Founder Steps on Landmine; Blows Up Company!

Here's a story of a founder who may have killed her company while doing what she really believed was best for her, the team, and the shareholders.

Company Z was doing pretty well. They were 4 years into their journey building a great new business. Revenues were growing slowly and some signs were very positive, but they were struggling to raise a next round of capital and running short on cash.

Then one day the CEO called an urgent board meeting to announce that the company had received an acquisition offer. She said that while she was talking to prospective investors, one who had a position in another firm (Company Y) asked if she was open to an acquisition instead. Never one to limit her options, she said yes and promised to bring it to her board.

At the board meeting she shared the term sheet from the acquirer and listed a number of reasons why she thought the potential synergies made sense and why the offer seemed fair. The deal was essentially an "acqui-hire" where investors would get stock in Y in exchange for their Z holdings, and management would get hired on to continue to run the company as a subsidiary of Y with compensation in both cash and stock. She encouraged the rest of the board and observers to review it carefully and recommended voting to proceed with exclusive negotiations.

BOOM! Right there she stepped on her first landmine.

Good intentions aside, she failed to recognize that as a board member herself she had a duty of loyalty to the shareholders and the company to recuse herself from any further negotiation with the prospective buyers or from attempting to influence the board's review of the opportunity.

Under Delaware law, a board member who is an "interested party" to any material transaction is required to immediately disclose the potential conflict. It is then up to the rest of the board to see that the conflicted member is properly excluded from further interactions or discussions until the board has determined the appropriate course of action. This is part of the "Duty of Loyalty" - that a all board members must recognize when they stand to gain from a potential transactions in ways that differ from how other shareholders might get treated. In this case, the potential salary and bonus for the CEO might be much higher under Y's policies than it has been at Z, and the amount and terms of the stock grant she might receive would be different from those offered to the shareholders of Y.

But it gets worse...

At the board meeting, multiple investors brought up concerns about this Duty of Loyalty and urged her to recuse herself. The conversation then went on to show that key shareholders were split in their support for and opposition to this deal. The group then discussed several possible negotiation points and strategies to attempt to improve the proposed offer. No other board action was taken.

Less than 24 hours later, the CEO sent another email to the board indicating that she had spoken again with the CEO of Company Y and asked about improving the deal along the lines discussed in the board meeting. The acquirer said they might be willing to improve the offer a bit on some fringe terms, but that valuation and structure proposed originally was their "best and final offer". She was now asking that the board meet urgently to approve the termsheet and enter into exclusive negotiations with Y.

BOOM! #2.

The board has now also failed the shareholders by allowing the CEO to have any direct negotiation with the potential acquirer. The company is now at great risk of a lawsuit from investors unhappy with ANY possible outcome of these negotiations. If the board votes to accept the terms and move forward with exclusive negotiations, some shareholders will likely sue. If the board moves to decline the terms, others will likely sue. All because the board and the CEO failed to recognize the nature of the situation and act accordingly in the best interests of the shareholders and the company.

A lawsuit could also jeopardize any potential negotiations with the acquirer and kill the deal since no one wants to acquire unhappy and potentially litiguous shareholders. It could cost the company's D&O insurance company millions of dollars and tie the company in knots for years of distracting and expensive litigation, which could further limit the company's options for raising money from any other investors.

What SHOULD she have done?

As CEO/Founder, If you ever receive an acquisition offer (or for that matter any type of proposal in writing or just verbal) in which you would stand to benefit personally in ways that differ from how shareholders might benefit, STOP. Inform other members of the board of your conversations and any offers received or discussed. Ask one of the independent directors to take on any future negotiations with the other party and RECUSE YOURSELF from the discussions until the rest of the board has decided how to respond. Make no further outreach to the other party unless instructed by your board to do so.

It's always a possibility that your company might exit sooner than you expected in a way that trades the upside in your stock for the possible upside in someone elses'. In some cases, that can be good for both management and shareholders. But in others, management might stand to gain much more than shareholders - at least in the eyes of some shareholders.

Reasonable people can disagree on what is the best outcome for the company. But if YOU would benefit more under one scenario, even the whiff of conflict is enough to turn friendly investors into potential foes who might conclude that their now best opportunity to maximize return of their capital is through the courts. And if those investors succeed at merely stalling further negotiations with your proposed new partners, you could wind up putting your company out of business and be left with NOTHING while everyone else fights over the carcass of your hard work.

And all the while you truly believed you were doing the right thing for everyone.

Sometimes it's hard to know when we are biased about something and possibly blind to implications we just didn't see. This happens often in areas where otherwise highly competent CEOs over-estimate their situational awareness and charge ahead into matters where their experience is far more limited.

Welcome to being human. The only way to fix lack of situational awareness in the long run is to gain more experience. And while you're working on gaining that experience, you need to rely on your independent board members (and/or your board chair) to help keep you from stepping on those landmines.

So choose your board members carefully. Value experience and expertise over friendship. And consider asking someone else to be board chair for a while as you watch and learn. The company's life quite literally might depend upon it.

Your "best intentions" aren't always enough.

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Pat LaPointe is Managing Director at Frontier Angels and CEO Entrelliance Foundation.