Strategically Addressing Special Board Situations

I recently published a blog about the power of committees to strengthen board engagement and give focus to key strategic areas of the business. Beyond the standard Audit and Compensation Committees, the use of special sub-committees can be effective to address sensitive situations like new litigation, cyber risk, fundraising, mergers & acquisitions, and even insolvency. While these situations will not always have currency for growth-stage boards, it is important to establish protocol for how to handle them should the need arise. 

Fundraising

The board’s role in capital formation can vary depending on the complexity of the cap table, whether the company is raising offensively or defensively, and whether the raise will be an inside or outside round.  

When raising an outside round (one in which new investors are brought in), the CEO leads negotiations with potential investors, while the board provides guidance on general parameters. The CEO will make a recommendation on financing terms based on feedback from the market, and a board vote is typically required to approve. It’s important that the board understands the voting structure beforehand to ensure that all directors understand the voting rights and thresholds.  

For an inside round, a special sub-committee of non-interested or non-participating board members should be created to lead the process; company counsel guides which directors are included in this committee. Independent board members will take a lead role in determining if the terms are in the best interest of all stakeholders.  

Mergers & Acquisitions

Board approval is required whenever a company wants to merge with or acquire another company. Establishing a Mergers & Acquisitions sub-committee is a best practice to review the potential deal and the financial performance of both parties, as well as other duties including:  

• Vetting and selecting the banker for the transaction  

• Choosing a lead negotiator for the company  

• Partnering with the Audit Committee to review accounting policies and internal controls  

• Working with the chairman and independent director(s) to resolve any conflicts between investors in both companies  

• Leaning on bankers and attorneys to ensure confidentiality throughout the process 

The sub-committee is also responsible for reviewing the company’s key valuation points ahead of any proposed deal to ensure that the company is getting adequate value for each of them. These can include:  

• IP and technology, including patents and trademarks  

• Material customer and vendor contracts  

• Employee and management issues  

• Pending litigation  

• Tax matters  

• Supplier and customer concentration risks 

Insolvency 

One of the most difficult board responsibilities is addressing insolvency. Typically, a company is considered insolvent when its liabilities exceed the fair value of its assets or when the company is unable to pay its debts. When this happens, the final decision on insolvency lies with the board. When making this decision, the board must:  

• Review its obligations with counsel  

• Review the company’s D&O insurance policy to ensure that all relevant directors are covered  

• Focus on its fiduciary duty to represent all shareholders equally, including common shareholders, creditors, vendors, etc.  

• Consider all alternatives to a down round financing, including expense reduction, new debt issuances, headcount reduction and whatever else it takes to remain solvent  

• Make sure that payroll and payroll tax obligations are prioritized. (If these responsibilities are overlooked, individual directors can be held personally liable.)  

If all else fails, a board sub-committee should be established to manage the wind-down process of the company. It’s important to remember that, once a company is considered insolvent, the board’s responsibility shifts from its shareholders to its creditors. 

 Growth-stage boards must be prepared for both best- and worst-case scenarios in order to meet their fiduciary duties and protect the company’s future. Special situations like fundraising, mergers & acquisitions, and insolvency, though not an everyday focus, demand thoughtful planning and swift action. Having a solid approach in place makes all the difference in ensuring the board and company can keep moving forward.