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THE THREE RULES OF NEGOTIATION.

These three rules of negotiation can mean the difference between your business’s success and failure.


To illustrate the power of these rules, we use the example of a simple negotiation between a small business without apparent leverage and a much larger business with immense leverage. These rules are also highly effective in transactions of much greater complexity and scope, in any industry, and with parties of differing size, interests, needs and challenges.

THE THREE RULES OF NEGOTIATION

Saul Winsten
The Winsten Group.Trusted Counsel LLC
www.thewinstengroup.com

Copyright 2018 Saul Winsten , all rights retained and reserved

These three rules of negotiation can mean the difference between your business’s success and failure.

Contracts are a means to establish and define commercial relationships, increase profitability and reduce risk. These three rules, when properly applied to contract negotiation, also can produce competitive advantage, enduring collaborative relationships, protection of intellectual property rights and business interests, and a wealth of other benefits for your organization.

To illustrate the power of these rules, we use the example of a simple negotiation between a small business without apparent leverage and a much larger business with immense leverage. These rules are also highly effective in transactions of much greater complexity and scope, in any industry, and with parties of differing size, interests, needs and challenges.

Rule One: Start with the End.

Wasn’t it Yogi Berra who said, “If you don’t know where you’re going, you’ll end up somewhere else?” He’s got something there.

Whether problem solving, negotiating a contract or resolving a dispute, you gain a decisive advantage when you begin your negotiation with the end in mind. Then build your strategy and action from there. Not taking the time up front to think through where you need to end up and how you will get there – making it up as you go along – is a mistake too often made.

Our client, a well-established EU-based business with a new USA subsidiary, designs and produces zero-defect, highly engineered products and is a Tier 1 supplier to large multinational manufacturers. It had just been selected by a much larger USA-based multinational Original Equipment Manufacturer (OEM) to negotiate a contract for production and supply of a component for the OEM’s engines. This OEM had earned a reputation for being tough on small suppliers. The OEM enjoyed its size, financial strength and market share, employing that clout in all negotiations. Our client knew that it would be difficult to obtain a profitable contract and retained us to assist in negotiations.

At the beginning of the process, we determined our client’s objectives, our end:
• to obtain a profitable exclusive contract for design and manufacture of highly engineered products in high volume,
• to protect our intellectual property and reduce our risk, and
• to establish and strengthen a new long-term, mutually beneficial relationship with this OEM and its affiliates.

Because our end was to build a productive long-term relationship, we approached negotiations as a collaborative problem-solving exercise, not an adversarial process with a single winner and a single loser. Every piece of correspondence, every interaction between the parties and negotiators, was intended to build trust and confidence.

Next, we identified and assessed our risks and opportunities, and strengths and weaknesses that might impact our ability to obtain the end we sought.

From there we identified our terms:
• what final terms we
needed, and why
• what terms we wanted
• how best to reach our end

Of course, need and want are very different things, not to be confused and never to be lost sight of. What we needed determined what our “walk away” points must be.

Here’s where Yogi comes in. If you don’t know what your objectives are and commit to them from the beginning, you will find yourself in negotiations being pushed or led back from one position to another. The end will be different from the one you hoped for.

Rule Two: Prepare. Prepare. Prepare.

Sun Tzu, the ancient Chinese military strategist and philosopher, said that the true master of the Art of War is one who wins the battle before it has started.

Likewise, the most successful negotiations are those for which careful research and planning begin well before the formal negotiations.

Before sitting down at the negotiating table, it is essential that you thoroughly know and understand the other party, its needs and its goals. Also learn as much as you can about its playbook, the persons with whom you will negotiate and the ultimate decision makers.

When you know yourself and you know your opponent – and apply that knowledge – you gain a significant advantage.

Back to our example:
Prior to our first meeting with the OEM leaders and negotiators, we learned all we could about the other party, its business, its product needs, its sources of competitive product supply, and its processes that might involve our product. Our USA president (an established and knowledgeable engineer), European executives (also established and knowledgeable engineers) and others in the company were in regular contact with the OEM’s engineers and procurement personnel. Through industry knowledge and contacts, we gained more information about the OEM’s negotiators and decision makers, their tactics and demands in similar negotiations, as well as how the OEM treated other suppliers and their intellectual property. And, of course, we carefully reviewed the OEM’s proposed procurement agreement.

When we sat down together, it was apparent the OEM hadn’t expended much effort to learn about us or develop a strategy for this contract. The OEM had bigger deals to think about and was confident that, with its strong leverage, we would accept its demands.

Based on our research, we anticipated that at the very end of negotiations – when we, the smaller party, would happily think the deal was done – the OEM would ask for more.

Because we knew what the OEM had demanded of other suppliers, we anticipated that we would be asked to warehouse our finished product at our sole expense, with payment by the OEM only after it took possession. This consignment arrangement would produce cost savings for the OEM, but it would burden us with additional costs and risk. We also knew the OEM had existing warehousing capacity and financial resources to easily handle its own storage of small components for just-in-time use.

We determined in advance that we would not accept this last-minute demand unless we were adequately compensated. We formulated a response consistent with our advantages (the OEM could not obtain a truly competitive product at this price on this timeline) and what the OEM viewed as our weakness (our size, and eagerness to enter this contract). In this case, we were going to try to turn a perceived weakness into an advantage.

Rule Three: Pay Attention and Seize Opportunity.

Sun Tzu instructed his generals to occupy the field of battle first. In doing so, they could secure the best ground from which to wait for the opposing army’s arrival, watch its moves, and quickly adapt to those moves to achieve victory.

When you apply the first two rules, you may have a better opportunity to occupy the field of battle first. You likely are prepared for engagement before and better than the other party. Thus, you can recognize and utilize favorable opportunities that arise. Some of these opportunities might be subtle, such as cues picked up by the behavior, body language and voice of the other parties.

Turning an opportunity to our advantage:
We arrived for formal negotiations at the OEM’s mammoth headquarters and were ushered into a large conference room dominated by a long, dark table. The OEM had already placed its negotiator, multiple procurement and engineering staff, other assistants, computers and paperwork at their end of the table. We were pointed to seats at the extreme other end. Clearly, the OEM was ready for its traditional adversarial negotiations.

We were prepared to change the dynamics.

We asked to move toward their end of the table, as it would be more conducive to discussion. They agreed. Throughout that day, we worked to create a dynamic of non-adversarial negotiations, of collaborative problem solving.

We already knew a great deal about what the OEM needed to meet its goals and schedules, its current product sourcing, and its supplier challenges. We knew our product capabilities and could calculate our design and production costs to a fraction of a cent. We also had a good idea of the performance, cost and availability of competitive products. With this knowledge, we were able to meet most of the OEM’s demands on terms that also benefitted us, or propose others that were acceptable to us. Our own demands fit the OEM’s budget and were for the most part easily accommodated. Protection of our intellectual property, particularly trade secret information, was crucial for us, and we pressed our requirements until the OEM agreed.

By the end of the second day, the OEM seemed satisfied with the results of negotiations. It now had a reliable supplier of a superior, highly engineered component, in desired volume, at desired cost, with a production and delivery schedule that fit its needs. We, too, were satisfied that the negotiated contract achieved our desired end. It was a classic win-win.

As anticipated, the OEM’s general counsel made the consignment demand after all else had been agreed to. We were prepared. We did not directly reject it, nor we did accept it. Instead, we followed our prepared script. We repeated calmly and deliberately that our product was measurably superior to anything they could procure elsewhere, was at an acceptable price, and would be produced and delivered on a schedule that allowed them to fulfill their customer commitments We used our small size to our advantage, repeating that this new demand would place burdensome costs and risks on us.

Then we said nothing.

Now, you know we wanted that contract. We wanted it signed before we left the OEM’s headquarters. We did not want to risk losing this contract or this new client. In fact, our European chairman and USA president had decided in advance that if push came to shove, the consignment arrangement could be acceptable if we were appropriately compensated. The OEM of course did not know that.

The OEM’s general counsel waited for us to respond. When we did not, he cleared his throat, shifted slightly in his chair, rounded his shoulders a bit and looked down. His voice was softer and of a different pitch when he said, “Well, that’s our final offer.”

It just didn’t look or sound like a final, take-it-or-leave-it demand. It looked like an opportunity for us to seize.

Our company chairman was tired. He began to shift in his seat and was about to speak. He later confirmed that he was about to accept their demand. However, at the last second, he took the cue to wait. He said nothing.

The silence following the “final offer” could not have lasted more than a few seconds. Our chairman thought it seemed longer.

Then the OEM negotiator sighed. “Well, okay. No consignment,” he said.

We all shook hands.

Deal done.

It was the single most profitable agreement ever obtained by our multinational client in its long history.

Saul Winsten is General Counsel of The Winsten Group.Trusted Counsel, LLC a leading legal, strategic and corporate affairs firm. He has served as General Counsel, executive, and trusted outside counsel of US and multinational businesses, non-profit organizations, and strategic alliances. Saul has also served with distinction as a member and leader of Boards of Directors.

