6.4 Managing Fiduciary Duty – Charting the Course

Proper exercise of the fiduciary duty of the Board of Directors is fundamental to a company’s success. In venture-stage companies, performing fiduciary duty well and transparently builds confidence and trust in the Directors – essential if the Board is to mentor the CEO and guide the company’s progress.

However, there are pragmatic challenges in executing fiduciary duty cleanly and transparently in early-stage technology companies. This is because many Directors and investors do not agree on what constitutes good governance. A group of venture capitalists (VCs) and consultants in Silicon Valley have developed a series of white papers articulating best practices for Boards and Directors of venture-stage technology companies [i], [ii]. While the articles claim a ‘company-first’ focus, they also note that when push comes to shove, VCs are not bound to act in the interest of all shareholders. This excerpt is quite instructive:

"The largest active shareholders and those who elect the Board are in fact the same people. Therefore the VC Board member is less compelled to listen to the voice of other shareholders than his publicly traded company counterpart … the investors that do the most work, have the most money at risk, and have the best track records will continue to drive the venture company’s agenda. Attempts to ‘level the playing field’ in the name of good corporate governance are surely inapplicable to venture capital." [i]

In addition, there is often a shareholders’ agreement that assigns many decisions to the VCs, such as veto on sales of assets, selection of the CEO, and restrictions on creating new classes of shares. This agreement in effect transfers residual control on many crucial matters to the investors.

Advocates of good corporate governance may find these long-standing practices disturbing. By reserving certain rights, VCs are inhibiting the Board’s ability to exercise its fiduciary duty on behalf of the company and its shareholders and this diminishes the role and credibility of the Board.

However, there is a growing sentiment that the inability or incapability of the Board to exercise its fiduciary duty is a major contributing factor in the poor performance of many venture-stage technology companies. Stricter practices are needed to improve governance and corporate performance.

The pragmatic challenge is that there are many experienced people who are willing to serve as Chairperson of early-stage technology companies. Most independent Directors (when they can be found) are chosen for their industry knowledge and operational experience, not for their governance abilities. That said, corporate governance is not a mystery and it is incumbent on all Directors to acquaint themselves with best practices and act accordingly.

Stay tuned for next issue’s article, which will delve further and examine how to steer the ship of fiduciary duty in a sea of conflict.

i]. "A Simple Guide to the Basic Responsibilities of VC-backed Company Directors",   Working Group on Director Accountability and Board Effectiveness, Chairman Pascal Levensohn, Oct 2007.

[ii]. Dennis T. Jaffe, Ph.D, Pascal Levensohn: "After the Term Sheet:  How Venture Boards Influence the Success or Failure of Technology Companies", Nov 2003.

This article first appeared in the Spring 2010 edition of The Hire Standard – the newsletter of Corporate Recruiters, British Columbia’s leading recruiters of high technology talent.