CONSIDERATIONS WHEN ESTABLISHING YOUR FIRST BOARD OF DIRECTORS

This document was prepared solely for use in a February 2, 2017 Minnesota CLE Webcast. Reproduction or dissemination without permission is prohibited.

Paul Knapp

Has served on 24 private, 2 public, and 9 non-profit boards

30 years of family business office experience including commercial real estate, operating companies, investments

Graduate of The College of St. Thomas, B.S., Finance, and William Mitchell College of Law, J.D.

John Bergstrom

Has served on 25 private, 5 public, and 7 non-profit boards over his 30 years in the growth company advisory business

Focus of expertise on strategic alternatives planning, executive compensation and corporate governance

Graduate of Gustavus Adolphus College, B.A. and University of Minnesota M.B.A.

The board-centered governance method developed over the past 500 years to provide for the representation of all who have an interest in an enterprise based on three concepts:

• Shareholders elect directors

• The board has the ultimate authority to select and supervise the company’s chief executive

• Directors, as peers, make decisions as a group subject to majority rule

Board-centered Corporate Governance

• Ensure the representation of all shareholders• Access valuable talent, expertise and insight• Present a better face to the community• Facilitate transition and management succession• Review/approve material transactions• Manage the CEO• Approve strategic plans• Approve budgets and supervise independent audit process

Why Have a Board?

• Advisory boards are normally intended to merely advise the CEO or the company

 • Advisory boards are not governing boards and do not have

the duties or authority of a board of directors • Advisory board members be exposed to personal liability

without corporate (articles/bylaws) protection or statutory protections or directors’ and officers’ liability insurance

Advisory Boards

• Familiarity with shareholder goals• Enthusiastic about the company’s mission, vision, and

values• Proven integrity• Articulate• Collaborative• Respectful of others’ opinions• Strategic thinker – not focused on minutiae• Functional expertise e.g. audit, governance or

compensation

Identifying Prospective Board Members

• A majority of board members of public companies must be independent: they cannot derive significant income from the company

• A minority of board members of closely-held private companies are likely to be independent: a majority are likely to be owners and managers of the business or family members of owners

• The number of independent board members generally increases as a company’s ownership becomes more widely-held

“Independent” Board members

• Identify the talents, expertise and experience of the prospect on which you hope to draw

 • Describe the board meeting commitment as well as the

time commitment outside of board meetings • Identify the committee on which you expect the board

member to actively serve, if any • Describe the compensation you intend to provide  • Identify the term limit

Soliciting Prospective Board Members

• Company mission, value and ethics statements• Company financial and operational history• Company strategic plan• Chain of command and organizational structure• Fiduciary and functional duties of the Board• Director communication with management, shareholders,

and others• Confidentiality • Role of Chairman

Board Orientation

Duty of CareA director is required, by statute in Minnesota, to act in good faith, using the care that an ordinarily prudent person in a like position would exercise under similar circumstances, and in a manner that he or she believes to be in the best interests of the company

 Duty of Loyalty

Directors must protect the interests of the corporation and act in the best interests of its shareholders

 Duty of Obedience

Directors must follow the organization’s governing documents and policies as well as state and federal laws

Board Member Fiduciary Obligations

In the absence of fraud, conflict of interest or other breaches of loyalty, a director will not be held liable to his or her corporation if he or she acted in an informed manner, in good faith and with a reasonable basis for believing that the action he or she authorized was lawful and in furtherance of the company’s purposes

The Business Judgement Rule

• Hire, fire, manage and compensate the CEO

• Plan for CEO succession • Review and authorize the company’s strategic plan • Manage budgeting and financial reporting to ensure short term

visability  • Manage risk • Establish and keep current the ethical conduct policies and

procedures which govern the company’s operations 

The Board’s Functional Duties

Directors should take all reasonable steps to avoid conflicts of interest with the company and promptly disclose any actual or potential conflict to the Governance Committee of the Board

Conflicts of Interest

• Depends on the financial strength of the company and the quality and experience of the directors

• Varies widely ranging from equity-only consideration to cash only programs

• Independent director compensation is typically structured as some combination of annual cash retainer, board meeting fees, equity awards (full-value shares or stock options), and committee chair premiums

• The most recent National Association of Corporate Directors (NACD) Private Company Governance survey reported average total compensation of $33,000 for $25 to $50 million revenue companies and $36,000 for $100 to $250 million companies

• Board members who are also full-time employees of the company are typically not provided separate compensation for their role as a board member

Board Compensation

• Typically elected from among the non-management directors serving on the company’s board of directors to act as a liaison between non-management directors and company management

• Manages the board, does not manage the CEO • Organizes the Board’s evaluation of the CEO • Consults with management on Board meeting agendas and leads

the board meeting  • Leads the executive session of the board and communicates key

outcomes of that session back to the CEO 

The Role of the Board Chair

• Most common standing committees of the board areoAuditoCompensationoGovernance

• Board committees enable critical work to be completed outside the board meeting

• Good committee management enables the larger board to address strategic rather than operational details

• Committees arise and evolve as the company grows and as the shareholder bases becomes less closely held

