EP 012 – Skadden

[00:00:00] Doug Chia: Welcome to the Public Company Series Podcast, powered by OnBoard: giving boards the clarity, security, and insights they need to make better decisions and lasting value. I’m your host, Doug Chia. This podcast series is designed to give corporate directors, executives, and governance professionals the insights and tools they need to build boards that are agile, resilient, and prepared for the future.

[00:00:32] Doug Chia: It is based on the book Board Structure and Composition, which is part of the Public Company Series published by the New York Stock Exchange and JP Morgan. My guests for today’s episode are Jeremy Winter and Michelle Gasaway. Jeremy and Michelle are both partners in the Capital Markets Group at Skadden.

[00:00:53] Doug Chia: They authored the chapter of the book entitled The Board Observer: Considerations and Limitations. Jeremy and Michelle, welcome to the show.

[00:01:04] Michelle Gasaway: Thanks, Doug.

[00:01:05] Jeremy Winter: Thanks. Great to be here.

[00:01:06] Doug Chia: So I’ll set the context for today’s discussion and then we’ll jump in. One instrument of corporate governance that doesn’t get talked about in the world of public companies yet is prevalent in the world of private companies, is the board observer.

[00:01:23] Doug Chia: A survey from January, 2024 showed that over 80% of venture capital funds who participated in the survey. Utilize board observers within their governance frameworks with a significant proportion planning to increase the use of board observers in the near future. So the underlying challenge that we’ll be discussing today is: how

[00:01:49] Doug Chia: a private company board with board observers transitions during the IPO process? First, we’ll cover what the board observer is and is not, which Jeremy and Michelle’s chapter of the book explains in more detail, including the purpose of board observers, distinctions of board observers from directors, the prevalence and use of board observers, their access to information, liability, and the increased regulatory focus on board observers.

[00:02:25] Doug Chia: We’ll also talk about the overall considerations for board structure and composition for private companies going through the IPO process. And so with that, let’s dive into this. So, uh, Jeremy, Michelle, let’s start with what is a board observer and why would a board have this? I mean, the term board observer, when I first heard it.

[00:02:51] Doug Chia: It sounded like it could be, you know, the proverbial fly on the wall during a board meeting or shadow director or something like that. So why don’t you just give an overview of this, this term and what it is, what it isn’t.

[00:03:05] Jeremy Winter: Sure. I think you might have just hit both sides of the spectrum. I mean, in some companies the hope is that the board observer is simply a fly on the wall, simply observing from the sidelines.

[00:03:13] Jeremy Winter: And yet in other companies, they’re some of the most respected voices in the room. And therefore often drive the agenda for a board meeting and are are invited to speak, more than welcome to speak. So I think they sort of run the gamut, depends on the, the nature of the observer, the nature of the company, and sort of what they have going on.

[00:03:32] Jeremy Winter: But they can be very active members of the board deliberation and they can be a fly on the wall.
[00:03:38] Michelle Gasaway: Yeah. And, and that’s the, one of the, the great things about a board observer and, and investors who are looking at a board observer, and whether that fits into their framework of investing is because it’s a function of contract.

[00:03:50] Michelle Gasaway: And so you write the contract with the information rights, the participation rights, whether they’re, it’s just the board or at the committee levels. And really the role that the board observer is going to play. And so, you know, the shadow director is the extreme where, yes, we’ll, we’ll get into that I expect on what happens if a board observer gets a little too active and a little too board of directors, like, and what that means, um, for liability and, and the other things that you mentioned.

[00:04:16] Michelle Gasaway: But otherwise, you know, you can write it in the contract and, and have it be really what works for the investors. So there is a lot of flexibility there in terms of what they’re trying to achieve by having a board observer and different investors will have different goals.

[00:04:30] Doug Chia: So that’s interesting. So a board observer is a creature of contract as opposed to statute or common law.

[00:04:39] Doug Chia: And so typically, how does a board observer differ from a, I guess, called regular director? It sounds like you can pretty much write it however you want, but you know, in terms of the classic board observer, what are we used to seeing?

[00:04:56] Jeremy Winter: So, because it’s a matter of, of contract, you have total flexibility. You don’t have this overhang of fiduciary duties and, and sort of corporate law impositions in terms of what the role has to entail.

[00:05:08] Jeremy Winter: The classical sense is the ability to attend board meetings, the ability to receive the same materials as the board. Typically at the same time as the board, uh, but not the ability to participate in discussions where you need to sort of protect the attorney-client privilege that exists when, for example, we as outside counsel are speaking to a board of directors as our client.

[00:05:29] Jeremy Winter: The manifestation of our client, the corporation. The classical board observer role is the ability to attend and participate in the deliberation at meetings, and simply exclusion from particularly sensitive matters.

[00:05:42] Michelle Gasaway: And then typically they’ll document that in, in whatever round they’re investing in or the documentation by which the investor is investing, be it the investor rights agreement or the voting agreement.

[00:05:51] Michelle Gasaway: Just like some investors will have likely have board seats set forth in those documents, some investors will prefer for their, you know, their governance documents or otherwise to specify instead that they have a board observer and they will look very similar in terms of access to meetings, access to information,

[00:06:08] Michelle Gasaway: um, but the board observer will be a right of contract and there are additional considerations, not only the rights that they have, but the protections that they’ll need. They don’t have the benefit of, of charter you know, indemnification, statutory indemnification. DNO insurance, because they’re not directors.

