Shear recommends that six to nine months before the company starts considering underwriters, “you should already be on your way to having independent directors identified, audit and compensation committees formed and code of ethics and conflict of interest policies drawn up.” Even private companies anticipating acquisitions would do well to comply with public compliance standards as a way of easing the transition, adding value and making themselves more attractive to the acquiring company. “If a company doesn’t have those controls in place, [the acquirer] may see it as a risk that could cause it to restate its earnings and potentially face federal or civil penalties,” notes Jon Karis, a partner at the law firm Nixon Peabody, who regularly advises directors on their duties.
Jay Lorsch, the Louis Kirstein Professor of Human Relations at the Harvard Business School, has written widely on corporate board issues. He takes an even longer view, recommending that companies put their boards in order three to five years before an IPO. “We’re no longer in a situation where it’s acceptable to build a company board at the last minute to go public,” Lorsch says. “It just doesn’t work.” The choice of director is crucial, and in the current post-Sarbanes-Oxley climate, independence is prized. Directors need to be more than independent, however; they should also have sound decision-making capabilities and financial savvy. “You want to make sure directors bring competencies that collectively give the board strategic value,” Shear argues. “There should be people who understand the industry that they’re in, who have diverse points of view and at least one who’s a burr under the saddle, who can ask hard questions in a nice way.”
The Devil’s Fiduciary
The board should have directors who are willing to pose tough questions to senior management, preparing them for the rigors of a liquidity event. Robert MacDonald, a life insurance executive and three-time CEO who currently sits on the board of Buffalo Wild Wings Grill & Bar, says he has grown accustomed to playing devil’s advocate at meetings. “To me, the most value a director can add to a board is to be candid, honest and straightforward,” he adds. “If you’ve been brought in as an independent, you have a duty to bring a fresh, questioning approach to things.”
COVER YOUR TAIL
A liquidity event presents an opportunity to review and, if necessary, amend directors’ and officers’ (D&O) liability insurance. If planned carefully, D&O insurance will serve to protect directors if disgruntled minority stockholders decide to take action after the event.
Board Assets president Hal Shear cites a case in which an acquiring company sued the directors after the acquisition in a dispute involving collection of receivables. The lawsuit forced the directors to pay the legal costs out of their own pockets.
To avoid this type of dilemma, directors can buy “tail coverage” to protect them from lawsuits for a select “tail period” after the sale. “Make sure your coverage has no exclusions,” Shear warns. |
When MacDonald joined the board of the sports-themed restaurant chain in September 2003, two months before its planned IPO, he soon found himself objecting to a proposed executive compensation plan be-cause he felt it favored those who were already the most highly paid in the company. MacDonald is a believer in giving the entire organization a “stake” in the same incentives. “My issues were philosophical in nature,” MacDonald recalls. “Honest people can disagree on the approach to the same objective.” Although the board eventually approved the proposal, he is happy he spoke up. “Possibly the best lesson is that both the board and management were open to discuss and consider alternative approaches. From my perspective as an independent director, that is the value of my contribution to the process.”
MacDonald’s previous experience leading two companies through acquisitions (LifeUSA Holdings in 1999 and Allianz Life Insurance in 2003) left him wary of valuations. When Buffalo’s bankers priced its stock at $14 to $16, MacDonald protested the range was too low. They increased the IPO terms once, and on November 20, the stock went out at $17. Although restaurant analysts such as Michael Smith of Oppenheimer & Co. say they too would have set the price in the mid-teens, MacDonald continues to contend the stock was worth more, noting that it gained 35 percent on its first trading day and has not dipped below $21 since. “Managements that haven’t been through the process before get caught up in the romance of doing an IPO and a road show,” MacDonald says. Along with Shear, he recommends approaching all advisors with cautious skepticism. “Investment bankers could have a potential conflict of interest in terms of pricing, and a director’s responsibility is to get the best price possible for the company and for the shareholders,” MacDonald adds.
Maximizing value is not merely a worthy goal; it is a fundamental goal, and failure to secure it raises liability issues for directors, Karis says. “The fundamental question when you’re selling a privately held business is: Did you sell it at a price and on terms which represent fair value to all stockholders and not just the insiders?” More than ever before, directors are all too aware that they can be sued for failing to act in the best interests of their company based on their knowledge and due diligence. Those involved in liquidity events should proactively protect themselves from possible fiduciary duty claims. Karis advises employing investment bankers to conduct research, actively seeking offers to get the highest bid possible and paying extra for a fairness opinion. The opinion, which comes in the form of a letter from a banking firm that declares a buyer’s offer a fair deal based on the financial climate and other deals in the industry, can help a director’s defense should a court ever investigate the propriety of a transaction.
Separating underwriting activities from writing a fairness opinion can further ensure bankers are working in the best interests of the company. “Tradition holds that you hire the same bank to do both, but a banker who’s making a percentage of the deal is not independent,” Karis says. “He’s interested in the transaction, and courts are realizing this.”
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