Process Counts – Board Considerations When Contemplating a Sale

Many thanks to Al Browne for his contributions to this article.

Whether you are a founder or venture investor sitting on the board of a portfolio company, you have fiduciary duties to think about when making board-level decisions.  These decisions often come under increased judicial scrutiny in the context of a sale transaction.  In addition to your basic fiduciary duties (a summary for Delaware private companies can be found in Your Duties as a Director: The Basics) the following are some additional considerations to think about when bringing your company to market, picking a buyer and negotiating the terms of sale:

1. In the sale context, Delaware law requires that, as a board member, you seek to maximize the value of consideration that is reasonably attainable for the company’s stockholders.  While there is no single blueprint that you must follow, courts have described the role of the board as akin to that of an auctioneer tasked with the duty of getting the best price for the stockholders of the company on exit. However, a director’s duty to obtain the maximum value for a company’s stockholders does not necessarily equate to an obligation to accept the highest price, as the offer with the highest price may have other features that make it less valuable (e.g., greater risk of not closing due to financing risk or antitrust concerns).
2. In discharging your fiduciary duties as a director, you should consider exclusively the interests of the common stockholders, as residual claimants, and avoid making decisions that would benefit preferred stockholders to the detriment of the common stockholders, unless the contractual terms of the preferred stock specifically mandate a different result (in which case you should deliberate – and be able to explain – why the sale was fair to the common stockholders in that context).
3. You should be sure to carefully review and understand any existing contractual obligations.  For example, your company’s stockholders may be contractually obligated to participate in a sale by means of a so-called “drag-along” obligation (whether or not the board approves the sale).
4. As a board member, you should be sure to understand and carefully evaluate any conflicts of interest involving other board members or management arising from the sale transaction; this factor, more than any other, can influence the standard of review a court will use to evaluate your decisions.
5. A conflict of interest may exist with respect to a board member designated by a venture fund if, on exit, the venture fund receives its previously negotiated liquidation preference (or other benefits by virtue of the preferred security) in excess of the per share amounts paid to common stockholders in the sale. A board member may also be conflicted if they are receiving a unique employment benefit (e.g., post-transaction employment or sale bonus) or unique economic benefit (e.g., rollover equity) in the sale.
6. As a board member, you should be aware that process counts when a court scrutinizes your decisions. With that in mind, you should be thoughtful about the process along the way and, as the circumstances allow:

• • Hold scheduled board meetings to discuss whether or not a sale transaction makes sense for the company, which should include a robust and thoughtful analysis of the company’s stand-alone strategy and prospects and intrinsic value.
  • Keep careful minutes that record the board’s deliberations, including acknowledgment of duties to common stockholders and discussion of fairness of the transaction to the common stockholders.
  • Do your diligence and engage skilled experts and advisors.
  • If practical, use an investment banker (and consider your banker carefully) to run a full sales process and bring the company to market.
  • Make sure conflicts of interest of directors and officers are disclosed to the board and, where applicable, to the stockholders.
  • If a majority of the board is deemed to be conflicted, consider setting up a special committee or at least getting independent non-interested directors to weigh-in on the sale.

*This article is based on Delaware corporate law.  While the specific law varies by jurisdiction, many of the same practical considerations apply.