Startup Toolbox

Jay Parkhill June 16th, 2008

My last post was a wonky one on changes in California law that affect company management’s ability to consider social good as well as shareholder value.  Here is a complementary piece to that, courtesy of Harvard Business School’s Working Knowledge newsletter.

Spending on Happiness — HBS Working Knowledge

The jist of the piece is that we spend our lives trying to accumulate money, but succeeding at that doesn’t make us any happier.  Instead, the researchers found that spending money on other people does increase happiness.

The article talks specifically about personal spending, but I am willing to bet that it holds true for companies as well.  Knowing that your company gives away money to help outside causes increases loyalty toward the business.

• Governance , business models , fiduciary duties , sustainability , triple bottom line

Jay Parkhill June 12th, 2008

There is a long-standing debate about the obligations of a company’s management to consider the needs of society at large. Economist Milton Friedman is famous for opining (to paraphrase) that the only duty of a company’s Board of Directors is to make money for the company’s shareholders.

In my view, this opinion completely sidesteps the issue of what time scale to consider, but it is entirely possible that a company could make tremendous short-term profit at the expense of segments of society at large, the environment, etc.

The California State Legislature has an opinion on this issue, too. There is a bill pending there (A.B. 2944 for the research-inclined) that would change the statutory duties of a director to include not only the company’s welfare, but society as well. The current duties of a director are to deliberate:

in good faith, in a manner that such director believes to be in the best interests of the corporation and its shareholders and with such care, including reasonable inquiry, as an ordinarily prudent person in a likeposition would use under similar circumstances.

As amended, a director would be permitted, but not required, to consider:

(i) The long-term and short-term interests of the corporation and its shareholders;

(ii) The effects that the corporation’s actions may have in the short term or long term upon any of the following:

(A) prospects for potential growth, development, productivity, and profitability of the corporation;

(B) The economy of the state and the nation;

(C) The corporation’s employees, suppliers, customers, and creditors;

(D) Community and societal considerations; and

(E) The environment.

Pros/Cons Analysis:

From the social welfare side, this bill would say clearly that directors need not hew to the Friedman viewpoint and may take a broad view of corporate duties. On the other hand, the list of factors a director may consider is long and not well-defined. Merely deciding on the company/shareholders’ best interests is difficult enough and it is not clear to me that this language adds anything that is not implicit in Board deliberations anyway. Would this language be useful in preventing a company from, say, strip-mining with knowledge that heavy metals will leach into groundwater?

The answer is “no, not by itself”.  However, this language does open the door for the B Corporation I have written about previously. B Corporations say loudly and clearly that their duties are to consider shareholder value alongside social benefits.  As noted at the top of this post, that is not a universally-held viewpoint.  Shareholders, directors, executives and the courts that eventually ajudicate questions of shareholder duty need some encouragement- not to mention law- to let them know that there can be more than one bottom line.

I am told that although 31 US states have similar laws on the books, this bill has been opposed from several sides.  Having passed the Assembly it is in the State Senate currently, but its odds of making it out and across the Governor’s desk are uncertain.  These things can take time, I suppose.  If it doesn’t happen this year, let’s hope for next.

• Governance , business practices , fiduciary duties , social welfare , sustainability

Jay Parkhill February 15th, 2008

It must be really tough to be Jerry Yang these days. First his no-sacred-cows 100 days campaign fizzled, now his Board is (if one believes the New York Post) seriously considering Microsoft’s tender offer.

Yang is a director as well, of course. That means that despite the obvious pride of ownership he has in the company, and his clear hope to turn things around rather than see the business picked up by anyone else, he needs to consider what is best for the shareholders.

But what is best? There is no way to answer this question, which is why directors and officers rely on the “business judgment rule” to shield them from Monday-morning quarterbacks everywhere. In short, so long as the Board acts conscientiously, considers all information that may be relevant to a decision and reaches a decision based on its analysis of all the facts at its disposal, the law provides significant protection- even if the Board’s decision works out badly.

In practice, emotions are hard to separate from facts. Yang and his fellow Board members need to put aside their personal feelings and decide whether the sale to Microsoft, sale to a third party, or going the course alone will bring the best outcome for shareholders. This is no mean feat, especially when you started the company and it has been part of your identity for a dozen years.

• Governance

Jay Parkhill January 29th, 2008

At least once a year since I started practicing law I have gotten a question about and copy of an official-looking letter entitled “Annual Corporate Minutes Compliance” or something similar. It’s a total scam and it has been a pet peeve of mine for years.