*The Three Rules article above was excerpted and adapted from speeches, workshops, and presentations provided to leaders, lawyers, Boards of Directors, senior executive groups, business groups, trade associations and others.

A FEW SIMPLE STEPS THAT DIRECTORS CAN TAKE TO MINIMIZE DIRECTOR LIABILITY

Directors of Public Companies should take these steps. Substantial Privately-Owned and Family-Owned and Managed Companies would do well to take them as well.

With a few simple steps, directors can reduce the burden of these lawsuits and protect themselves from the most common tactics utilized by stockholders’ attorneys.

Seven Tactics for Minimizing Director Litigation Headaches

Published by Craig Zieminski and Andrew Jackson Craig Zieminski, July 10, 2017

Law firms that specialize in suing directors will scrutinize nearly every major transaction, public offering, stock drop, restatement, and press release filed by public companies. For instance, according to Cornerstone Research, stockholders file lawsuits challenging the majority of public company transactions valued at more than $100 million, with an average of three lawsuits per transaction. An effective defense of these almost-inevitable lawsuits can begin long before they are filed. With a few simple steps, directors can reduce the burden of these lawsuits and protect themselves from the most common tactics utilized by stockholders’ attorneys.

1. Vet conflicts early and often. Perhaps the easiest way to avoid fiduciary duty liability is to avoid situations where you have conflicting interests in a transaction or other board decision. Due to various protections under Delaware law, directors are rarely held liable for poor or ill-informed decisions if the directors are not self-interested (unless they are grossly negligent), and articles of incorporation almost universally protect directors from monetary damages for such decisions. By contrast, Delaware fiduciary duty law imposes exacting standards for directors who participate in board decisions when they have a material self-interest in that decision. Thus, any major board initiative should begin with a full analysis of each director’s potential self-interests, and this analysis should be updated throughout the initiative. Of course, this analysis requires you to stay organized with your outside business interests (e.g., your employer’s customers, suppliers, and competitors) and personal financial situation (e.g., ownership interests). Recusing yourself can be the stitch in time that saves nine.

2. Treat all board communications formally. The documents that often cause the most trouble in litigation are informal e-mails between two directors. Even if e-mails contain nothing objectively negative regarding the board decision at issue, such e-mails can raise questions about the board’s deliberative process, especially if the issue raised in an e-mail was not discussed with the full board. A skilled plaintiff’s counsel can often interpret a casually written message in an unintended manner. In most instances, if a director raises any concern outside of a board meeting, the full board should resolve that concern and memorialize the process in a contemporaneous document (e.g., the minutes). If you have said anything in an e-mail that is inconsistent with your ultimate vote on an issue—even if you were just playing “devil’s advocate”—you should be prepared to square your communications with your vote. In other words, make sure your concerns are resolved through the deliberative process before making your decision.

3. Maximize efficiency in pressing circumstances. Perhaps underestimating how quickly and diligently directors and their advisors can work in exigent circumstances, plaintiffs’ attorneys often allege that board decisions were too rushed. For instance, in one of the more infamous Delaware fiduciary duty decisions, a financial advisor did not send any valuation materials to a board of directors until 9:42 p.m. on the night that the directors met to vote on a merger. The board met at 11 p.m. and approved the merger that night. Tight deadlines are often unavoidable, but directors can take steps to maximize the efficiency of the process. For instance, request early drafts of meeting materials, make your advisors work around-the-clock when necessary, and don’t wait until the board meeting to ask questions. At the end of the day, you need to be able to honestly state that you had enough time to fully consider any issues or concerns and come to a reasoned decision. Use your resources efficiently to get to that point.

4. Make your advisors an asset, not a liability. The quality and independence of a board’s advisors is a direct reflection on the quality and independence of the board’s process. This scrutiny begins when a board (or committee) selects its outside advisors. Stockholders may cry foul if directors simply accept management’s recommended advisor, especially if any member of management may have a self-interest in the relevant transaction.

To avoid these common allegations, interview multiple advisory firms, thoroughly inspect their potential conflicts, and negotiate for a fee structure that aligns the advisor’s incentivizes with the best interests of the stockholders. Stockholders also regularly allege that advisors are “deal cheerleaders” who bend their analysis to support the board’s wishes. To rebut these allegations, insist that your advisors objectively analyze the relevant issues, and ask them to obtain the board’s approval for any significant assumptions, methodology decisions, and other subjective portions of their analyses. To the extent possible, you should also resist your advisors’ efforts to load their work-product with disclaimers. Above all, carefully analyze your advisors’ work-product, ask questions, and do not rely on their opinions until you understand and approve of the efforts and reasoning underlying those opinions.

5. Ensure that the meeting minutes fully reflect the process. We cannot overstate the importance of minutes in litigation against directors. First, judges and juries typically place more weight on contemporaneous records of a board decision than after-the-fact testimony. Second, depositions often happen several months (if not years) after a challenged board decision, and minutes are an important tool for refreshing directors’ memories. Ask the board secretary to draft minutes promptly after a board meeting so that you can review them while the meeting is still fresh on your mind. When reviewing minutes, make sure that they accurately reflect a summary of the issues discussed, the specifics of any decisions reached, and a list of all attendees (plus mid-meeting arrivals and departures). Not every single statement made during a meeting can or should be part of the minutes, but it is important for the minutes to reflect every topic discussed at the meeting. Ask yourself: “If I’m questioned about this meeting at a deposition next year, will these minutes help me answer questions and show the court that we fulfilled our duties?”

6. Know the boundaries of the attorney-client privilege. The attorney-client privilege is not a guarantee that all correspondences with counsel are shielded from discovery. For instance, contrary to many directors’ (and attorneys’) beliefs, the attorney-client privilege does not protect every e-mail on which an attorney is copied. Rather, an e-mail is generally privileged only if the correspondence is sent in furtherance of requesting or providing legal advice. Parties in litigation are often required to redact the “legal advice” portion of e-mails and produce the remaining portions. Thus, an e-mail (or a portion of an e-mail) concerning purely business issues might not be shielded from production. Additionally, communications with certain persons that would ordinarily be privileged, including in-house and outside counsel, may not be privileged under certain circumstances. Further, even if a document is undisputedly privileged, litigants sometimes waive the attorney-client privilege for strategic reasons, such as when the board asserts that it made a challenged decision in reliance on advice from counsel. While it is vital to have open and honest communications with your counsel, it is also important to remember that those communications may be shown to an opposing party. If there is something you would not write down in a non-privileged e-mail, then consider calling your attorney instead of sending an e-mail.

7. Use a board-specific e-mail address. By exclusively using a non-personal e-mail address for board-related correspondences, you can significantly reduce the odds of personal e-mails (or e-mails concerning your other business endeavors) becoming subject to discovery. Too often, we see directors using their “day job” e-mail addresses for their directorial correspondences; this can lead to situations where your employer’s confidential information must be copied, reviewed by your outside counsel, or (worse yet) produced to the opposing party in litigation. The same holds true for personal e-mail addresses, which some directors use for their family’s bank statements and board-related e-mails. The best way to potentially avoid this situation is to proactively segregate board-related e-mails to a different e-mail account. Some companies create e-mail addresses for their directors. If yours does not, consider creating an e-mail account and conducting board-related business solely from that address.

Craig Zieminski and Andrew Jackson are litigation attorneys at Vinson & Elkins LLP. They specialize in representing companies and their directors in lawsuits alleging breaches of fiduciary duties, partnership agreement duties, merger agreements, and federal securities laws.

Businesses And Boards-Curing A “Defective Corporate Act” Under Delaware Law

The Exposure
Under the Delaware General Corporation Law (the “DGCL”) otherwise permissible corporate acts that do not satisfy the consent and other procedural requirements of the DGCL, the corporation’s organizational documents or any other agreement to which the corporation is a party, are deemed to be “defective corporate acts” and are generally held to be void and of no legal force and effect.[i]

In sum, founders and their Boards should, at minimum, undertake the below listed procedural steps* in order to ensure that otherwise defective corporate acts are cured and ratified in the manner prescribed by the DGCL.

WRITTEN BY:

Fox Rothschild LLP

The Problem
As every founder knows, starting and scaling a company is an extremely difficult and multi-faceted undertaking. In addition to the primary goals of developing a viable product, finding (and in some cases building from scratch) a robust market, and raising the capital necessary to sustain and scale their business and operations, founders and their core teams also grapple with the day-to-day management and operations of a growing enterprise, whether that be personnel issues, forecasting cash needs and burn rates or tackling the legal and regulatory hurdles that often go hand-in-hand with the creation of disruptive technologies. Unfortunately, given the size and complexity of the average founder’s workload, it is no surprise that emerging companies of all sizes occasionally neglect to heed the advice of their attorneys and ensure that any and all corporate actions taken by the company and its officers are properly authorized and, if necessary, approved by the company’s Board and stockholders.