Committees

• Reviews the accounting and financial reporting and control policies and procedures

• Recommends to the Board of Directors the firm of certified public accountants to be retained as the company’s independent auditors

• Reviews policies and procedures relating to business conduct (“compliance”)

• Establishes and manages the whistle blower process • Manages risk

Audit Committee

• Recommends to the Board the compensation of the CEO and often other executive management

• In more formal private boards that seek to emulate public company practice, the committee may be entirely empowered to establish compensation plan without involvement of the full board

• Recommends to the Board the compensation of independent directors

• Helps Chair conduct the annual evaluation of the CEO

Compensation Committee

• Nominates directors for election or re-election and manages ongoing board succession planning

• Develops and maintains a succession plan for the CEO and policies regarding succession

• Recommends to the Board a set of corporate governance principles

• Reviews executive and board member conflicts of interest and recommends resolution to the board

• Conducts a periodic board self-evaluation

Governance Committee

• Directors direct, CEOs lead and managers manage

• The board oversees management but does not manage

• The board works to ensure that the CEO manages the company’s financials well, exercises strong leadership, develops a strong team of senior staff, and communicates well with all stakeholders

The Board’s Relationship with the CEO

• Rolling one year board calendar

• Tie committee meeting schedule to board meetings

• Schedule shareholder meetings, nomination and election of officers, board self-evaluation, election of officers and directors, orientation, and retreat

The Year Long Schedule

• Provide agenda and other advance materials to the directors no later 48 hours before the meeting

• If possible, hold a board dinner the night before the meeting, particularly if the directors are coming from out of town

• Include a consent agenda that includes all financial and operational information and metrics presented in a consistent fashion from meeting to meeting

• Maintain confidentiality

Managing Board Meetings

• An extended half or full day meeting once a year to consider important topics in-depth

• Sample topics include strategic issues affecting the company, the mission, vision, and values statements, succession planning, acquisitions, sale or recapitalization of the company

• Scheduling opposite time of year from annual planning and budget approval

The Board Retreat

• Board members should generally have complete access to the CEO and CFO and to information regarding the company’s operations

• Board member access to other executives should generally be provided subject to advance notice to the CEO of such meetings

• The CEO should bring managers into Board meetings to provide additional insight regarding items in their areas of expertise

• Directors generally refer all inquiries from the media, shareholders, or customers to management and do not individually speak for the corporation

Board Interaction with Management, Employees and Shareholders

• Mission – What the company does

• Vision – What the company will become

• Values – How the company will behave

The Mission, Vision and Values Statements

• Hire outside party to manage the review process and report the results in an independent fashion back to the board

• Ask that directors rate the CEO and their fellow directors on preparedness, insight, contribution, judgment, knowledge and overall effectiveness

• Deliver all results to Chairman and specific results to specific directors

Periodic Board Review

• Death/disability/departure of CEO

• Product liability incident/recall

• Major lawsuit filed or legal decision issued

Crisis Management

• Clearly articulate board member term limits

• Consider tying board service to the board member’s current status, responsibilities and activities

• Ensure that the company’s by-laws provide a simple, easy and convenient method to remove directors

Term Limits

• Private companies and their boards are exposed to ever increasing potential liabilities from an ever increasing universe of potential litigants: shareholders, employees, customers, vendors, acquirers and acquires.

• Many states have adopted statutes that limit the personal liability of a director in actions brought by the company or its shareholders for monetary damages for breach of fiduciary duty of care as a director, provided this provision is contained within the company’s articles of incorporation

• Directors and Officers (“D&O”) protects directors from litigation

Board Member Liability and Insurance

• Prepare for and attend meetings • Understand the business judgement rule • Ask questions and get professional advice if necessary • Make note of your disapproval • Make sure the company’s articles, bylaws and D & O

insurance provide maximum protection

Director Guidelines to Avoid Liability

The Balance Point, Cary J. Tutelman and Larry D HauseThe Board Game, How Smart Women Become Corporate Directors, Betsy Berkheimer-Credaire Boards of Directors and the Privately Owned Firm: A Guide for Owners, Officers, and Directors (Hardcover) by Roger H. FordBoards that Deliver, Ram CharonBoards that Make a Difference: A New Design for Leadership in Nonprofit and Public Building Better Boards: A Blueprint for Effective Governance (J-B US non-Franchise Leadership), David A. NadlerDirectors and Boards, Tom HortonFundamentals of Corporate Governance, Varallo, Dreisbach and Rohrbacher, ABA, 2001Governance is Governance, Kenneth N. Dayton, Independent sector, 2001Great Companies Deserve Great Boards, A CEO’s Guide to the Boardroom, Beverly BahnThe Handbook of Corporate Governance, Edited by Richard LeBlanc, Wiley, 2016The Historical and Political Origins of The Corporate Board of Directors, Frankin A Gervurts, Hofstra Law ReviewOrganizations, by John CarverOwning Up, Ram Charan   Running Board Meetings: How to Get the Most from Them, Patrick Dunne MBA   The National Association of Corporate Directors and national accounting and law firms also routinely generate interesting papers on current governance topics affecting private companies.

Private Company Governance Resources

Thank You