November, 2016

In This Issue

Soliciting Initial Outside Directors for Private Companies - Corporate Secretaries and the Private Board

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Wed, Nov 30, 2016

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Soliciting Initial Outside Directors for Private Companies

Private and family-owned companies with tenured outside directors have learned how to attract, evaluate and retain other outsider directors. Experienced directors create value by leveraging their knowledge and well-established relationships to effect change. But where does this start? A critical step to recruiting initial directors is to understand that candidates likely lack institutional knowledge, and have no meaningful relationships with current directors or the company.  
Private companies seeking their initial outside directors are typically mature businesses in their second or third generation of leadership. They have experienced multiple business cycles and the leadership is self-aware. They are looking for outsiders to fill specific needs. Often they engage consultant to lead them through this process.
The consultants help the owners design the new board (how many directors, insiders/outsiders, candidate criteria, compensation, nominating process) and manage the selection process. The first request for resumes is typically described in a one page anonymous summary. Once an initial phone interview is scheduled, candidates receive a 2-3 page description of the business. Sometimes they receive a marketing/sales presentation from a recent sales meeting. While useful, these documents lack context.
While this practice is sufficient to run the process, it is also one-sided. The consultants are properly focused on the needs of the owners, not the needs of the candidates. The candidates may experience a series of surprises as the discussion unfolds. How does that help to expedite the best matches? While a partner in a private equity fund, we would receive hundreds of  investment summaries each year, before signing non-disclosure agreements. These teasers were usually two pages in length, and told our firm what we needed to determine if we should commit resources to a project. The company summaries I have seen as a board candidate have a fraction of the  content the typical investment summary. 
Candidates are deciding if they should invest a significant amount of personal time and if they should accept reputational risk when they evaluate joining a new board. My experience suggests that the selection process would be improved if it were less opaque.
Key Questions to Consider
The critical point to consider is that outside candidates for director seats frequently have little or no institutional knowledge, no sense of the company's culture, and little or no critical business data when they submit their resume to the search committee. While the current Board, owners and their consultants are intrinsically in tune with these issues, the candidates are not. They are often recruited from different industries.  Professionals seeking board seats will "opt in" until they have a reason to leave the process. Better information will accelerate the weaning process.
After reviewing a dozen searches that I have been involved in, I have concluded that these four questions need to be considered when designing the search:
What non-public data do we provide to the candidates, and when do we provide it?
This is the most difficult of the four questions, since there may not be much precedent to provide guidance. Other than its bank, the company likely has not shared critical information with any outsider. The best first step is to consider "what would I want to know if it were me" but remember that the incentives are not the same.
How do we build and test relationships through the process?
Phone interviews are an effective first screen, but good relationships grow through mutual shared experiences. A good process usually  includes an opening dinner, with a full day of meetings the next day, including factory tours. These tours should highlight major product lines and capabilities, and a chance to socialize with the full management team. The more time spent together, the better.
If the company is looking for multiple initial outside directors, what can it do to test the compatibility between candidates?
Since the outside seats are typically slotted for specific skills, consider scheduling non-competing candidates (e.g. a finance person and a marketing person) together for on-site interviews to create interactions you can observe.  I participated in this once and found it very beneficial. Meeting other candidates allows them to gauge the talent pool, and get a sense of where the process is headed. I have been on boards where the initial outsiders learn of each other when they shake hands at the first meeting. That approach extends the time needed to build effective relationships.
How do we structure the recruitment process to dovetail into the on boarding process?
Plan the on boarding process first and work backwards! Part of this depends on the committee structure, and the interviewing that deals with committee needs. (e.g. Audit, Compensation, Nominating) Matching people  for committee discussions, separate from the full Board, will expedite on boarding. 
It is important to remember why outsiders serve on private  boards. The reasons to serve as an outside director for a private company are (1) to have a meaningful impact on the organization, (2) to expand their network, (3) for professional growth, and for those who are at or near retirement, (4) to stay engaged.  While the compensation provides respect for the time spent at meetings, it is usually not the prime motivation.  Successful professionals serve as outside directors because they want to. Over the course of a typical three-year term, there will be enough late flights, early wake-ups, difficult conversations and calendar conflicts to de-motivate the candidates who are incented only by money.  Better data will allow outsiders to understand their ability to have an impact, and stronger relationships will motivate them to act.
The typical Board meets quarterly, with a few calls between meetings. Many private boards do not have formal Audit, Compensation and Governance subcommittees. This reduces the opportunities to work together. I have found that in these situations, newcomers may need a full year to become integrated. 
When soliciting candidates for initial outsider director positions, consider providing more than a few descriptive pages to brief the candidates. (Chart 1) Most, if not all, of this will be revealed not later than their first Board meeting. In addition to improving the interview process, you will likely receive fresh ideas to improve your business.
Once directors know each other, they will naturally start talking offline, which is the best way to build good working relationships. The goal is to have a strong, collegial environment that welcomes constructive dissent, fosters resolution, and promotes good governance. While cost is always a concern, consider inviting candidates to a few more meetings,  plant tours or sales events early in their terms. Since the expected term is measured in years, amortizing these travel costs over 24-36 months may make it an easy decision.
As the process moves forward, the best candidates will want to understand the risk of being a Director. Chart 2 provides a list of information that good candidates will inquire about. As a fiduciary, they will both want and need this information.
Electing outside directors  is  a commitment measured in years.  Many companies purposely limit the information they provide to candidates, either from habit or due to competitive fear. The habit will need to disappear when the outsiders are elected, and the fear is often not justified. Providing timely, critical datasets, and multiple opportunities to build personal relationships is critical to selecting and on boarding the best outside directors. It is a learning process for the owners, frequently more so than for the candidates.