[00:06:25] Michelle Gasaway: That is also something that people would want to specify in the documentation as well, that that appoints their board observers, so they make sure that they have the protections as well, because they’re not going to get the benefit of the statute on those.

[00:06:38] Jeremy Winter: And I suppose we should mention the, the, the primary differentiating factor is, is that the board observer does not get to vote in the meeting.

[00:06:44] Jeremy Winter: That’s sort of like the, the key factor that makes somebody a board observer as opposed to a director. So we should sort of start from that baseline assumption.

[00:06:51] Michelle Gasaway: In your words, a fly on the wall.

[00:06:53] Jeremy Winter: Yes.

[00:06:53] Doug Chia: Yeah. But I guess, you know, being a fly on the wall means you, you don’t speak. Can you have a board observer who kind of like, yeah,

[00:07:02] Doug Chia: the condition is this person must, you know, have duct tape on their mouth the whole time?

[00:07:07] Michelle Gasaway: No, they, they can speak, they, they just don’t get to vote as when the board actually takes, passes a resolution, they cannot vote on that resolution. But, but the speaking is actually why board investors can add so much value.

[00:07:20] Michelle Gasaway: So we’ve talked a lot about the investor perspective of why an investor might want a board observers so that they can get information about the company, engage with management, engage with the board on the strategic direction, bring a lot of the investors’ experience to bear on the board, especially on a private company board, but it is equally, can be beneficial to the board itself so that they get the benefit of that investor’s experience.

[00:07:42] Michelle Gasaway: The investors often have a long history of, of serving on boards, especially if they’re VC investors who then, you know, roll off when a company becomes public. But it’s equally as beneficial to the company to have a board observer that can really engage with the board and add that value, which is, you know, it works both ways and benefits

[00:07:59] Michelle Gasaway: both parties.

[00:08:01] Jeremy Winter: And companies will often insist on a particular individual serving as the board observer representing a particular fund. You might be willing to give one of your smaller investors, not a board seat, not an actual voting position on your board, but an observer seat so long as this one individual who you respect and think will cooperate and play nicely in the sandbox with the rest of your existing board,

[00:08:22] Jeremy Winter: so long as that is the individual who’s attending the meetings, and if not that individual, then you need to revisit again, it’s a matter of contract, so you need to revisit that contract and decide whether you want that investor to have a different individual attending your meetings.

[00:08:34] Doug Chia: So in, in terms of the, you know, fiduciary duty, is that really a function of not having a vote or is that something that you could write it into the contract or you could write it out of the contract?

[00:08:50] Jeremy Winter: Absolutely. In fact, it used to be a part of the, the NVCA model form used to include, it used to impose fiduciary duties on observers. And if you think about how closely they act to a true voting director in some of these private companies, it makes a lot of sense they would have fiduciary duties. I mean, it’s very important that they impose the same candor and duty of loyalty to the corporation.

[00:09:14] Jeremy Winter: Do not take that really sensitive information from these early stage companies and bring it to one of the other portfolio companies on whose board they actually sit. Those are all very important features of a board observer’s role. But the fiduciary duties do not apply as a matter of law. And so instead, what you’ve seen over the past few years is that, uh, consensus has emerged among these companies that in engaging a board observer and providing them that access, you impose similar duties as a matter of contract, a duty of confidentiality, and, and certain restrictive covenants on what they’re able to do with the information that they receive when attending your meetings.

[00:09:48] Doug Chia: What about public companies?

[00:09:50] Michelle Gasaway: So it’s a lot more rare in public companies and, and if you think about the fundamentals of why investors typically want a board observer and why a company wants a board observer for information flow, seeing what’s going on with the board, there will be a tension in a, in a public company as well, between what type of investor

[00:10:09] Michelle Gasaway: it is. So for example, in a public company, they’re making SEC filings. So the information, the financials, a lot of the information and inspection rights that you would want as a, a board observer, frankly, a board member of a private company that’s out there in the public filings. So there’s less of that that you need. If as a board observer, you want earlier access to that information and you still wanna play a role in terms of a strategic advisor,

[00:10:34] Michelle Gasaway: you know, engaging with the board, giving the benefit of your experience, which you do see in a lot of certain, certain companies, companies that are coming out of restructuring early stage IPO, companies of the VCs happen to stay on. Then there’s a tension between, you’re a board observer, you’re not a board member, but you’re getting the same information and you have to think about, are you the type of investor that you know wants to trade in the securities of the public company?

[00:10:59] Michelle Gasaway: And you’re getting this inside information. And oftentimes, board observers aren’t subject to blackout periods. But if you’re getting material non-public information in your capacity as a board observer, you very much should be mindful of the securities laws and, and whether or not you can trade. And a lot of investors don’t want that in terms of a public company and being saddled with, you know, those types of restrictions of being a board observer.

[00:11:23] Michelle Gasaway: So when we have clients say, well, I’m making a large investment in a public company, I would be great to get a board observer’s seat so that I can see what’s going on. And you have to have that conversation of, okay, what are you looking to achieve with what is going on? Because you will be subject to restrictions.