The Exposure
Under the Delaware General Corporation Law (the “DGCL”) otherwise permissible corporate acts that do not satisfy the consent and other procedural requirements of the DGCL, the corporation’s organizational documents or any other agreement to which the corporation is a party, are deemed to be “defective corporate acts” and are generally held to be void and of no legal force and effect.[i] The pre-2014 historical body of Delaware case law held such corporate acts, taken without “scrupulous adherence to the statutory formalities” of the DGCL, to be acts undertaken “without the authority of law” and therefore necessarily void.[ii] Prior to the enactment of Sections 204 and 205 of the DGCL, the relevant line of Delaware case law held that corporate acts, transactions and equity issuances that were void or voidable as a result of the corporation’s failure to comply with the procedural requirements of the DGCL and the corporation’s governing documents could not be retroactively ratified or validated by either (i) unilateral acts of the Corporation intended to cure the procedural misstep or (i) on equitable grounds in the context of litigation or a formal petition for relief to the Court of Chancery.[iii] In short, there was no legally recognized cure for such defective actions and the company was left forever exposed to future claims by disgruntled shareholders, which could ultimately jeopardize future financings, exits and ultimately the very existence of the company.

The Statutory Cure
Luckily, for those founders who make the potentially serious misstep of failing to obtain the required consents and approvals before taking a particular action (e.g. issuing options to employees or executing a convertible note or SAFE without the prior consent of the Board), in 2014 Delaware enacted Sections 204 and 205 of the DGCL, which served to clarify the state of the law in Delaware and fill a perceived gap in the DGCL by providing new mechanisms for a corporation to unilaterally ratify defective corporate acts or otherwise seek relief from the Court of Chancery.[iv]

While both Section 204 and 205 were intended to remedy the same underlying issue and provide a clear process for ratifying or validating a defective corporate act, the mechanics set forth in the respective sections take disparate routes to arrive at the intended result:

Section 205 provides a pathway for ratification that runs through the courts, allowing a corporation, on an ex parte basis, to request that the court determine the validity of any corporate act.
Section 204, on the other hand, is considered a “self-help statute” in the sense that the procedural mechanic provided for in the statute allows a company to ratify the previously defective act unilaterally, without the time and expense involved with petitioning the court for validation of the corporate act in question.
In the case of early stage companies, the expenditure of the heavy costs and valuable time associated with seeking validation in the Court of Chancery render Section 205 a less than ideal tool for curing defective acts. This post focuses on Section 204, which provides a far less onerous mechanic for ratifying defective corporate acts, allowing a corporation to cure past errors “without disproportionately disruptive consequences.”[v]

Section 204 in Practice
Section 204 provides a company with a procedure to remedy otherwise be void or voidable corporate acts, providing that “no defective corporate act or putative stock shall be void or voidable solely as a result of a failure of authorization if ratified as provided in [Section 204].”[vi] Pursuant to Section 204, a corporation’s Board may retroactively ratify defective corporate acts by adopting written resolutions setting forth:

the specific defective corporate act(s) to be ratified;
the date on which such act(s) occurred;
the underlying facts that render the act(s) in question defective (e.g., failure to obtain the authorization of the Board or inadequate number of authorized shares); and
that the Board has approved the ratification of the defective corporate act(s).
Additionally, if a vote of one or more classes of stockholders was initially required to authorize the defective act at the time such act was taken (e.g., the approval of a majority of the Series A preferred stockholders in the case of an act that falls within the purview of the Series A protective provisions), then ratifying resolutions of the relevant class of stockholders is also required in order to cure the prior defect in the corporate act.

In sum, founders and their Boards should, at minimum, undertake the below listed procedural steps* in order to ensure that otherwise defective corporate acts are cured and ratified in the manner prescribed by the DGCL.

A resolution by the Board that states (i) the defective corporate act to be ratified, (ii) the date of the defective act, (iii) if shares or other equity is involved, the number, class and date of the equity issuance, (iv) the reason for the defect, and (v) the approval and ratification by the Board of the defective corporate act.
Approval of the stockholders or a particular class of stockholders (in form of a written consent) if such an approval was required at the time of the defective corporate act.
Proper notice of the ratification sent to all stockholders (including stock that may have been invalidly issued). The notice must include a copy of the ratifying resolution/consent and an explanation that any claim that the ratification in question is not effective must be brought before the Court of Chancery no later than 120 days from the effective date of the ratification.
In certain circumstances, the filing of a “Certificate of Validation” with the Delaware Department of State to cure the defective corporate act being ratified (e.g., if shares were issued without filing the necessary Certificate of Amendment to increase the authorized shares of a corporation).
*This list should not be considered all-inclusive. Each situation is unique and further actions may be required depending on the underlying facts and the cause of the defect in question.

Takeaways
The potential adverse impact of an uncured defective corporate act cannot be understated. For an early stage company seeking to raise capital from venture investors or other outside parties (or eventually exit through an acquisition), the risks associated with such defective acts are particularly acute. As a practical example, a corporation’s failure to observe the proper procedures in the election of a director can result in the invalidation of such election. In the event of such a defective election, actions taken by, or with the approval of, the improperly elected Board may be void or voidable. This or other defective corporate acts may result in the corporation being in breach of representations and warranties in any number of contracts, including stock purchase agreements executed as part of a financing round or M&A transaction.

Generally speaking, relatively extensive due diligence is typically the first step in all venture financings and other major corporate transactions. As part of this process, counsel for the investor or acquiror will undoubtedly review all material actions of the company along with the corresponding Board and stockholder consents as a means of “tying out” the company’s cap table. Any defective corporate act that was not later ratified by the company in accordance with Section 204 or 205 will at best need to be ratified or validated in advance of the closing of the transaction, and at worst may result in either (i) a reduction in the company’s valuation due to the perceived risk that past actions are ultimately void or unenforceable, or (ii) in extreme situations, the abandonment or termination of the transaction.

In an ideal world, companies of all sizes would always observe the proper procedures in authorizing corporate acts and ensuring that all other necessary steps had been taken to ensure the validity of such actions. Unfortunately, in the fast-paced and often frenzied world of a startup, certain “housekeeping” items occasionally fall by the wayside. Upon the discovery of a defective corporate act by a company or its counsel, it is vital that the proper ratification procedures be undertaken in order to ensure that any and all past actions that could potentially be rendered defective are rectified and ratified in accordance with Section 204 (or in some cases Section 205) of the DGCL.

[i] A “defective corporate act” includes any corporate act or transaction that was within the power granted to a corporation by the DGCL but was thereafter determined to have been void or voidable for failure to comply with the applicable provisions of the DGCL, the corporation’s governing documents, or any plan or agreement to which the corporation is a party. See 8 Del. C. § 204(h)(1); See also, e.g., Blades v. Wisehart, C.A. No. 5317-VCS, at 8 (Del. Ch. Nov. 17, 2010) (holding that “scrupulous adherence to statutory formalities when a board takes actions changing a corporation’s capital structure”); STAAR Surgical Co. v. Waggoner, 588 A.2d 1130, 1136 (Del. 1991) (“Stock issued without authority of law is void and a nullity.”).

[ii] See, e.g., Blades v. Wisehart, C.A. No. 5317-VCS, at 8 (Del. Ch. Nov. 17, 2010) (holding that “scrupulous adherence to statutory formalities when a board takes actions changing a corporation’s capital structure”); STAAR Surgical Co. v. Waggoner, 588 A.2d 1130, 1136 (Del. 1991) (“Stock issued without authority of law is void and a nullity.”).

[iii] Id.

[iv] See H.B. 127, 147th Gen. Assemb., Reg. Sess. (Del. 2013): “Section 204 is intended to overturn the holdings in case law . . . that corporate acts or transactions and stock found to be “void” due to a failure to comply with the applicable provisions of the General Corporation Law or the corporation’s organizational documents may not be ratified or otherwise validated on equitable grounds.”

[v] In re Numoda Corp. S’holders Litig., Consol. C.A. No. 9163-VCN, 2015 WL 402265, at 8 (Del. Ch. Jan. 30, 2015).

[vi] 8 Del. C. § 204(a).

[View source.]

Corporate Governance and Change

Corporate Governance and Change

A Quick Review Of Basics

By: Saul Winsten,General Counsel
The Winsten Group.Trusted Counsel LLC.
A national Legal, Business, and Corporate Affairs firm
thewinstengroup.com

What is “Governance”?

Governance has been defined in different ways. For our purposes, corporate governance may be understood to mean the system, processes and relationships by which a corporation is controlled and directed. Boards of Directors are responsible ultimately for governance, the control and direction of the corporation they serve.
For brevity our discussion will focus on this topic as applied to closely-held and family-owned business corporations.

What has changed?