There are a number of companies that bilk unsuspecting corporations in this way. These companies ask for $100-$200 and in most cases will send a rote form of “shareholder meeting minutes” that won’t be valid because they will refer to an annual meeting that likely never happened on a date arbitrarily picked by the scammer.

I was pleased to learn recently that the California Attorney General has sued some of the more egregious participants in this obnoxious practice.

For the sake of getting the facts out, here are the legal requirements in California:

1) California corporations are required to submit a list of officers and directors along with the address of the company and agent for service of process every year. The fee for this is $25, and the California Secretary of State sends a form that looks like this to do it:

Corporations can also e-file here: https://businessfilings.sos.ca.gov/. Bottom line- if it doesn’t say it is from the California Secretary of State, suspect a scam.

2) Corporations in California are required to maintain minutes of Board and shareholder actions. Corporations are also required to hold annual shareholder meetings, but no agency will suspend a corporation’s right to do business for failure to hold the meeting or adequately document it so don’t fall for that scare tactic (NB: shareholders and potentially even third parties might have claims against a corporation if it fails to keep good records and respect the rights of its constituents, but that is a completely different kettle of fish).

3) If a corporation fails to file the statement described in #1 its right to do business will be suspended. I strongly recommend staying current with filings, but if the corporation is suspended, it can be reinstated in almost all cases merely by filing the delinquent report and paying the $25 fee (for each overdue year).

This is the kind of thing no one should have to remember or think about, and it drives me crazy. So to all the business owners out there- next time you get a letter asking for money to prepare your annual minutes, check it carefully to be sure it comes from- and the check is payable to- the California Secretary of State, or ask your lawyer to take a quick look.

• Governance , legal

Jay Parkhill September 14th, 2007

Cumulative voting is one of those theoretical legal concepts I’ve generally tried to avoid- it involves math, the archnemesis of attorneys everywhere.

Math matters, though, and so does cumulative voting. It can give small shareholders a voice on a company’s Board of Directors, or even swing the balance of power in certain situations.

In as few words as possible, then, here is what you need to know about cumulative voting:

What it means. Cumulative voting means that instead of voting shares for each director on a slate, shareholders can throw all of their potential votes behind one candidate. In other words, if there are 3 directors and I own 1 share, instead of voting my one share for each director, I can put all 3 behind a single candidate.

Not all states have it. Delaware allows it, but corporations must specifically provide the right in Certificate of Incorporation. In California, cumulative voting is an “inalienable” right of shareholders of private companies- it can’t be written out of the Articles of Incorporation or bylaws. Public California companies listed on NASDAQ, the NYSE or ASE are allowed to eliminate it. Other states vary.

It must be actively exercised. In California a shareholder must notify the corporation before voting of his/her intent to vote cumulatively, and then the entire election runs cumulatively.

How it is calculated. This is the math part. The formula for calculating how many votes are needed to elect a director is:

where

X = the number of shares needed to elect a given number of directors

S = the total number of shares represented at the meeting

D = the total number of directors to be elected

Even simpler is this online calculator.

Cumulative voting can be an important right for minority shareholders. Even if it doesn’t allow a shareholder group to control the Board, it can provide visibility into Board discussions and that can sometimes make all the difference. Wikipedia has a longer explanation with history, for those interested in reading further.

• Governance , legal

Jay Parkhill October 5th, 2006

Prior to the start of this year, Board actions by written consent had to be unanimous for California corporations, as in every other state of which I am aware. This is generally good policy- all Board members should be made aware of proposed actions. Board meetings must be preceded by formal notice; written consent actions do not require notice and the easiest way to ensure that everyone was advised is to require everyone to sign.

A slight disconnect exists, though, where a director has a personal interest in a matter under consideration- e.g. approval of a loan to/by a director. If the action is approved at a meeting the interested director can abstain from voting, but if the action is by written consent the director was still required to sign her approval.

The new law, codified in Section 308(a)(8)(b) of the Corporations Code, now allows an interested director to abstain from a written consent action as well, provided that the potential conflict is described in the written consent and the director abstains in writing.
This seems like a reasonable step by the California legislature. I have certainly talked to many clients who would have preferred to be on the record abstaining from votes on matters concerning them. The procedural steps are also sensible; disclosure should be a part of any well-written set of resolutions in any case.

My only question is what happens if someone decides disclosure was not sufficient? The law introduces a gray area where none existed before: either a consent was signed by all directors and the action was approved, or it was not. The new law allows for some uncertainty, and it will be interesting to see how matters evolve.

The legislature apparently considered this as well- the law sunsets at the end of 2010, indicating to me that it is meant as a test run to see how it works in practice. I wonder how many companies will actually take advantage of the provision?

• Governance