[00:11:40] Michelle Gasaway: And a lot of times they’re willing to say, this makes a lot of sense. Particularly people coming into strategic investors, long investors, they’re not looking to trade. They have commercial arrangements, collaborations, and the whole purpose of why they want a board observer is what you know we originally talked about, which is they want to help drive the strategic direction of the company.

[00:11:58] Jeremy Winter: But it’s at least something that you have to think about, which you don’t as much in the private company context. It’s a, it’s a double-edged sword and so you want the information, but sometimes you don’t want the information and you have to do that calculus before you accept a role as a board observer and start receiving that information.

[00:12:12] Jeremy Winter: And that’s often why we’ll see some VC directors will roll off a board ahead of the IPO because they want to be able to trade as soon as the stock becomes eligible for trading.

[00:12:20] Doug Chia: So it’s really a matter of, it’s just more complicated when it comes to public companies for various reasons, and with private companies it’s just a lot cleaner without disclosure and all of that kind of stuff.

[00:12:33] Doug Chia: You know, in terms of investors that do or don’t like this, um, in the public company sphere, obviously, the large institutionals like BlackRock, State Street, Vanguard dominate. Do we have any idea of how they view board observers in general? Is this something that’s like frowned upon or they really don’t care?

[00:12:57] Jeremy Winter: I think they typically don’t like to [00:13:00] agitate. I think there are some public company investors who have no problem developing a reputation as overbearing on the, the companies in which they take sizable investments, and I, I think you would never really read that about the BlackRocks and State Streets and, and Vanguards.

[00:13:13] Jeremy Winter: So I, I don’t think that they particularly care about being in the room at the time of the, the deliberations. I, I think that they, their investment thesis is, is established at the time of their investment and they’re happy to monitor their investment and, and preserve the ability to trade out of their investment whenever they deem appropriate based on the publicly available information.

[00:13:34] Michelle Gasaway: And I would say in terms of a perspective that large investors might have on whether a company has a board observer or not, you know, that’s not someone those investors appointed, but just looking at the company as a whole and whether they do have board observers, it’s going to come down to whose board observer are they?

[00:13:49] Michelle Gasaway: Like Jeremy said, is it more of an investor that is going to sort of take a more outsized role or look to take an outsized role or comes with certain reputation behind them putting a board observer on, what is the board observer doing? You know, who are they is, you know, is it, is it an affiliate, affiliated board observer?

[00:14:07] Michelle Gasaway: And, and you’ve got an independent board with a very strong affiliate voice in there. So in terms of just the overall perspective of, of board observers, especially in public companies, it, it can come down to who, who has the relationship with the board observer, why are they there? And sort of what is, what is the purpose of, of the investor’s goal, as well as the company’s goal for having that observer.

[00:14:27] Doug Chia: So are board observers up for election or are the shareholders pretty much stuck with whatever the board negotiates with whoever’s, you know, picking these board observers?

[00:14:42] Michelle Gasaway: So it’s a matter of contract as well in the public company. And if you have a large investor coming in, even a public company, there could be still be investor rights agreement.

[00:14:51] Michelle Gasaway: There could be a shareholder’s agreement. If it’s a lender, there could be something in a loan agreement if it’s someone you know akin to sort of a restructuring related investor, you could have it in whatever contract they have with the company. And so it’s still a matter of contract. They’re not up for an election like a board is under state law.

[00:15:09] Michelle Gasaway: And so investors, you know, other than, you know, trying to sort of agitate the company in different ways, um, they don’t have a say on who the board observer is because again, it’s, it’s a matter of contract, not a matter of statute or, or corporate law in terms of having them up for election.

[00:15:26] Jeremy Winter: And it’s really a, a bilateral contract, just the company and the investor that appoints the observer or the observer themselves.

[00:15:32] Jeremy Winter: So I think if the observer is going to be removed, it’s going to be by the investor who designated them as an observer and then replaced with perhaps a different individual from that fund who can provide more value, play more nicely in the sandbox with the existing management team, things like that.

[00:15:48] Doug Chia: Yeah. ’cause I guess with a dissident director Black Rock, State Street and Vanguard, you know, you’re trying to lobby them to get them on board with that, ’cause they’re voting. So in this case, even at BlackRock, state Street and Vanguard are like this board observer thing, we’re, you know, not good with it.

[00:16:05] Doug Chia: It’s like too bad. You don’t really have a choice, is a contractual thing. So you kind of have to trust the board on that. But that, I guess brings us to another issue in terms of what about proxy advisory firms? Obviously, like we said, they, nobody has a vote, so it’s not like they can recommend a vote on the observer, but they could recommend, you know, the nom gov chair should be dinged or you know, some of the other directors.

[00:16:35] Doug Chia: Are you seeing that in terms of proxy advisory firms actually taking a stance here?

[00:16:41] Jeremy Winter: I haven’t seen shareholder bases or the proxy advisory firms get too spun up over the, the role of board observers. That’s not to say I can’t envision a situation where it would happen and where it would be warranted, but this again, they’re non-voting flies on the wall, and so they don’t normally invoke that type of reaction where they develop a, a lobby against them.

