Considering Selling Your Company? Be Clear on Your Fiduciary Duties

Looking out for everyone sometimes means going the extra mile.
By Louis Lehot, business lawyer and partner at Foley & Lardner LLP in Silicon Valley, and formerly the founder of L2 Counsel, P.C.

These days, most entrepreneurs bring their companies to market for sale for one of three main reasons:

  1. It was a goal from the start to launch a business and sell it eventually;
  2. The venture has not been making any significant progress since its inception or;
  3. It is time to leave the business industry and enjoy retirement with the profits acquired. More about the eight key stages of M&A transactions here, and more on structuring the sale of your startup here.

Suppose you are contemplating selling your company as an investor or company founder who sits on the board. In that case, you have critical fiduciary duties to consider when making these types of big decisions.

Presumably, the highest duty is known to the law, the fiduciary duty is an obligation of loyalty and good faith to a person or entity. It requires dedication and care that does not allow a violation without exposure to personal liability. Fiduciary duties do not permit undisclosed conflicts of interest, and they also require transparent sharing of all information where even a whiff of conflict could be spotted in the rearview mirror. Before a person becomes a director of a corporation, much like the trustee of a will, it is essential to have a thorough understanding of fiduciary duties to others.

Today, a director can take the most critical steps to ensure compliance with fiduciary duties by attending every meeting, reading materials in advance, and considering the interests of all parties concerned, especially those not in the room. As a fiduciary, your actions will be viewed in hindsight with a 20/20 vision.
In recent years, the intersections of personal relationships with significant business decisions have received judicial scrutiny like never before, especially related to sales of securities. In a paradigm-shifting Delaware Chancery opinion, the court found that the undisclosed co-ownership of a pleasure craft among two directors (in the absence of any other factor) could potentially constitute a conflict of interest when the company upon which board the two directors served made a business decision.

When your company is for sale, your duties become heightened, and your fiduciary duties expand to include exerting best efforts to obtain the highest possible value for all stockholders. You should consider the interests of the common stockholders as “residual claimants,” therefore avoiding decision-making that benefits preferred stockholders to the detriment of the common stockholders. Oftentimes, your hands are tied, such as when the value of the company does not exceed the aggregate liquidation preferences of the preferred stockholders. What to do? Some companies in this situation may consider a “carve-out” of some amount of proceeds for the common stockholders (even those not comprising the current executive team required to execute the sale).

Following are simple guidelines you can follow to stay on the right side and walk the line:

  • schedule regular meetings to discuss whether or not a sale transaction makes sense for the company, including analyzing the company’s strategy, prospects, and value.
  • do your diligence and engage skilled experts and advisors. Engaging an investment banker to run a full sales process and bring the company to market provides useful cover to demonstrate that you exerted your best efforts to achieve the highest possible terminal value for all stockholders. (More about engaging an investment banker here.)
  • make sure to document the process in clearly drafted minutes reflecting a thorough consideration of all factors.
  • be sure conflicts of interest of directors and officers are disclosed to the board and stockholders if needed and reflected in the minutes.
  • if conflicts of interest exist among board members, set up a special committee or use independent non-interested directors to provide a check and balance in the process.

The global M&A outlook in 2021 is looking very strong. Following these simple rules will go a long way to ensuring successful execution.

Louis Lehot is a partner and business lawyer with Foley & Lardner LLP, based in the firm’s Silicon Valley, San Francisco and Los Angeles offices, where he is a member of the Private Equity & Venture Capital, M&A and Transactions Practices and the Technology, Health Care, and Energy Industry Teams. Louis focuses his practice on advising entrepreneurs and their management teams, investors and financial advisors at all stages of growth, from garage to global. Louis especially enjoys being able to help his clients achieve hyper-growth, go public and to successfully obtain optimal liquidity events.

Originally published on Medium

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