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Corporate Secretaries and the Private Board

The modern Corporate Secretary is an invaluable resource to the Board and a critical member of the executive management team.  The Corporate Secretary is responsible for ensuring that Boards of Directors has the proper advice and resources to discharge its fiduciary duties to a company’s shareholders.  Under state corporate laws, every company is required to have a Corporate Secretary.  While a key responsibility of the Corporate Secretary is the artful preparation of minutes of the Board’s actions during Board and Committee meetings to reflect the Board’s proper exercise of its fiduciary duties, the role of the Corporate Secretary has expanded over time to include many other managerial and administrative responsibilities.  The Corporate Secretary in any company has become a key consultant to the Board of Directors and the executive management team, providing advice regarding Board responsibilities and logistics.  As a result, the Corporate Secretary has evolved to become a senior corporate officer who provides strategic advice to a company’s Board about corporate governance issues due to a greater focus on corporate governance by Boards and executive management
Corporate governance is important to public companies from a defensive standpoint relative to a focus on corporate compliance, activist shareholder initiatives, securities disclosure class action lawsuits and aggressive SEC enforcement efforts.  At the same time, corporate governance is important to all companies, including private companies, from a proactive business standpoint.  Good governance is good business because it increases productivity, enhances public relations and community involvement, supports employees and allows the Board to focus on increasing shareholder value.  The Corporate Secretary often becomes not only a critical advisor to the Board regarding the design and ongoing maintenance of a sustainable governance framework, but also a key member of the executive management team relative to the implementation and support of that framework with Board reporting acting as the drawbridge between executive management and the Board that the Corporate Secretary supports.  
The modern Corporate Secretary performs critical managerial and administrative responsibilities in the following six categories:
Corporate governance structure design, implementation and maintenance
Corporate governance program and process development and enhancement
Board of Directors and Board Committee support
Corporate governance service provider engagement and management
Executive management team collaboration
Legal entity governance management
The Corporate Secretary is responsible for the design, implementation and maintenance of a properly structured corporate governance framework.  This framework typically includes a Board of Directors and Board Committees, such as the Audit Committee, Finance Committee, Compensation Committee, Risk Management Committee and Disclosure Committee.  The Board and each Board Committee meet at regular intervals, and each Committee Chair reports to the Board regarding the deliberations and decisions of his or her Committee.  The Board deliberates and makes decisions regarding issues and transactions that are material to the Company’s operations and its future.  The Corporate Secretary performs the critical role of ensuring that the Board and each Board Committee operates according to the provisions of the Company’s Articles of Incorporation, Bylaws and Board and Board Committee Charters as well as other foundational documents of the Corporation.    
In the category of corporate governance program and process development and enhancement, the Corporate Secretary is responsible for the efficient and effective operation of the Office of the Corporate Secretary, the identification and implementation of best corporate governance practices, the facilitation of periodic corporate governance program and process development, review, enhancement and implementation and the development and implementation of delegation of authority and resolution approval processes.  The Corporate Secretary also serves as an advisor to the Board, often with the assistance of outside consultants, to address Board governance concerns and improve Board effectiveness, conduct corporate governance audits, administer Board evaluations and Board skills assessments, facilitate Board retreats, assist with the resolution of succession planning issues and design and implement Director education and orientation programs. 
With respect to Board and Committee support, the Corporate Secretary manages Shareholder, Board of Directors and Committee meetings.  He or she attends those meetings and prepares minutes of those meetings.  In addition, the Corporate Secretary presents resolutions to the Board of Directors for approval of material transactions and corporate authorizations.  Other responsibilities of the Corporate Secretary in this category include the management of corporate compliance with Board and Committee charters and foundational documents such as a company’s articles of incorporation and by-laws, collaboration with shareholder services and investor relations staff and maintenance of key corporate documents and records.
The Corporate Secretary is also responsible for the engagement and management of third party corporate governance service providers to enhance the efficiency and effectiveness of the operation of the Office of the Corporate Secretary.  These specialized service providers include:
Agenda management and Board reporting solutions;
Board portal providers;