[00:17:04] Jeremy Winter: They’re, they typically don’t have enough power to warrant anybody’s energy and attempt to get them out of the room.

[00:17:08] Michelle Gasaway: And, and as we talked about earlier, it’s rare in public companies, um, versus private companies. And so when you do see it in public companies, there’s typically a str more of a strategic reason for it.

[00:17:20] Michelle Gasaway: Not always, but often it, it’s a commercial arrangement collaboration. We’ve got a restructuring advisor and someone’s sort of an observer to, to guide that. Um, otherwise, you know, if someone really wants to get a control position at a public company, they’ll look, put people on the board, right? The board observer is not going to achieve the objective if they’re trying to sort of lobby for, for activism or change at the company.

[00:17:42] Michelle Gasaway: They need people on the board to do that, and so it’s just a rare situation. I can see sort of edge cases where perhaps if they were acting too much as a shadow director or really engaging in decisions or pushing the board to places that there could be objections, but I think it would be an edge case on the facts.

[00:18:01] Doug Chia: But I’m guessing the, the board observer is probably, if, if a public company were to have one, it would probably be because there was one on the IPO and it’s just kind of carry over or it’s an activist that is suggesting this, or maybe it’s kind of like they, they had some kind of compromise that, okay, board’s not gonna take a dissident director and they just settle on

[00:18:23] Doug Chia: “Okay, you got a board observer”, I would guess that’s typically the case that boards aren’t like, “Hey, we need a board observer, let’s go find one.”

[00:18:33] Michelle Gasaway: No, there there’s, there’s an inve, like, like, like Jeremy said, it’s a bilateral agreement and so you get to their, you get there bilaterally, right? Where an investor wants to bring something to the table and the company believes that that is something that is useful for it and it’s board to have an observer in the room.

[00:18:50] Michelle Gasaway: It’s not usually the company just waking up one day and saying, “Hey, we, we need to go find a, a board observer.” It’s benefits on both sides.

[00:18:57] Jeremy Winter: And in some cases it’s just an extra voice in the room. Perhaps an investor already has a designee on the board, but wants to be able to send two individuals to each meeting just to have an extra voice in the room or, or extra support for the the person who’s serving on the board.

[00:19:11] Jeremy Winter: And so that’s sometimes the context where you’ll see it in a public company as well.

[00:19:13] Doug Chia: Okay, so, so there are situations where, where you’ll have a dissident director and a board observer, essentially, I wouldn’t say representing the same activist, but they’re put in there by the same activist. So, okay.

[00:19:27] Doug Chia: That’s pretty interesting. But I guess, you know, it’s pretty clear to me why an investor. Uh, particularly an activist who’s, who’s kind of, you know, negotiating this, why it benefits them to have an observer in the room. It’s not entirely clear to me why it’s beneficial to everybody else. Uh, namely, you know, the rest of the board and management.

[00:19:52] Jeremy Winter: So I think often the board and management team will want a particular individual to serve as a director because they think that they would provide a lot of value, and in some cases the right individual in management’s eyes might not be interested in serving as a director because of the increased liability that comes with that role, the obligations, the duties.

[00:20:11] Jeremy Winter: And perhaps that individual is willing to serve as a non-voting board observer who attends meetings, provides guidance, but doesn’t have the duty of loyalty, the duty of care, the duty to be fully informed about all decisions, all key matters facing the company. It’s a lot easier to serve as a board observer.

[00:20:27] Jeremy Winter: And so if the management team wants that individual to be assisting the management team in those meetings, uh, that individual might prefer a role as a board observer.

[00:20:36] Michelle Gasaway: And, and as, as Jeremy said, it’s, it’s another voice in the room, right? So. The company and, and its board can, regardless of whose observer it is, they’re getting information from that observer.

[00:20:46] Michelle Gasaway: They’re getting new perspectives. The, typically, the board observer has a long history of serving with companies, ideally public companies, um, may have been a board member in the past and can really bring that experience and, and another voice in the room for the board. And, and maybe it’s something if you, you know, if it’s an activist that is looking to have this board observer, it could be a perspective that, it’s just a new perspective.

[00:21:09] Michelle Gasaway: Um, and so the board can, can, you know, benefit from that.

[00:21:13] Jeremy Winter: But you’re absolutely right to question the, the utility. In all circumstances, many times the observer is installed by an investor who wants to be hearing everything that happens in the room and is not providing much value to the management team or to the rest of the board.

[00:21:26] Jeremy Winter: That is often the case.

[00:21:28] Doug Chia: The kind of noses in, fingers out, just plain noses in and that’s it. So I take it, these people get paid, right? I mean, I, it’s all based on contract, but these guys are getting paid, you know, maybe not full director retainers, but typically they’re getting, they’re not doing this stuff for free, right?

[00:21:49] Jeremy Winter: So typically the value that they are providing is to the investor that is sending them as sort of the ears in the room. And so they are paid by the investor that they represent. I think when you see the company paying somebody who’s serving this role, it the title is usually a little bit different.

[00:22:05] Jeremy Winter: It’s more of a, an advisor, a strategic advisor, uh, who’s engaged to assist the board in their, in their deliberations. But typically when we think of a board observer, the classical sense, it’s uh, somebody who is designated by an investor and is therefore representing the investor in that room and, and is compensated by the investor that’s sending them there.

