the road, but should add real value to the company and make its operations and future transactions more successful.

Read More