Considering an IPO? Find the right board
By Maureen Milford
The message couldn’t be clearer to private company boards looking to go public: Don’t even think about an initial public stock offering without a diverse board of directors.
Goldman Sachs, last year’s leading underwriter of U.S. initial public offerings, will only handle IPOs for private companies in the United States and Europe if the organization has at least one diverse board member, Goldman’s CEO, David Solomon wrote in a piece on LinkedIn in January after making an announcement at the World Economic Forum in Davos. The rule takes effect on July 1. And beginning next year, the number will rise to two diverse candidates for IPO clients, Solomon says.
Goldman’s directive illustrates the increasing scrutiny of board composition among companies looking to raise capital from public investors. Gone are the days when all-white male public boards could be stacked “with employees and with purveyors of professional services to the management such as investment bankers, commercial bankers, and outside legal counsel,” as it was described by the distinguished Harvard Business School professor and governance pioneer Myles L. Mace in a Rutgers Law Review article in 1979.
Today, investors want company boards that best exhibit the qualities needed to handle its critical oversight duties. That means a board composed of directors with multifaceted talents, experience, skills and capabilities. A board composed of directors with varied backgrounds combined with diversity of gender, race and age intensifies the board’s capacity to make sound and effective decisions, corporate governance experts say.
“You need to bring expertise to the table to demonstrate to the investors that the board will have the skill set to appropriately oversee management and steward their assets wisely,” says Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware.
On top of this, boards face numerous legal requirements, including California’s new law that requires any public company headquartered in the state to include women on the board. Companies also must be in compliance with various rules and policies of the stock exchanges and the U.S. Securities and Exchange Commission.
This process takes time, says Christopher Austin, a partner at Orrick, Herrington & Sutcliffe law firm. He counsels companies to begin discussions with suitable director candidates 18 months prior to the target date for an IPO.
The goal should be to assemble a group of people that will help the company “best navigate challenges faced by a public company,” Austin says. Ideally, a board should be composed of directors with experience in finance, corporate governance, compensation issues, public company experience, cybersecurity and accounting, to name a few, experts say.
Importantly, prospective directors should be aligned in their vision for the company, Austin says.
“They’ve got to be able to get along,” he says.
Next, there’s the legislative and exchange requirements for a public board. Some company underwriters will often suggest or require a board and governance structure that is fully compliant at the time of the IPO, according to “Assembling Your Public Company Board of Directors” by Orrick, Herrington & Sutcliffe law firm.
The NYSE and Nasdaq both have policies that require the majority of directors be independent except in the case of “controlled” companies where more than half of the voting power is held by an individual, group or other company after the IPO.
Under the independence policies, the board must determine that the directors have no material relationship with the listed company or as a partner, shareholder or officer at another business that has a significant business relationship with the company.
The SEC and exchanges also have independence requirements for three committees – audit, compensation and nominating/corporate governance.
“Most private company boards do not meet these standards and advance planning prior to the IPO can help avoid problems during the transition process,” the Orrick piece says.
Furthermore, when it comes to diversity most private company directors appear to think it’s not that much of a problem. Roughly two-thirds of the private company directors surveyed by National Association of Corporate Directors reported that their boards do not face challenges in diversifying their composition, according to the 2018-2019 Private Company Governance Survey. What’s more, nearly 6 percent said one or more director opposed the idea of board diversification.
Solomon of Goldman Sachs pointed out that in the last two years, more than 60 companies in the United States and Europe went public without one diverse board member.
“Part of this has to do with the simple fact that the pool of candidates has traditionally been focused on those with CEO or CFO or other board experience. As the corporate world has been painfully slow in moving on promoting talented people of diverse backgrounds, this has impeded the opportunity set for many individuals with decades of experience and important skills that could help companies make better decisions, driving enhanced returns for their shareholders,” Solomon wrote.
While there are no requirements for board size smaller boards of a handful of directors can create workload challenges for members, according to the Orrick article,
“The audit committee, in particular, will have a greatly expanded role following the IPO, and many audit committee members are reluctant to sit on multiple committees,” the article says.
“As a practical matter, therefore, some public companies, particularly those with a larger market capitalization, will choose to have at least six independent directors.”
Austin says for a board to be nimble it’s best to have no more than 9 to 11 directors.
Tips for setting a public company board, offered by Orrick, Herrington & Sutcliffe, include:
- Decide on your board size and how many independent directors you will need.
- Examine which current directors meet the independence requirements for the board and committees.
- Determine whether the board lacks sufficient diversity, including accounting, finance or public company experience.
- Have a director compensation plan in place when soliciting potential candidates.
- Decide if the board composition beyond the legal requirements should be changed for marketing purposes.