[00:22:24] Michelle Gasaway: It’s a little bit different than, you know, an IPO situation where they’re just pre IPO, they’re just sort of there to, again, to get the information and other things. For a public company, to have a board observer there’s typically some strategic or financial or, you know, other reason that, that they’re there because, as we said, most board observer, just like most, many board roles, those rights terminate upon an IPO and as a company moves into IPO, they’re moving into public company status, typically without board observers.

[00:22:53] Doug Chia: Okay. That, that’s interesting. Because I was thinking, I mean, to me it was like, all right, if a company has a board observer and the company is paying them like they pay directors, it’s almost like they just hiring a permanent consultant who gets to talk, they bring their expertise, they don’t get to vote, etcetera, etcetera.

[00:23:11] Doug Chia: But it’s, it’s not exactly like that.

[00:23:14] Michelle Gasaway: I would rather be paid as a consultant, I think than a board observer. You probably get paid more.

[00:23:20] Doug Chia: Got it. Yeah, probably. You know, we talked about contractual rights, uh, and, and access to information. What do you typically see in terms of, does a board observer typically get access to everything everybody else gets on the board Portal?

[00:23:38] Doug Chia: Or are there limitations that are typically gonna come along with this board observer status?

[00:23:46] Jeremy Winter: It’s one of those things that really does vary across industry and the nature of the observer. A lot of times when you see a board observer, it’s a matter of necessity from an invest a strategic investor that cannot serve on the board due to regulatory issues, and therefore they might have access to the same board portal, but only a subset of the information that wouldn’t be competitively sensitive given the nature of their day job at a perhaps a competitor

[00:24:13] Jeremy Winter: of the, the company whose board meetings they’re attending. So it’s, it definitely varies both across industries depending on the, the nature of this, the sensitivity of the information that is typically addressed at a board meeting, for example, in, in, uh, early stage biotechs where they, you know, need to be super guarded about the information that is seen by somebody that’s not on the board.

[00:24:34] Jeremy Winter: And also by the nature of, of who the observer is they’re representing.

[00:24:38] Michelle Gasaway: And then obviously if you have a, you know, more of a strategic type investor, not a sort of a financial investor there, obviously there are a lot of things that go along with that in terms of, you know, competition regulations and overlapping boards and interlocking boards and that type of thing.

[00:24:53] Michelle Gasaway: But. Um, those types of investors, again, if, if they’re in the same space, then the company would typically want limitations again in what they’re sharing in terms of trade secrets, other things like that, that is competitively sensitive. If you’ve got an investor that’s, you know, investing and, and wanted a board observer seat for various reasons, like we talked about earlier,

[00:25:12] Michelle Gasaway: they may want even more restrictions on what they actually get, um, in terms of if there’s periods of time when they want, may wanna be free to trade or do other things that they don’t want to be getting necessarily all the information the board is getting. Then of course there’s privilege concerns, confidentiality, which will be in the board observer’s

[00:25:31] Michelle Gasaway: contract typically on the confidential information. Um, but again, there will be typically more limitations because a company needs to be free to give its directors who are actual directors the information that they need to appropriately and completely exercise their duties, like Jeremy’s talked about.
[00:25:48] Michelle Gasaway: But a board observer is a matter of contract, and so the information that they have access to can completely be framed by contract.

[00:25:57] Jeremy Winter: It’s sort of an odd shift that you’ll see sometimes where an an observer or an investor wants all of the information, wants all of the information, and then all of a sudden wants none of the information.

[00:26:06] Jeremy Winter: Please don’t taint me. Please revoke my access to the portal, and if you want to post some information, please check with me first so I can’t be ascribed access to that information and have it prevent me from trading.

[00:26:18] Doug Chia: Do whatever you want, just keep me out of it kind of thing.

[00:26:22] Jeremy Winter: Check me first.

[00:26:22] Doug Chia: Yeah. Okay. Um, so keep me off of signal.

[00:26:26] Doug Chia: Um, you know, we talk, keep talking about contract. Um, do these contracts need to be filed in the case of public companies as material agreements?

[00:26:36] Jeremy Winter: It depends on where the provision lives. Often this will live in a contract that ends up being publicly filed, but not because of the observer provision. It’s typically the observer, right?

[00:26:47] Jeremy Winter: Is associated with some other type of shareholders agreement that contains material rights that actually require the filing of that agreement. But no, I wouldn’t think that just a non-disclosure agreement with a board observer and, and a promise to an investor to allow one representative of that investor to attend meetings is a material contract that would need to be filed.

[00:27:08] Michelle Gasaway: Yeah, a lot of times the board observer rights come again, especially for public companies, they come with something else that is going on. There’s another situation, there’s more rights that the investor is getting. It may be an investor is making a large investment and this is part of their investor rights agreement or the side letter they’re getting in connection with that investment.