With ever increasing market competition, and pace and magnitude of technological change, the challenges encountered by closely-held and family-owned businesses and their Boards have grown. The traditional or legacy structures for governance, or legacy leadership may no longer be appropriate. New governance structure, processes, and leaders may be called for.

Questions concerning governance often include questions concerning the role and responsibilities of the Board, and how governance may be evolving in response to change. Below is a quick review of basic principles, and of some increasingly common business adaptations to change.

Basic Principles:

The Role and Responsibilities of Boards

Board responsibilities are separate from those of management. Boards are not to manage the business; executive management has that responsibility. The Board’s role and its responsibilities include:

1.To advise and consult with management on corporate strategy, operational performance & effectiveness, key performance metrics, executive performance and compensation, risk management, and growth and change matters
2.To provide oversight of and approve corporate strategy and strategic plans, major
acquisitions and divestitures, management and business performance, strategic matters,
company resource planning and needs, legal compliance, protection of assets, budget and
significant financing, mergers, and corporate reorganizations
3.To plan for executive and Board succession, select new executives, and
recommend new Board members

Board Requirements

Boards and Board members must act solely in and for the interest of the corporation. Board members should be qualified to carry out Board responsibilities, be informed and knowledgeable of matters that may come before the Board, exercise prudent business judgement, and act free from conflicts of interest that compromise such action and judgement.

Fiduciary Duties

Boards of Directors and individual Board Members have “Fiduciary Duties”, to act prudently, in and for the interest of the business and shareholders, with care, honesty, prudence, and in good faith.

The primary fiduciary duties have been referred to as “Duty of Care”, and “Duty of Loyalty”. Some courts and securities regulation also refer to a “Duty of Candor” or “Duty of Disclosure”. Various courts have identified and discussed specific aspects of these duties.

The “Duty of Care” requires Board members act with knowledge of the pertinent facts and circumstances, with care, after due consideration of all relevant information.

The “Duty of Loyalty” requires Board members act in the best interests of the corporation and shareholders, and to ensure that actions are taken in good faith.

“Good Faith” has been defined by Black’s Law Dictionary as requiring Board members act with “(1) honesty in belief or purpose, (2) faithfulness to one’s duty or obligation, (3) observance of reasonable commercial standards of fair dealing in a given trade or business, (4) absence of intent to defraud or to seek unconscionable advantage”.

Liability for Breach of Fiduciary Duties

Boards and individual Directors have been found liable for breach of their fiduciary duties.

Defense to Claim of Breach of Fiduciary Duties

A defense to an action against a Board for Board action is sometimes called “the business judgement rule”. Under that rule, a court generally will not “second guess” a Board decision if the Board: (i) followed a reasonable and informed process; (ii) took into account all relevant facts and circumstances; and (iii) made its decision” in good faith”.

Adaptations to Change
These include but are not limited to:

Enhanced Board “on-boarding” and education

To properly prepare new Board members for joining the Board and carrying out Board responsibilities, businesses and organizations are paying increasing attention to proper orientation, introduction and education of Board members. The need for such action increases with the size of the organization, complexity of the organization and its activities, demands of shareholders and stakeholders, and the nature and complexity of risks to which the organization is subject.

Use of Board Committees:

As the quantity and complexity of matters that Boards are to act upon have increased, the use of committees and the need for enhanced committee and Board expertise has increased.

Some matters, particularly complex matters requiring special expertise, are increasingly delegated to committees of the Board, which in turn make recommendations for Board deliberation and action. Committees such as Compensation, Audit, Governance, and Nominating, among others, are common.
Many Boards have an Executive Committee of corporate officers, who are tasked with developing recommendations on policy and other matters for Board action.

Matters requiring special expertise may be delegated to a committee which includes members with that special expertise.

An example of a committee tasked with matters requiring special expertise is the Audit Committee. This committee is charged with developing recommendations concerning matters concerning accounting policies, financial reporting, and other audit related matters. It is responsible for oversight of the independent auditor, internal financial control policies, financial risk management policies, and the performance of the internal audit function.

Another example is the Nominating and/or Governance Committee where identification of desired qualified candidates for Board service, selection of nominees for Board positions, governance standards and processes, Board and CEO evaluation may be discussed and recommendations made.

Other committees requiring specialized knowledge may be used by a business’ Board. These include Cybersecurity, Technology, Legal, Finance, Strategic Planning, M&A, HR, Ethics/Corporate Responsibility, and Environmental Committees, for example.

Addition of Independent and Specially Qualified Directors:

Another response increasingly used by Boards of closely held businesses, including family-owned or managed businesses, is the addition “Independent Directors” to their Boards. These Independent Directors assist the Board in carrying out its responsibilities by bringing independent thought, needed specialized expertise, and special perspective to those Boards. Examples of the knowledge and expertise sought and retained for Independent Directors include proven industry and outside business leadership, legal, finance, technology, cybersecurity, and other specialized expertise.
Some courts, notably Delaware, have addressed the issue of what makes a Board member “independent”.

Use of Board Counsel

Some larger businesses and organizations have retained special Board Counsel to provide independent advice and guidance on Board and governance matters of special concern. Board Counsel have been found especially useful where perspective, guidance, and advice independent of Board or executive leadership relationships, is desired.

Conclusion

Governance changes are driven by a number of factors. Growth, market competition, disruptive technology, regulatory requirements, and succession generated dynamics for example, may compel a company to change the way it does business, manages risk, and the way it is governed.
Businesses and organizations that will succeed are those prepared for change.

Heads Up: Board of Directors, Resignation from the Board, Duty of Loyalty.

When a venture capital fund invests in an emerging growth company, it typically seeks to protect its investment by obtaining the right to designate a member of the Board of Directors. While many of these individual designees are experts in their field and have vast networks of valuable relationships at their disposal, a newly designated director may be unfamiliar with the duties imposed on him should he want to resign. Paul Hastings Client Alert

March 2017 Follow @Paul_Hastings

Resigning From a Board of Directors:Considerations for VC Fund Designees
By Samuel A. Waxman, Jordan L. Goldman & Brooke Schachner

When a venture capital fund invests in an emerging growth company, it typically seeks to protect its investment by obtaining the right to designate a member of the Board of Directors. While many of these individual designees are experts in their field and have vast networks of valuable relationships at their disposal, a newly designated director may be unfamiliar with the duties imposed on him should he want to resign.

Delaware law generally gives the Board of Directors broad authority to manage the business affairs of a corporation. Although this level of discretion is generally extended to the ability to resign, there are various factors that should be considered when weighing the value of keeping a seat against the potential turmoil and liability associated with resignation. Designated directors often reflexively consider resignation when the company has run out of money or is heading into the so-called “zone of insolvency” out of fear of personal liability. Resigning at this point, however, may actually give rise to the very liability the director was seeking to avoid. As a result, it is important for a director to know when he can resign versus when he should resign.

I. The Benefits of Sitting on a Board: A Seat at the Table
The best way for a venture capital fund to remain informed and maintain influence on a company’s decision-making is to hold a seat on the Board. Directors have the power to vote on matters mandated by Delaware law, the certificate of incorporation, or the investment documents that affect material aspects of the business and its stakeholders. For example, Board approval may be necessary for: amendments to the certificate of incorporation and bylaws; equity grants or transfers (whether stock, options, or warrants); distributions to stockholders; borrowing or lending money; adopting an annual budget; hiring or terminating members of senior management (or amending their terms of employment); adopting employee benefit plans; a sale of material assets of the company; adissolution of the company; and/or entering into agreements and transactions of material importance to the company (intellectual property licenses, mergers, or IPOs).

This remains true even if the investment has gone sour. Directors will continue to have say over bridge financings, the direction of DIP loan packages, and other key decisions that need to be made by a company in distress.

II. Should I Stay or Should I Go?
Under Delaware law, a director generally may resign at any time, unless the certificate of incorporation or bylaws require otherwise. Notably, however, a director may not resign when doing so would constitute a breach of the duty of loyalty.

A. Duty of Loyalty
Directors have a duty to act in the best interests of the shareholders—personal benefit is secondary, even if management is making questionable choices. For example, simply resigning upon discovery of flagrant crimes committed by corporate insiders, without attempting to rectify the issue, may constitute a breach of the duty of loyalty. In In re Puda Coal Shareholders’ Litigation, a CEO was accused of theft through unauthorized transfers which went unnoticed for 18 months. A third party brought the suspected criminality to the attention of the independent directors, but the directors were “stonewalled” by management when they attempted to bring suit. So, the independent directors resigned from the Board. The Delaware court was critical of the directors’ decision to resign rather than cause the company to join a related derivative suit, stating that simply resigning at that point (while the company was in hot water) might be a breach of the duty of loyalty.