Legal entity management system providers;
Non-U.S. subsidiary management firms;
Registered agents;
Stock transfer agents;
Director education resources;
Annual meeting service providers;
Shareholder identification services:
Abandoned property compliance services; and
Director recruiter and related services.
It is important for the Corporate Secretary to develop productive relationships with these types of corporate governance service providers.
The Corporate Secretary regularly collaborates with a corporation’s executive management team to plan Board and Committee meetings, develop related meeting objectives, identify matters for Board and Committee discussion and decision-making and develop, distribute and present Board and Committee materials.  In addition, the Corporate Secretary assists the executive management team with the production of annual reports and financial press releases, manages the resolution of director and officer indemnification insurance issues and interacts with the company’s CEO, CFO, Controller, financial communications staff, external auditors and securities counsel regarding the corporate governance aspects of a company’s financial statements.
Finally, legal entity governance management is another critical responsibility of the Corporate Secretary in a company that has subsidiaries.  The Corporate Secretary will serve as the Corporate Secretary for a company’s subsidiaries, joint ventures and other domestic and non-U.S. legal entities.  This responsibility involves ensuring that the company appropriately manages its global legal entities, facilitating periodic subsidiary Board of Directors meetings and maintaining subsidiary corporate minute books.  
The Corporate Secretary’s performance of this broad set of responsibilities in these six categories reflects the substantially expanded role of the modern Corporate Secretary. 
The performance of the Corporate Secretary role in a professional and robust manner is very important to both private and public company Boards of Directors.  While there are many unique corporate governance requirements that are applicable to public companies, both private and public companies need to comply with the same corporate laws of the states of their incorporation and manage related legal liability risks.  It is important for private companies to practice good corporate governance in order to be able to mitigate legal risks related to applicable state corporate laws and to be prepared for sale, “going public” and financing transactions and provide corporate governance related documents to third parties such as external auditors and regulatory authorities.  The Corporate Secretary brings unique value to the Board regarding its implementation of good corporate governance practices and is therefore charged with the responsibility to fulfill the many demands that are placed on him or her by the Board in order to manage the Board’s adherence to good corporate governance practices designed to address both legal liability risks and transaction preparedness requirements.
The two key legal risks faced by both private and public companies that can be mitigated by the practice of good corporate governance by a company’s Board of Directors, as facilitated by a company’s Corporate Secretary, relate to “piercing the corporate veil” actions and breach of fiduciary duty claims.  First, plaintiffs in a lawsuit against a corporation will often ask the judge presiding over the lawsuit to “pierce the corporate veil”, or ignore the separateness between a corporation and its shareholders, and hold shareholders responsible for the liabilities of the corporation.  While there are several factors that a court will consider when determining whether to allow the “corporate veil” to be ignored, a key consideration is whether the corporation has operated as a legal entity separate from and independent of its shareholders.  The risk of “piercing the corporate veil” is significantly reduced when the corporate governance of the corporation is robust, properly documented and transparent.   In order for a corporation to defend a “piercing the corporate veil” action, the corporation’s Corporate Secretary should artfully prepare Board and Committee minutes and otherwise document that the Board took appropriate actions to maintain the separate legal existence between a corporation and its shareholders.  This includes the preparation of accurate and detailed records of important decisions made by the Board as the governing body of the corporation and the proper maintenance of corporate minute books and related corporate documents.      
Secondly, shareholders of either a private or public corporation will often claim that the corporation’s Board of Directors breached its fiduciary duties of care and loyalty or failed to follow what is known as the “business judgment rule”.  The ability to defend against these types of shareholder lawsuits is reduced when Board and Committee decision-making is diligently and properly documented by the corporation’s Corporate Secretary.  To document the Board’s exercise of its duties of care and loyalty and observance of the “business judgment rule”, the Corporate Secretary should prepare minutes to demonstrate that the Directors of the corporation:
Are informed, well-advised and deliberative;
Make careful and educated decisions;
Exercise reasonable diligence in gathering and considering all material information;
Explore, understand and weigh alternative courses of conduct that may be available;
Weigh benefits versus harm to the company and its subsidiaries when considering specific courses of action;