[00:27:27] Michelle Gasaway: Um, so it’s typically that it ends up getting filed because of all of that information. And then oftentimes you, sometimes you do see it disclosed as well. Um, you know, some companies find it helpful to disclose that they’ve got a board observer and you read their proxy and it talks about like, yes, this fund has a board member, but then they also have a board observer.
[00:27:46] Doug Chia: So you’re not gonna see some situation where there’s a board observer,

[00:27:51] Doug Chia: they have some kind of just retainer letter and that spells out all of their rights and limitations and it doesn’t get filed, doesn’t get disclosed, essentially nobody knows about it at that point. That’s not really a thing. That’s the ultimate shadow or ghost director, I guess. Phantom director. One thing you, you said a couple times was that it varies across industries.

[00:28:15] Doug Chia: Understanding that this is a very, you know, kind of small pool that we’re looking at, are there industries that tend to consider this or, or have this show up?

[00:28:28] Jeremy Winter: It’s really such a small sample size that it, it would be hard to generalize and say one indu, it’s typical in any industry. Um, I think it’s more a function of what the company is going through.

[00:28:39] Jeremy Winter: As Michelle mentioned earlier, something like a restructuring where expertise that didn’t previously exist on the board is suddenly required, and you’re not gonna expand the board and, and have an a new individual elected. But if you want a consultant or advisor maybe who isn’t paid as such, then you can have somebody start attending your, your board meetings and provide that guidance.

[00:29:01] Michelle Gasaway: Or, or you’re a younger public company and or, you know, a private company or a younger public company and you know, you may be doing a lot of strategic arrangements, strategic investments, where you find it’s actually helpful to, for, you know, those strategic investors may not want a board seat, but they may want, you know, a board observer, right?

[00:29:18] Michelle Gasaway: May useful as you execute on the collaboration agreement or the other type of commercial agreement. Um, while, while you know, you’re partners with that company to, for them to have a board observer in the room.

[00:29:28] Doug Chia: In terms of the contractual rights for information, you know, we talked about the rights. Are there limitations that are pretty standard in terms of, okay, you don’t get to see X, Y, Z other than, you know, the obvious one, like, you know, attorney-client privilege?

[00:29:48] Doug Chia: Are there other things that, you know, it’s pretty, you know, standard that, yeah, you don’t get to see this?

[00:29:54] Jeremy Winter: I, I think the three that you see are attorney client privilege, some type of really commercially sensitive information and matters that present a conflict of interest. And the last two buckets are, there’s often a lot of overlap, but it depends on who the observer is representing

[00:30:12] Jeremy Winter: uh, really will dictate how often those things come up. If it’s a strategic investor that is, as Michelle said, in some type of a collaboration agreement with the, the company, then it’ll come up more often than when it’s a pure financial investor, not really at risk of potentially competing with the, the company or, or having other arrangements where you would wanna restrict the information going to them.

[00:30:33] Doug Chia: So let’s get into liability. You know, there’s various kinds of liability for a director, um, you know, and other legal considerations by fact of being so close to, uh, the, the insider information. What’s going on with liability on observers?

[00:30:54] Michelle Gasaway: So I would say there’s, there’s, there’s two kinds of liabilities they should be concerned about.

[00:30:58] Michelle Gasaway: There’s the breach of contract, right? Where there, there’s confidentiality and, and other provisions in there that they need to be mindful to, to, you know, obviously not breach their, their agreement with the company and then the statutory regime in terms of the securities laws, fiduciary liabilities, that type of thing.

[00:31:16] Michelle Gasaway: Um, the securities laws we talked about, obviously, if they have inside information, they shouldn’t be out there trading the company securities because, you know, just like any other investor, you shouldn’t trade on on MNPI, whether you’re a board observer or not. And board observers are more likely to have the information, as Jeremy said, shut down the access to the portal.

[00:31:32] Michelle Gasaway: Don’t give me the information ’cause I don’t want to be restricted. Uh, and then there’s obviously the, the fiduciary duties and, and that type of thing where obviously a, you know, a, a plaintiff in a securities case or, or a board case is going to sort of sue the entire list of, of directors and executive officers and anyone else who may be around the table.

[00:31:53] Michelle Gasaway: And, you know, unless the board observer has really gone to a place where they’re effectively functioning as a, a director and perhaps doing a little too much, um, typically they’re not going to be, you know, have the same liability that a, a director does under, you know, fiduciary duty laws. Or in terms of if you get sued in a securities case for disclosure in your IPO perspectives, those statutory liabilities or, or people that sign the registration statement, the board observer’s not signing the registration statement, for example.

[00:32:24] Jeremy Winter: Yeah, that’s the goal. Keep them insulated from those typical sources of liability for a director. So as long as they don’t take too much of a role and, and sort of function as a director, as Michelle said, they should be safe, save, you know, breach of contract and insider trading, the things that could apply to anybody, whether or not you’re a board observer.

[00:32:43] Michelle Gasaway: But it’s a good point in the sense that just because, just like they don’t have the statutory liabilities, they don’t have the same statutory protections or under the DNO policy and indemnification agreements, typically that cover directors. Statutory indemnification under state law for directors, they’ll have to be mindful [00:33:00] of, you know, either having the investor provide the insurance or having the company indemnify them or dealing with that through contract, because just like the, the liabilities are by statute and they shouldn’t fall into statute,

[00:33:12] Michelle Gasaway: they also are not going to get the protections of the statute as if they were an actual member of the board of directors.