Similarly, in Rich v. Chong, another Delaware case, the court determined that ignoring numerous red flags and resigning from the Board may have constituted an abdication of the directors’ duties. In this case, the company completed its public offering in 2009. In 2010, it revealed discrepancies in its financial statements, and in 2011, auditors discovered a $130 million cash transfer to third parties in China. A 2010 stockholder suit urged the company’s audit committee to investigate, but the investigation was abandoned in 2012 due to management’s failure to pay the fees incurred by the audit company’s advisors. The company also failed to hold an annual stockholder meeting for several years despite a 2012 court order to do so. The independent directors subsequently resigned. Chiding the directors, the court stated that “the conscious failure to act, in the face of a known duty, is a breach of the duty of loyalty.”

Directors of companies with foreign operations, moreover, are subject to a heightened fiduciary duty. Delaware Supreme Court Chief Justice Strine’s view on local companies with foreign operations is that a director’s required engagement is even more strenuous (e.g., traveling to that foreign country, having language skills, and knowing the culture).

B. Reasons for Resignation
A director may want to resign from his position on the Board for several reasons. If the company breaks the law or materially breaches its bylaws or shareholder agreements, without immediate rectification, a director may consider resignation. In addition, a director may deem it necessary to resign over disagreements among the Board members. Deadlocks and discord can severely impede progress—a particular concern for growth companies. While discussion and debate is healthy for an effective Board, intractable differences of opinion about the company’s future can stall innovation and stifle success. Similarly, a fundamental opposition to some of the company’s major practices could be reason enough to step away.

Designees are often selected for board seats because of their expertise in a particular field and their vast network of connections. However, a conflict of interest may arise as a result. If conflicts of interest persist and become irreconcilable, a director’s exit might be best for all parties involved. Still, a director’s fiduciary duties to the corporation and its shareholders must be at the forefront of one’s concerns, and if an exit may constitute a breach of the duty of loyalty, directors must think twice
2
about resignation. In addition, while the director himself may not have a personal conflict, a designated director might wish to resign if the fund they represent is going to engage in certain debt financing transactions with the company.

Additionally, a director may want to resign if he is unable to obtain adequate protection against personal liability. A director should ensure that the company has a sufficient director and officer (“D&O”) insurance policy and an indemnification agreement in place that protects individual directors. It is important to make sure D&O policies have a proper tail so that directors are still covered even after they leave the Board. A director is often best served staying on the Board as long as possible to make sure that the D&O insurance is kept in place at the expected levels and/or to best negotiate a tail on his exit. Without appropriate D&O insurance, directors may face liability for certain claims against the corporation. Notably, a recently enacted California law includes directors in the group of individuals that may be held personally liable for unpaid final wages. While a director may be covered by insurance or indemnification in this instance, it is important to be aware of state laws that may subject corporate agents to additional liability.
Finally, evidence that management is not acting in the best interests of the shareholders may be cause for a director’s resignation. But again, a director has to be sure that his exit does not unduly harm the company or breach a fiduciary duty owed to the shareholders.

III. Practice Tips for the Director Pondering Resignation
When considering resignation, a director must act in the best interests of the company. Current or potential directors should research whether there are any unusual restrictions on resignation in the certificate of incorporation or bylaws or unusual internal procedures and policies.

Moreover, a director should take specific steps upon the discovery of illegality or malfeasance, namely:
1. A director’s first duty is to take reasonable steps to stop any ongoing legal or ethical violations.
2. If met with stonewalling, the director should seek independent legal counsel.
3. A director who decides to resign may want to submit a written statement to the chairman for circulation to the Board and possibly to the shareholders.
Following these general steps will ensure that a director can leave a Board while guarding against potential liability. The decision to resign from a Board must not be made flippantly. Facts and circumstances will rule the day; regardless, a director must always mind his fiduciary duties to the company and its shareholders.
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Heads Up: Boards, Businesses, Leaders- CyberSecurity, Risks and Responsibility, Heightened Requirements.

Dickinson Wright

Corporate boards recognize that cybersecurity is and will remain a high priority because of the attendant risks on so many levels. And two recent matters – one a case and the other a high profile internal investigation – portend that an imminent frontier in corporate monitoring will be cybersecurity.

Cybersecurity is “hot” and will stay “hot” for corporations, executives, regulators, law enforcement and legislators. Rarely is there a corporate compliance discussion in 2017 where cyber isn’t “the” topic or a material part of the discussion. Corporate boards recognize that cybersecurity is and will remain a high priority because of the attendant risks on so many levels. And two recent matters – one a case and the other a high profile internal investigation – portend that an imminent frontier in corporate monitoring will be cybersecurity.

Recent governmental attention to corporate cybersecurity programs suggests strongly that cyber oversight will be the next priority area for corporate compliance monitoring. The Securities and Exchange Commission (SEC), for example, announced in January 2017 that cybersecurity compliance procedures would be a key focus for its Office of Compliance Inspections and Examinations (OCIE) this year.i OCIE previously announced cybersecurity as a priority for its 2016 examination program,ii tracking its September 2015 cybersecurity examinations initiative.iii Considering prior enforcement actions by the SEC against investment advisors and broker-dealers to address allegedly inadequate cybersecurity policies that enabled data breaches, the SEC’s announcement is no surprise. Similarly, the Federal Trade Commission (FTC) has been flexing its enforcement muscle through actions alleging that policy failures led to the exposure of confidential consumer information.iv These actions consistently result in settlements that impose cybersecurity enhancements designed to prevent similar future incidents. In the absence of an informed and sufficient monitoring program, however, it is difficult to assess effectively whether the corporations are implementing the negotiated settlements properly and, perhaps more importantly, as expected by the agency.

The SEC has a well-established track record for using independent corporate monitors across a broad range of cases. The FTC, on the other hand is in its infancy doing so, somewhat surprisingly. In a September 2016 settlement, the FTC jumped into the monitorship space by imposing a monitor to ensure compliance with a settlement that required a company to change fundamentally its compensation structure by rewarding actual sales rather than recruitment of new distributors. Although that FTC settlement did not present a cybersecurity issue, the FTC nevertheless set the stage to connect monitorships with the agency’s already active regulatory attention to cybersecurity matters. An example of such an opportunity presented on March 1, 2017 when Yahoo announced, in its Form 10-K filed with the SEC,v that as a result of an internal investigation associated with three cybersecurity incidents – including the theft of data from more than one billion accounts – the Company “took certain remedial action, notifying 26 specifically targeted users and consulting with law enforcement.” The 10-K describes the cyber-centric “other remedial actions” as follows:

The Board has directed the Company to implement or enhance a number of corrective actions, including revision of its technical and legal information security incident response protocols to help ensure: escalation of cybersecurity incidents to senior executives and the Board of Directors; rigorous investigation of cybersecurity incidents and engagement of forensic experts as appropriate; rigorous assessment of and documenting any legal reporting obligations and engagement of outside counsel as appropriate; comprehensive risk assessments with respect to cybersecurity events; effective cross-functional communication regarding cybersecurity events; appropriate and timely disclosure of material cybersecurity incidents; and enhanced training and oversight to help ensure processes are followed.

The 10-K also references 43 related class action lawsuits and the company’s cooperation with the SEC, the FTC, the United States Attorney’s Office for the Southern District of New York, and two State Attorneys General. Additionally, the General Counsel and Secretary resigned, receiving no severance payments. Moreover, the CEO gave up $12 million in stock and did not receive her 2016 cash bonus. It is easy to see where breaches and remediation as Yahoo disclosed could become the door-opener for a cybersecurity monitor.

Traditional corporate monitoring models allow for the implementation of an independent monitor to oversee an organization’s compliance with imposed obligations over a period of time. Independent monitors, by operation of the monitorship agreement, typically receive access to the subject company’s personnel, files, books, and records that fall within the scope of the settlement agreement and have authority to take necessary steps to become fully informed regarding the monitored company’s operations, within the parameters of the agreement. The independent monitors also are free to communicate with the regulatory body (or agency) regarding the monitored company’s corrective measures (or lack thereof). If the subject organization is found not to have complied with the terms of the settlement (i.e., not adhering to the compliance and other policies, procedures and steps designed to remediate and correct the conduct that gave rise to the settlement), then penalties can be assessed, including reinstitution of the criminal or regulatory action(s), and extension of the monitorship. And, particularly in the cybersecurity area, systems vulnerabilities easily can challenge the test of compliance with the settlement terms.

Cybersecurity-related regulatory actions, however, usually do not follow this model. Instead, many cybersecurity settlements and consent orders mandate only that independent third-party professionals periodically assess and report on the implementation of information privacy and cybersecurity safeguards. Because cybersecurity settlement agreements do not typically include an active independent monitor with the requisite background and experience to assess an organization’s remedial cybersecurity measures on a granular level, the benefits of an imbedded qualified professional to ensure true remediation are absent from the impacted company. Ideally, a cybersecurity monitor would and should have through knowledge, skill, training, experience, or education sufficient up-to-date technical expertise and a measurable level of experience – preferably a minimum of five years of demonstrable experience dealing with cybersecurity or incident responses – to act in a cyber-monitoring capacity. Also, the cybersecurity monitor should hold a minimum of one relevant technical certification. Instead, the present norm is the less beneficial periodic spot-checking undertaken by professionals who likely do not have the level of knowledge of the organization or an in-depth appreciation of the issues surrounding what gave rise to the settlement and need for remediation in the first place.

