Welcome to the February 2009 edition of The Director’s Dilemma newsletter. I hope you find it interesting, informative and inspiring.

I advise Boards and Directors on complex and challenging issues which can be resolved in a variety of ways. Each way has different pros and cons for the individuals and companies concerned. Every month this newsletter considers three experts’ responses to a real issue. Which response would you choose?

Dave was a successful senior executive at a large listed company. He retired early and wanted to remain active helping small companies. He thought his experience of strategic planning, budgeting and investment appraisal would be useful to listed start-up companies.

His broker suggested he invest in a small company that had some potentially excellent products but was undercapitalised and failing to gain traction in the marketplace. Dave did his due diligence on the finances and checked that none of the senior staff or directors had records of misconduct. He met and liked them all.

There was resistance when he suggested that, as he was investing several million dollars, he should join the board. When it was clear that he was not interested in being a passive investor, and would seek another company if he could not join the board, they relented and he was voted in at the next AGM.

Since then he has felt ‘the odd man out’ at board meetings, has realised that much is being discussed and decided without him at informal meetings, and has been outvoted on several issues. The CEO is a protégé of the Chairman and the remaining two directors are longstanding friends of both. They vote as a cohesive block and don’t really even pretend to listen to or consider Dave’s contributions. They have doubled the CEO’s salary and the director’s fees. Dave’s funds are being spent but the products that interested him are not being developed or marketed.

Now they are determined to use the company’s remaining funds for an acquisition that Dave believes will destroy value.

What should Dave do?

Ed’s Answer

To me, things look very dark for Dave. There are two pertinent discussions. First, what should Dave have done? Second, what can Dave do now?

What should Dave have done?

  • When becoming a minority investor at this magnitude in a closely held company, Dave should have insisted on a contractual agreement (fully enforceable in this country) to protect his investment and to lay out a clear buy out price formula if he decides he wants out. In a number of countries minority investors have few rights in closely held companies, especially if actions are approved by the board.
  • With an investment this large, it would have been reasonable to have an agreement on how the bulk of the funds were to be used.
  • With a very large investment, it would be reasonable to ask for additional seats on the board or an agreement that he has a veto over using funds for purposes other than those stated in the original investment agreement.
  • Seeking to be a minority investor in a closely held company, Dave should have run when it was clear that the owners and senior management were not eager to have his advice or have him on the board. Many closely held companies will run as long as they have access to someone elses' money.

What can Dave do now?

  • Dave does need to examine if his analysis of the situation is objective and factual.
  • Given the stated case, it does not sound like an easy or friendly buy out can be arranged. The funds seem to be dwindling rapidly.
  • Dave needs to see if he has any course of action against the broker.
  • He needs to review the company by-laws to see if the decisions made outside the board room are in violation of either by-laws or the law.
  • He needs to see what verbal or written agreements he has that may have been violated giving him some grounds to complain.
  • He needs to review applicable law covering his situation as a complaining minority owner.
  • He should decide if the threat of going to the stockholders or suing will give him a better negotiating position than he seems to have at present.
  • It appears his only approaches are suing or going to the stockholders. Ouch.

Ed Runner is a Board Member at Tri City Family Services in Geneva Illinois, Course Leader Instructor at American Management Association and President of E C Runner & Associates Inc, a firm consulting on improving boards and organisations.

Julie’s answer

Dave has rights as a shareholder and as a director. He must not mix these; to do so would engender conflicts of interest. He must safeguard information given to him as a director and not use it for personal benefit. It is not ‘his money’ but belongs to all the shareholders now.

As a shareholder:

  • If Dave can join with others to control more than 5% of equity he can requisition an AGM. Resolutions to remove or add directors or alter remuneration are common. A pre-emptive ‘don’t make that acquisition’ resolution would be rare but not impossible.
  • Internet chat rooms might give insight into how other shareholders view current developments.
  • Dave can sell down his stake to reduce his exposure.
  • He may have a case if the prospectus stated funds were to be raised for specific purposes and that is not happening.

As a Director:

  • If Dave really thinks they are headed for disaster and can’t prevent it he should resign, fast. He should then decide what to tell the regulator about his resignation; a lawyer might help with this.
  • Small cap listed companies often make huge changes to plans. Usually this is so they can survive. Dave should talk to other NEDs from the sector for a reality check.
  • If he wants the company to succeed he should get this board to function. Ensuring decisions are made properly in meetings and drafting an agreed charter would help.
  • He needs to either build a relationship with the Chairman or get support to stage a coup. The customers, bank or auditors could be useful allies.
  • Threatening to resign and/or requisition an AGM will get him listened to but won’t build relationships. Dave needs to decide whether he wants to play nice one more time or if it is now too late for that.

Dave should seek expert advice and peer support whichever strategy he chooses. Playing nice is neither a safe nor an easy option in these circumstances but it may still give a better outcome than a fight to the (probably bitter) end.

Alan’s Answer

The question seems to boil down to fight or flight.

Dave should not get into a fight without a good chance of winning so he should assess his power base. What is the shareholding split between the board and others, and is there a possibility of mobilising additional shareholding support?

Has the Board conduct been transparent - do the minutes reflect the strength of Dave's views - has he ensured that his protests have been recorded including his opposition to the Board being used as a rubber stamp?

Does the acquisition depend on raising additional funding?  If so the power of a non-aligned Director is increased.

If Dave's power base is low then he should consider cutting his losses and marking it up to experience or settle in to playing the role of the grit in the oyster that creates the pearl.

I am sure that many NEDs will relate to this case as Boards often want an NED for some particular reason - money - expertise - contacts but not for an independent and forceful contribution outside that.

In my experience the NED is well advised to get between the money and the Company if he is to be effective in the absence of a good Chairman.

Alan Hindley is Independent Director and Chairman Baylis Brands plc, & ComplySoft Ltd. He is also Chair of C. Dir Advisory Pan at Cedar Associates and an Independent Director at Cedar Associates.

Note from Julie:
This dilemma really touched a chord. There were so many experts who wanted to contribute and so many directors who wanted to share similar experiences. I wish I could print them all but this is a newsletter not an encyclopedia. I really appreciate every reader who has contacted me about this and all the previous dilemmas.

The opinions expressed above are general in nature and are designed to help you to develop your judgement as a director. They are not a definitive legal ruling. Names and some circumstances have been changed to ensure anonymity.

What’s new

Video tips – I occasionally present courses for IIR Executive Development. Together we have recorded a brief video to consider ‘Would you, could you, should you join a board?’   

Book review – Directors do a lot of reading. I keep a note of my thoughts on each book I read. Here is my review of Presenting Phenomenally by Derek Arden.

Where’s Julie? – This month I shall be in Tasmania on 3 February, Newcastle on 4 February, Sydney on 20 February and Canberra on 23, 24 and 25 February.  I hope I will see you there!

This newsletter – If you have any ideas for improving the newsletter please let me know. If you are reading a forwarded copy please visit my website and sign up for your own subscription. It is (still) free.

Suggestions for dilemmas – Thank you to all the readers who have suggested dilemmas. I will answer them all eventually.

Be an expert – I will post the next dilemma on LinkedIn. If you would like to feature in March just log on to my Q&A and type in your advice. I will pick the best answers to be published in the next newsletter. 

Farewell until next issue (due 1 March 2009). Enjoy governing your corporations; we are privileged to do what we do!

Best wishes

www.mclellan.com.au | PO Box 97 Killara NSW 2071
email julie@mclellan.com.au | phone +61 2 9499 8700 | mobile +61 411 262 470 | fax +61 2 9499 8711