[00:33:18] Doug Chia: So just by sitting in the room and maybe being named in the document, if you don’t sign the the securities filing, then you are not on the hook, um, where, you know, I guess, well not every director, but, but usually a, a majority of directors have to sign the 10K, but if this could go to court and someone says, you know, tells the chancery, the, the Court of Chancery look, there’s this board observer, and from what we know, they influence things in the boardroom so much

[00:33:53] Doug Chia: without even having the vote that you should consider them kind of like a director and slap them with fiduciary duties. Is that, are there cases like that, that have actually, you know, kind of come out based on facts and circumstances?

[00:34:08] Jeremy Winter: The argument was made recently, uh, a, a case maybe five or or so years ago.

[00:34:13] Jeremy Winter: Uh, but I think what you’ll see is it’s a really high bar to establish that somebody was functioning as a director when they don’t have that voting power, as you mentioned, I mean, that is the hallmark of serving as a director is an actual, say at the board level. You can agitate as a, as an activist shareholder, but that doesn’t suddenly make you a director.

[00:34:32] Jeremy Winter: And I think in, in that case, the facts did not warrant finding that the, the individual who was named despite having not signed the registration statement, didn’t warrant the, the individual being deemed as a, a director.

[00:34:45] Doug Chia: So I guess, uh, you know, absent kind of criminal mischief of, uh, threats of violence or bribery or something, that’s, it’s pretty hard.

[00:34:54] Doug Chia: So let’s move into pre IPO considerations for board structure and composition, you know, beyond this board observer anomaly or rare instance. So companies going from, uh. Private to public, you know, there are all kinds of considerations. Anytime you, you have a, a board. So how do you advise your clients in terms of, okay, let’s talk about size and structure and that kind of thing?

[00:35:26] Jeremy Winter: So, so we’re constantly surveying the market to, to figure out what the average size is. And it hasn’t moved meaningfully, at least in the past few years at the IPO stage. Boards can then balloon from there. But at the IPO stage, you typically see it within a small, a small range in terms of number. I think what’s more important is having the breadth of experience that you need to be respected as a public company.

[00:35:47] Jeremy Winter: And so to your point, one of the earliest conversations we have when initiating an IPO process is what do you expect the the board and management team to look like at the time you go public? Do you have all of the expertise that you need? To fill all of those committees, and if not, what is the process going to be

[00:36:04] Jeremy Winter: to find somebody You need to fill X, Y, and Z roles where you might be lacking on your current board of directors, and the public might expect you to have more?

[00:36:13] Michelle Gasaway: Yeah. And, and to as, to start thinking about it well in advance, right? So that you can go out and look for those, you can think about what will be the right fit for your board when you go IPO, what you’re going to present to the market as, as sort of, you know, your debut board, um, and the experience, the industry experience, the financial experience.

[00:36:31] Michelle Gasaway: Um, the history of serving on public company boards as you look to transition from your private company, you know, VC dominated or founder dominated board to a public company board. You know, figuring that in advance and then balancing that with, you know, I think the average I saw recently was, you know, 5 to 10, somewhere around there.

[00:36:50] Michelle Gasaway: You know, you want it large enough that, you know, not everyone has to serve on every committee, hopefully. And you get the most diverse group, you know, of experience and, and other diversity characteristics that you know, different investors, you know, look for and have, but not have the board be so big that it becomes completely unwieldy and you can’t get the board together.

[00:37:10] Michelle Gasaway: Um, especially as a new public company.

[00:37:12] Doug Chia: What about, um, board leadership? Is there anything that you are talking to a pre IPO company about that might be different than a mature company that’s making decisions on, on, you know, separate versus, you know, combined CEO Chair?

[00:37:32] Michelle Gasaway: I would say that for, especially for founder led private companies, there is some, a lot of education there, especially where the founder has been the CEO and the chairperson of the board and talking about how that dynamic is going to work as a public company with a board that comes in and really has, has oversight, and then there is the executive officer role.

[00:37:52] Michelle Gasaway: And thinking about how you split up the CEO versus the chairman role, especially if it’s going to, you know, if the founder’s going to keep control. So you, you elect to be a controlled company, for example, under stock exchange rules, or you, you know, you’re going to be a non-controlled company or, or you elect to, to comply with the regular waste stock exchange rules.

[00:38:10] Michelle Gasaway: There obviously is a lot of founder dynamic and education depending on the founder and, and what experience they’ve had and, and being on, you know, founding and IPOing companies and being on public company boards.

[00:38:23] Jeremy Winter: And it’s really a moment of, of growth for them. Uh, if you think about how they operate as a private company, that board was stacked with their, their friends, their investors that they brought in and welcomed to invest in the company.

[00:38:35] Jeremy Winter: And a lot of those individuals that have, you know, been in meetings with them for the past however many years it takes to develop a company and go public, which is now shorter than ever, but that’s been the dynamic in the board meetings for that founder’s entire time running the company. And once you’re public, you’ve got new directors and new obligations and board meetings are more structured and less casual.

[00:38:58] Jeremy Winter: And so one of the, the things that we’ll talk to ’em about is whether they’re, whether they want to be the chair of the, the public company board or, or whether they want to give up on some of the administrative responsibilities of running the, the board process, or if they wanna be chair and have something like a lead independent director to assist with some of those administrative responsibilities in, in running a public company board.