This seemingly minimalist approach to corporate cybersecurity monitoring is surprising because proper implementation of cybersecurity safeguards is, by design, meant to be tailored to a specific organization. It is not always clear, however, that proper implementation necessarily will satisfy regulators’ expectations. For example, many experts view the National Institute of Standards and Technology’s Framework for Improving Critical Infrastructure Cybersecurity (the “Cybersecurity Framework”) to be a benchmark for modern digital security implementation standards. In a seeming inherent contradiction, the FTC has opined that (1) the Cybersecurity Framework is not something with which an organization can “comply,” and (2) even if an organization follows the NIST Cybersecurity Framework (which the FTC describes as “a set of industry standards and best practices to help organizations identify, assess, and manage cybersecurity risks”), then that does not necessarily mean an organization’s cybersecurity policies will withstand regulatory scrutiny.vi Additionally, cybersecurity enforcement actions often are precipitated by incidents exposing sensitive third-party information, which in turn result in the near inevitable perceptions of an absence of cybersecurity buy-in from management teams and a failure to fully appreciate various cybersecurity risk vectors. Periodic spot-checks of corporate policies, and even implemented practices, can miss these issues; meanwhile, an independent and informed monitor with appropriate in-depth knowledge of a company’s remedial efforts undertaken pursuant to a settlement agreement would be well-positioned to identify and remediate corporate deficiencies while simultaneously satisfying regulators’ expectations.

Properly addressing modern and emerging corporate and regulatory cybersecurity concerns demands a new compliance prism and model as part of settlement agreements with government agencies. Rather than simply accepting periodic external assessments, matters involving cybersecurity should be addressed more effectively through the use of a cyber-knowledgeable independent corporate monitor. That monitor will be able to appreciate the technical cyber and substantive needs of the subject company, have intimate knowledge of that company, and understand the goals and objectives of the regulatory body with the cyber-compliance expectations. Equally important is that the monitor will be in a position to ensure – from an informed position – that the company implements proper cybersecurity practices, and the Board, management and staff receive appropriate cyber-training. Thus, the not-too-distant future is now for cybersecurity monitoring and monitors.

i U.S. Securities & Exchange Commission, SEC Announces 2017 Examination Priorities (Jan. 12, 2017), https://www.sec.gov/news/pressrelease/2017-7.html

ii U.S. Securities & Exchange Commission, SEC Announces 2016 Examination Priorities (Jan. 11, 2016), https://www.sec.gov/news/pressrelease/2016-4.html

iii U.S. Securities & Exchange Commission, OCIE’s 2015 Cybersecurity Examination Initiative (Sept. 15, 2015), https://www.sec.gov/ocie/announcement/ocie-2015-cybersecurity-examination-initiative.pdf

iv E.g., Federal Trade Commission v. Wyndham Worldwide Corporation, 799 F.3d 236 (3d Cir. 2015); Federal Trade Commission v. D-Link Corp., No. 3:17-cv-00039 ((N.D. Cal. Compl. filed Jan. 5, 2017))

v https://www.sec.gov/Archives/edgar/data/1011006/000119312517065791/d293630d10k.htm

vi See Andrea Arias, Fed. Trade Comm., The NIST Cybersecurity Framework and the FTC (Aug. 31, 2016), https://www.ftc.gov/news-events/blogs/business-blog/2016/08/nist-cybersecurity-framework-ftc

Improving Family Owned Business Boards And Governance With Addition of Specially Qualified Independent Directors

This article originally appeared in The Family Business Boardroom quarterly newsletter.

Seven Steps to Recruiting Value Add Independent Directors
director_recruiting_final
© The Family Business Consulting Group
By Anne Hargrave

The Addition Of Specially Qualified Independent Directors To Family Owned Business Boards and Improved Governance Processes Is Increasingly Common, and Of Interest To Successful Family Owned Businesses.

Incorporating independent directors into a family firm’s board is considered one of the standards for family business success. The prospect of finding independent directors who can both challenge business leaders and represent ownership interests can be daunting. Following these seven steps will help identify directors who will add value to the family business enterprise.

1. Establish a Nominating Committee
Identify three to four people to manage the director search process and recommend candidates to the board, which is responsible for electing a new director. The nominating (or governance) committee can facilitate an inclusive process, incorporating stakeholder perspectives to identify candidates who will support the needs of the business and the shareholders.

2. Collect Stakeholder Opinions
Soliciting stakeholder opinions on the characteristics of a new director gives participants an opportunity to express their point of view and will make it easier to accept the ultimate conclusion of the board. It is helpful to:

Review strategic challenges and board member expertise – Consider how your industry is evolving and the degree to which the business is prepared. What parts of the strategic plan are new territories for management? What skills might a new director have to support management in executing the plan?
Assess the board’s culture and function – Clarify what you would like to maintain and what you would like to change. Consider the impact of near term retirements on the board’s culture and whether you are seeking a director who might become the chair in the future. What director characteristics are important to enhance the board’s functioning?
Consider family and shareholder dynamics – Independent directors who build relationships with shareholders, spouses and future shareholders can be valuable in creating alignment between the board and shareholders. What characteristics will be important for a new director to relate well with shareholders?
Explore potential added value for management – Ask management to identify specific skills in a new director that will be helpful to them. Taking into consideration the board’s view of management’s opportunities for growth, what attributes might a new director have to mentor to management?
3. Create a Board Prospectus
As a tool for recruiting new directors, the prospectus outlines important factors about the business and the expertise desired, including:

A summary of the business’ history, products, markets served, strategic focus and size
Rationale for seeking a new director
Board structure, including number of independents, committees, meeting frequency and board fees
Board responsibilities
Desired director experience, attributes and education
4. Solicit and Review Candidate Pool
The nominating committee manages a process of circulating the prospectus to colleagues, advisors and personal contacts requesting candidate referrals. They collect and review candidate resumes to establish a pool of candidates whose background aligns with the prospectus, at least on paper. Using a firm experienced in searching for family business directors can be helpful in expanding the candidate pool.

5. Conduct Interviews
The nominating committee then narrows the candidate field incrementally until a qualified director has been identified. It is helpful to break the interviewing process into the stages noted below to compare candidates and share thinking about the right fit for the board.

a) Provide candidates with the prospectus and confirm their interest.
b) Interview each candidate via telephone.
c) Review the interview outcomes and identify a small group of candidates for in-person interviews.
d) Invite candidates to meet in person with nominating committee members.
e) Review the in-person interview outcomes, determining whether you have the right candidates to choose amongst. If so, move forward.
f) Consider the value of additional interviews or a chemistry fit social gathering with key stakeholders for the final candidates.

6. Decide
When you have identified a board candidate whom you believe has the right skills, values and cultural fit, extend an invitation. At that time determine whether or not the candidate is interested in accepting, contingent upon reference checks.

7. Conduct Reference Checks
Conduct reference checks and any additional vetting to confirm the candidate’s value add to other boards, their level of expertise, and, if they have had family business experience, the manner in which they were helpful to the family and business system.

Boards Of Directors in 2017: 5 Trends To Be Aware Of.

Previously posted in Private Company Director Magazine

The Responsibilities Of Boards Continue To Increase, Demanding Increased Director Awareness and Understanding Of Developments Likely To Impact That Business.

2017 Board of Directors Predictions: 5 Trends to Watch
By Brian Stafford

“For board members and directors tasked with guiding their companies through these changes and the complexities that could arise in the aftermath of 2016, change is needed in the boardroom as well. From expanding skillsets to greater accountability for brand reputation and issues management, here are five of the top trends that will make the biggest impact on boards in 2017”.

2016 was a year marked by significant changes—stunning political upheavals via Brexit and our own controversial new President-elect; a growing number of big-ticket, multi billion dollar M&A deals amid massive enterprise court battles, particularly in the technology sector; evolving regulations and proposed governance standards; as well as persistent and increasingly destructive cyber security attacks, threatening everything from the outcome of the U.S. election to the sale of Yahoo to Verizon for $4.8 billion.

For board members and directors tasked with guiding their companies through these changes and the complexities that could arise in the aftermath of 2016, change is needed in the boardroom as well. From expanding skillsets to greater accountability for brand reputation and issues management, here are five of the top trends that will make the biggest impact on boards in 2017.

Prediction 1: Individual Accountability Becomes a Focus

Board members will be measured by more than just collective financial performance, but also for their personal effectiveness, diligence, ethical quotient (EQ) and contribution to the corporate brand. Thus, it will be imperative for board members to evaluate the security of their confidential digital communications (both personal and professional), and adopt modern best practices designed to protect the integrity of sensitive information, and ultimately, the brand’s reputation.