Obtain independent advice from experts and understand their findings and the basis for their recommendations;
Have a reasonable basis for believing that information provided to the Board is reliable; and
Take time to make informed decisions.
There are also “transaction readiness” dynamics underlying the proper performance of the Corporate Secretary role in private corporations relative to implementing sale, “going public” and financing transactions and requests for corporate governance related documents by external auditors and regulatory authorities.  A private company needs to be prepared to provide accurate and complete corporate governance documentation as part of the due diligence process that is a critical to any corporate sale, “going public” or financing transaction.  Transactional due diligence requires demonstration of good corporate governance and internal controls, and transaction closings require documentation of transaction authorization, officer signature authority and the like.  Also, a private company that is preparing for an “initial public offering” must be sure that it has a robust corporate governance structure in place in advance of going public so that it can comply with public company SEC and listing requirements when the IPO is implemented.  Finally, private companies, through their Corporate Secretaries, must be able to adequately respond to requests for high quality corporate documents by their lenders, external auditors and tax and other regulatory authorities.  
In summary, a private corporation will be better able to defend against plaintiffs’ attempts to “pierce the corporate veil” and shareholder lawsuits claiming breach of fiduciary duty, execute corporate transactions and provide required information for financial statement, tax and other audits if the corporation robustly follows good corporate governance practices and procedures with the proactive and professional assistance of its experienced Corporate Secretary.  Due to the many and varied aspects of and dynamics related to properly performing the Corporate Secretary role in any corporation, a company’s Corporate Secretary should demonstrate an executive presence coupled with solid communication skills, be detail-oriented and flexible, be able to lead and work within a multi-disciplinary setting to achieve consensus, maintain an appropriate perspective no matter how difficult a particular situation in a Board or Committee meeting might be and understand evolving best practices in corporate governance and advise the Board and executive management accordingly.
In most large, publicly traded corporations, an employee performs the role of the Corporate Secretary.  If the company maintains a law department, the Company’s general counsel or another member of the Company’s law department usually serves as the Company’s Corporate Secretary.  Some large public companies, particularly those with wide networks of global subsidiaries, maintain an Office of the Corporate Secretary separate from the company’s legal department.  Typically, the Corporate Secretary of large public corporation has developed detailed knowledge regarding the role and responsibilities of the Corporate Secretary as a result of learning the specifics of the role from his or her predecessor and by participation in the Society for Corporate Governance, the professional association for corporate governance professionals in the U.S.   
Private company Boards of Directors will typically elect a company employee who has other professional responsibilities to the role of the Corporate Secretary.  That employee is usually the private Company’s attorney on staff, if there is one, or the Company’s Chief Administrative Officer or Chief Financial Officer who may not be an appropriately experienced or knowledgeable Corporate Secretary by background or training.  In order to enhance the performance of the role of the Corporate Secretary in those companies, there are external consultants who are available to provide external corporate governance support.  A company that seeks to improve the robustness of its corporate governance capabilities can engage those specialized corporate governance consultants in order to enhance corporate governance capabilities without increasing staff, allow company officers who are charged with performing the Corporate Secretary role to focus on their primary professional responsibilities and enable the company’s corporate governance function to be performed by an experienced professional corporate governance professional.  It can be a distraction and a liability to have an officer such as the Chief Administrative Officer or the Chief Financial Officer perform the Corporate Secretary role, and the General Counsel, if there is one, is better left to focus on supporting business operations and attending to the Company’s legal defense needs.  An outside corporate governance service provider has the resources and relationships to fully deliver the services of an expert and professional Corporate Secretary in cases where internal professionals who have been assigned the Corporate Secretary responsibility do not have the experience, background, resources or time to do so.  Also, in the case of private equity controlled companies, the use of an outsourced Corporate Secretary service provider allows for uniformity and consistency with respect to corporate governance practices at all of a private equity firm’s portfolio companies.  Outsourced Corporate Secretary services also provide expert and professional corporate governance support to emerging growth companies, subsidiaries of other companies and not-for-profit corporations.      

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