Prediction 2: Diverse Board Members Wanted (& Needed)

Boards have often been criticized for lacking the diversity and modern skillsets needed to compete in today’s fast-paced and technology-driven business world. However, in order to both solve complex challenges facing businesses today, as well as capitalize on market opportunity globally, more diverse views, experiences and skill-sets in the boardroom are needed.

This evolution will revolve around three key areas:

1. More women as directors
2. Board members with varied skill sets (such as technology and security)
3. Unwavering commitment to technological adoption in the boardroom, and across the enterprise.

Prediction 3: Greater Accountability Calls for Improved Collaboration

In 2017, board members must also have more transparency, authority and collaboration to advise and make key decisions in tandem with company decision makers.

As the level of accountability grows, there will need to be a redistributed line between the board and executive management. This new redistribution will also guide how the board interacts with activist investors, shareholders and each other.

Prediction 4: Cyber Security Becomes a Board Problem

In 2017, boards will need to strongly consider adding individuals with CIO/CISO experience. Cyber security is perhaps the single biggest risk to enterprises today, with breaches impacting corporations around the world daily, and many are not ready for battle.

To help better prepare, boards will need to make it a priority to enhance public-private partnerships and utilize third party providers to leverage the cumulative cyber-knowledge of its whole network. This will help solve fundamental problems like a lax security culture, knowing where data is located and how regulations will impact the company.

Prediction 5: Political Changes Enter the Boardroom

President-elect Donald Trump promises to bring about a variety of changes to foreign policy, domestic practices and corporate governance. With Trump in office, board members will need to keep an even closer eye on how corporate governance is set to change, including new requirements for board oversight as well as the evolving role of the corporate secretary. In fact, there’s already talk of potential changes to key legislations such as dismantling Dodd-Frank and swift immigration and labor changes.

2017 will undoubtedly be a transformative year for many enterprises and the boards that govern them. While time will tell how each of these trends will impact boards, I am willing to bet that those that continue to evolve and adhere to industry best practices will outperform those that stick with the status quo.
Brian Stafford is Chief Executive Officer of Diligent Corporation. Brian is responsible for all day-to-day operations, with a focus on accelerating global growth and incorporating scale into the business in order to seamlessly manage the growth. Brian previously served as a Partner at McKinsey & Company, where he founded and led their Software-as-a-Service Practice. Prior to his tenure at McKinsey, Brian was the Founder, President and CEO of CarOrder, a division of Trilogy Software based in Austin, Texas. Brian is also an active seed stage investor and start up advisor. His other passion lies in the arts, supporting the NYC community in his role as a BAM board member.

How Some Family Offices Are Changing Their Investment Strategies

Previously posted on LinkedIn.

Food For Thought On Some Family Offices’Changing Strategies for Investment, and For Direct Investment In Particular.

Balancing what can, therefore, be a rather imprecise notion of ESG performance or “impact” and the asset’s financial performance within the decision-making and constitutional framework of a family office may not be without its complications and some will take to this approach more readily than others.

Family Office Insights
Sustainable and Impact Investing: An Increasing Focus for Family Offices
As highlighted in our previous “Family Office Insights” piece, the last few years have witnessed a growing number of family o ces undertaking direct investments and developing their human and technical resources as enablers for such investments. While not without its challenges, such a strategy can deliver economic benefits by way of reduced fund management fees while giving investors a greater level of engagement and in uence within the underlying businesses.
At the same time, we are seeing mounting evidence to suggest that more and more family o ces are turning their focus and capital allocations toward businesses and assets that satisfy certain environmental, social and corporate governance (ESG) criteria and/ or that seek to achieve positive social or environmental “returns” or “impact” alongside nancial performance.
This is, of course, not a trend that is exclusive to family offices and should not come as a surprise. We live in a world of increasing interest in the environmental and social consequences of business and trade, where the behavior of corporations is scrutinized more and more rigorously, and so the impetus for making investments in and supporting organizations that have a positive impact on society will surely continue to strengthen. As social awareness and pressure increases, it seems inevitable that the whole gamut of investors, across the private and public sectors, will look to increase their exposure to, or use of, products or assets that satisfy certain ESG, “green” or “impact” criteria in one way or another.
Nor is this a recent phenomenon; the idea of investing to align with ethical standards or to incentivize or disincentivize certain types of environmental or social behavior is long established.
What has perhaps been a catalyst for the more recent trend, however, is a realization by many investors that companies (and the instruments deriving from them) operating ESG-sensitive business practices are capable of matching, if not outperforming, their peers and comparable investments from a nancial perspective.
Converging Trends
There could be said, to be some degree, of correlation between the growing trend of direct investments by family o ces and the increase in capital being allocated by family offices to businesses or investments that operate with ESG considerations at their core, especially those that can truly be said to be “impact investments.”
The Millennial generation is undoubtedly more influenced by and
in tune with ESG concerns than their forebears, and with a large number of 30-40-year olds now starting to assume greater decision- making responsibility within their own family organizations,
greater proportions of the capital at their disposal is now being aimed in this direction. The emergence of a new cohort of global entrepreneurs with strong social and ecological consciences and loud social media-enabled voices no doubt adds further support to the momentum of a generation who want to put their money to work in a socially productive and bene cial way, while still generating acceptable investment returns.
More particularly, while liquid assets in this space such as ESG- oriented equity funds become increasingly prevalent and investable and will continue to attract a meaningful share of available capital, alternative assets such as direct investments can o er a much more “hands-on” approach to ESG investing, by removing intermediaries and often giving investors a role in the operation or governance of a business, enabling them to make an “impact.” Reputational benefits by association may also accrue to families that are seen to be actively involved with ESG businesses and investments, which can add to the appeal for some family organizations. For the right asset and assuming nancial performance targets are achievable, there can then be a compelling investment rationale at the con uence of these developing trends.
What Are the Challenges?
In the case of direct investments, identifying and gaining access to the right investment opportunities and then executing them will present the sort of challenges with which family offices are increasingly familiar.
As well as the typical hurdles of sourcing deal flow and identifying investment opportunities, there is the more fundamental question
of how to measure performance as far as ESG or “impact” is concerned. This is essentially an emerging asset class that is still in its infancy; there is no such thing as standardized criteria with which to measure “impact” against, and while corporate governance (the “G” of ESG) has received considerable attention and is some way toward more global or regional standardization, the other limbs of this commonly used acronym remain di cult to quantify or verify. In the US and in other jurisdictions, including the UK, the development of the “bene t corporation” model, aimed at addressing ESG concerns and social investing more generally, does, however, show signs of providing one form of veritable framework in which to join a for-profit enterprise with a social investment goal.
While the general trend seems, therefore, to be one of ever-increasing development, transparency and disclosure (other examples of which include the “comply or explain” regimes for public companies, requirements for regulated funds and the proliferation of ESG-oriented indices in the public equity and debt markets), which will help with the evolution of best practice and benchmarks for many investors, an assessment of performance from an ESG or “impact” perspective will often be to a large extent subjective.
Balancing what can, therefore, be a rather imprecise notion of ESG performance or “impact” and the asset’s financial performance within the decision-making and constitutional framework of a family office may not be without its complications and some will take to this approach more readily than others.
How Advisers Can Help
There will be a range of areas in which external advisers can help, depending on the asset in question and what the investment aims and objectives are.
A thorough understanding of the business model and particularly the supply and distribution chains will be critical and, accordingly, a more bespoke and possibly more intrusive approach to due diligence might be necessary. Likewise, a familiarity with the markets the business operates in and the local public policy landscape may be more valuable than it might otherwise be. Negotiating and obtaining appropriate governance and information rights, giving an ability to direct or monitor specific aspects of its investment, can also become a crucial aspect of the deal terms and may go beyond what is typically sought by a minority investor. Where direct investments are made in real estate, analyzing and agreeing to the terms and conditions applicable to tenants and potential service providers can also be a means of shaping the performance and credentials of the asset. In the case of funds and listed entities, where the opportunity for direct “impact” will be more limited, investors may wish to consider how they can influence performance or behavior by way of shareholder activism or softer, more diplomatic means such as raising concerns with directors and fund managers directly. With such a variety of approaches and considerations, there will, therefore, be numerous ways in which advisors should be able to add value to the process throughout the life cycle of the investment.

Contacts
Robert J. Shakespeare
Of Counsel, Singapore
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E robert.shakespeare@squirepb.com
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McKinsey on Disruptive Technology-Driven Change In The Automotive Industry.

McKinsey Dec 2016
Shared previously on LinkedIn:

“Technology-driven trends will revolutionize how industry players respond to changing consumer behavior, develop partnerships, and drive transformational change.”
You will note that some of the strategic issues raised, are similar to issues being faced by manufacturers of other complex products.The ability to recognize and effectively respond to these issues will be of increasing concern and value.

Today’s economies are dramatically changing, triggered by development in emerging markets, the accelerated rise of new technologies, sustainability policies, and changing consumer preferences around ownership. Digitization, increasing automation, and new business models have revolutionized other industries, and automotive will be no exception. These forces are giving rise to four disruptive technology-driven trends in the automotive sector: diverse mobility, autonomous driving, electrification, and connectivity.

Most industry players and experts agree that the four trends will reinforce and accelerate one another, and that the automotive industry is ripe for disruption. Given the widespread understanding that game-changing disruption is already on the horizon, there is still no integrated perspective on how the industry will look in 10 to 15 years as a result of these trends. To that end, our eight key perspectives on the “2030 automotive revolution” are aimed at providing scenarios concerning what kind of changes are coming and how they will affect traditional vehicle manufacturers and suppliers, potential new players, regulators, consumers, markets, and the automotive value chain.

This study aims to make the imminent changes more tangible. The forecasts should thus be interpreted as a projection of the most probable assumptions across all four trends, based on our current understanding. They are certainly not deterministic in nature but should help industry players better prepare for the uncertainty by discussing potential future states.

1. Driven by shared mobility, connectivity services, and feature upgrades, new business models could expand automotive revenue pools by about 30 percent, adding up to $1.5 trillion.

The automotive revenue pool will significantly increase and diversify toward on-demand mobility services and data-driven services. This could create up to $1.5 trillion—or 30 percent more—in additional revenue potential in 2030, compared with about $5.2 trillion from traditional car sales and aftermarket products/services, up by 50 percent from about $3.5 trillion in 2015 (Exhibit 1).

Connectivity, and later autonomous technology, will increasingly allow the car to become a platform for drivers and passengers to use their time in transit to consume novel forms of media and services or dedicate the freed-up time to other personal activities. The increasing speed of innovation, especially in software-based systems, will require cars to be upgradable. As shared mobility solutions with shorter life cycles will become more common, consumers will be constantly aware of technological advances, which will further increase demand for upgradability in privately used cars as well.

2. Despite a shift toward shared mobility, vehicle unit sales will continue to grow, but likely at a lower rate of about 2 percent per year.

Overall global car sales will continue to grow, but the annual growth rate is expected to drop from the 3.6 percent over the last five years to around 2 percent by 2030. This drop will be largely driven by macroeconomic factors and the rise of new mobility services such as car sharing and e-hailing.

A detailed analysis suggests that dense areas with a large, established vehicle base are fertile ground for these new mobility services, and many cities and suburbs of Europe and North America fit this profile. New mobility services may result in a decline of private-vehicle sales, but this decline is likely to be offset by increased sales in shared vehicles that need to be replaced more often due to higher utilization and related wear and tear.

The remaining driver of growth in global car sales is the overall positive macroeconomic development, including the rise of the global consumer middle class. With established markets slowing in growth, however, growth will continue to rely on emerging economies, particularly China, while product-mix differences will explain different development of revenues.

3. Consumer mobility behavior is changing, leading to up to one out of ten cars sold in 2030 potentially being a shared vehicle and the subsequent rise of a market for fit-for-purpose mobility solutions.

Changing consumer preferences, tightening regulation, and technological breakthroughs add up to a fundamental shift in individual mobility behavior. Individuals increasingly use multiple modes of transportation to complete their journey; goods and services are delivered to rather than fetched by consumers. As a result, the traditional business model of car sales will be complemented by a range of diverse, on-demand mobility solutions, especially in dense urban environments that proactively discourage private-car use.

Consumers today use their cars as all-purpose vehicles, whether they are commuting alone to work or taking the whole family to the beach. In the future, they may want the flexibility to choose the best solution for a specific purpose, on demand and via their smartphones. We already see early signs that the importance of private-car ownership is declining: in the United States, for example, the share of young people (16 to 24 years) who hold a driver’s license dropped from 76 percent in 2000 to 71 percent in 2013, while there has been over 30 percent annual growth in car-sharing members in North America and Germany over the last five years.

Consumers’ new habit of using tailored solutions for each purpose will lead to new segments of specialized vehicles designed for very specific needs. For example, the market for a car specifically built for e-hailing services—that is, a car designed for high utilization, robustness, additional mileage, and passenger comfort—would already be millions of units today, and this is just the beginning.

As a result of this shift to diverse mobility solutions, up to one out of ten new cars sold in 2030 may likely be a shared vehicle, which could reduce sales of private-use vehicles. This would mean that more than 30 percent of miles driven in new cars sold could be from shared mobility. On this trajectory, one out of three new cars sold could potentially be a shared vehicle as soon as 2050.

4. City type will replace country or region as the most relevant segmentation dimension that determines mobility behavior and, thus, the speed and scope of the automotive revolution.

Understanding where future business opportunities lie requires a more granular view of mobility markets than ever before. Specifically, it is necessary to segment these markets by city types based primarily on their population density, economic development, and prosperity. Across those segments, consumer preferences, policy and regulation, and the availability and price of new business models will strongly diverge. In megacities such as London, for example, car ownership is already becoming a burden for many, due to congestion fees, a lack of parking, traffic jams, et cetera. By contrast, in rural areas such as the state of Iowa in the United States, private-car usage will remain the preferred means of transport by far.

The type of city will thus become the key indicator for mobility behavior, replacing the traditional regional perspective on the mobility market. By 2030, the car market in New York will likely have much more in common with the market in Shanghai than with that of Kansas.

5. Once technological and regulatory issues have been resolved, up to 15 percent of new cars sold in 2030 could be fully autonomous.

Fully autonomous vehicles are unlikely to be commercially available before 2020. Meanwhile, advanced driver-assistance systems (ADAS) will play a crucial role in preparing regulators, consumers, and corporations for the medium-term reality of cars taking over control from drivers.

The market introduction of ADAS has shown that the primary challenges impeding faster market penetration are pricing, consumer understanding, and safety/security issues. Regarding technological readiness, tech players and start-ups will likely also play an important role in the development of autonomous vehicles. Regulation and consumer acceptance may represent additional hurdles for autonomous vehicles. However, once these challenges are addressed, autonomous vehicles will offer tremendous value for consumers (for example, the ability to work while commuting, or the convenience of using social media or watching movies while traveling).

A progressive scenario would see fully autonomous cars accounting for up to 15 percent of passenger vehicles sold worldwide in 2030 (Exhibit 2).

6. Electrified vehicles are becoming viable and competitive; however, the speed of their adoption will vary strongly at the local level.

Stricter emission regulations, lower battery costs, more widely available charging infrastructure, and increasing consumer acceptance will create new and strong momentum for penetration of electrified vehicles (hybrid, plug-in, battery electric, and fuel cell) in the coming years. The speed of adoption will be determined by the interaction of consumer pull (partially driven by total cost of ownership) and regulatory push, which will vary strongly at the regional and local level.

In 2030, the share of electrified vehicles could range from 10 percent to 50 percent of new-vehicle sales. Adoption rates will be highest in developed dense cities with strict emission regulations and consumer incentives (tax breaks, special parking and driving privileges, discounted electricity pricing, et cetera). Sales penetration will be slower in small towns and rural areas with lower levels of charging infrastructure and higher dependency on driving range.

Through continuous improvements in battery technology and cost, those local differences will become less pronounced, and electrified vehicles are expected to gain more and more market share from conventional vehicles. With battery costs potentially decreasing to $150 to $200 per kilowatt-hour over the next decade, electrified vehicles will achieve cost competitiveness with conventional vehicles, creating the most significant catalyst for market penetration. At the same time, it is important to note that electrified vehicles include a large portion of hybrid electrics, which means that even beyond 2030, the internal-combustion engine will remain very relevant.

7. Within a more complex and diversified mobility-industry landscape, incumbent players will be forced to compete simultaneously on multiple fronts and cooperate with competitors.

While other industries, such as telecommunications or mobile phones/handsets, have already been disrupted, the automotive industry has seen very little change and consolidation so far. For example, only two new players have appeared on the list of the top-15 automotive original-equipment manufacturers (OEMs) in the last 15 years, compared with ten new players in the handset industry.

A paradigm shift to mobility as a service, along with new entrants, will inevitably force traditional car manufacturers to compete on multiple fronts. Mobility providers (Uber, for example), tech giants (such as Apple, Google), and specialty OEMs (Tesla, for instance) increase the complexity of the competitive landscape. Traditional automotive players that are under continuous pressure to reduce costs, improve fuel efficiency, reduce emissions, and become more capital-efficient will feel the squeeze, likely leading to shifting market positions in the evolving automotive and mobility industries, potentially leading to consolidation or new forms of partnerships among incumbent players.

In another game-changing development, software competence is increasingly becoming one of the most important differentiating factors for the industry, for various domain areas, including ADAS/active safety, connectivity, and infotainment. Further on, as cars are increasingly integrated into the connected world, automakers will have no choice but to participate in the new mobility ecosystems that emerge as a result of technological and consumer trends.

Automotive & Assembly

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