[00:39:18] Michelle Gasaway: And then just also the dynamic of the founder may very well be the controlling shareholder and still have voting control with, you know, high vote stock or something like that. Um, and, but while they’re the controlling shareholder, you know, the board of, of a public company, it sort of operates on behalf of the shareholders, but there also has a very strong oversight and risk management and other responsibilities.

[00:39:41] Michelle Gasaway: And so the dynamic does change Post IPO.

[00:39:44] Doug Chia: You know, we mentioned committees. What do you typically see in terms of when you’re advising these pre IPO companies? Um, I would imagine they have audit, nominating, and comp, and probably a couple other committees, strategic planning or something like that. What do you, you know, is it just all over the place?

[00:40:05] Doug Chia: Do they already have kind of the big three in place or, yeah. What, what are you seeing and advising?

[00:40:12] Jeremy Winter: I’d say we’re more often seeing audit committees in one to two years before the company goes public. It’s good to sort of develop the, the muscle memory that comes from having regular meetings of a committee and, uh, you can delegate certain responsibilities to the audit committee that will need to be delegated to the audit committee once you go public and just

[00:40:32] Jeremy Winter: develop that cadence and familiarity. We’ll often see comp committees in private companies, but for something like a nominating and governance committee, there isn’t much of a role to be had. It’s not to say that we don’t see them, but most of the director seats in a private company are, are sort of spoken for by something like a voting agreement where each, each venture capital firm gets to appoint one individual they’re choosing.

[00:40:53] Jeremy Winter: There isn’t much for the nominating committee to do in terms of director searches or evaluating the, the board’s performance, the types of things that they would do once you’re public.

[00:41:03] Michelle Gasaway: Yeah. And, and completely agree with that. I mean, the audit committee is, is so important, um, both for the, you know, oversight of the financial statements and, and reviewing those and asking questions about those.

[00:41:13] Michelle Gasaway: And also related party transactions, which are very important. Um, and some early stage, you know, IPO companies or as you go through IPO and, and what those transactions look like as you roll into a public company.

[00:41:25] Doug Chia: Yeah, it’s definitely welcome to the world of being a public company. In terms of these

[00:41:32] Doug Chia: changes, obviously, uh, you know, a lot of is, is gonna be driven by regulation, but you see companies make these changes pre IPO, um, you know, well before the IPO or kind of just on the IPO date. What do you typically advise here?

[00:41:50] Michelle Gasaway: I think we advise, you know, get the audit committee in early, as Jeremy said, so that people can get used to operating as as an audit committee.

[00:41:58] Michelle Gasaway: Um, definitely, you know, as you near IPO as, as you think about your overall board and start that thought process well in advance, you should think about and populating the committees. Who will be the right people that you would like to serve on those committees? What do they bring to the committee? What is their experience?

[00:42:16] Michelle Gasaway: Particularly on the audit? The audit committee, which will as a public company, need certain, you know, financial sophistication and experience requirements. Um, so definitely, you know, we always tell clients, don’t underestimate the time it will take to really put the board and those committees together and be thoughtful as you debut as a public company.

[00:42:35] Michelle Gasaway: So start early.

[00:42:36] Jeremy Winter: And whether or not they start meeting and, and adopting that cadence well ahead of the IPO it’s, it’s, it’s just really important to think about what you’re going to need at the time of IPO. Because if you are searching right now for a diverse industry expert, conversant in AI and cybersecurity issues, who is a financial expert, sufficient to chair your audit committee, you’re gonna be searching for a while.

[00:42:58] Jeremy Winter: There are some, some gaps that are really hard to fill, uh, depending on where the markets are.

[00:43:04] Michelle Gasaway: Yeah, and I think that’s a really important point ’cause people are asking more and more from their boards and committees these days. You know, it’s not that you just need an industry expert or a financial expert or someone who understands the comp committee and can talk to your comp advisor or all of that.

[00:43:19] Michelle Gasaway: You need cybersecurity experts. You need experts, you know, in terms of risk management. And so there’s a, a whole host of, you know, responsibilities and expectations of board members today that just keeps growing.

[00:43:32] Doug Chia: Then in, in terms of the composition of the board, IPO obviously is, you know, either an opportunity to revamp the board or, or maybe not.

[00:43:44] Doug Chia: It’s just kind of like, okay, well, like we got a good board, let’s just keep it in place. But I gotta imagine that there’s a lot of turnover swapping out, you know, maybe some people leave because they just, you know, they’re not big investors anymore, that kind of thing. So how do you see pre IPO companies going through all of this kind of thinking and you know, I’m wondering if there’s like political considerations as well?

[00:44:13] Jeremy Winter: And I would say emotional ones as well, but on both sides. We had one earlier this year where it was, it was really there, there were tears at the, the board meeting where, uh, certain directors were thanked for their, their service, but they were gonna be rolling off the time of the IPO. It’s, it’s a big moment for the company, and if you’ve been on the board for a long time and you’re very emotionally attached to the company, it’s uh, it’s a difficult goodbye.

[00:44:34] Jeremy Winter: Uh, but you know, it starts with early conversations about, about what each party wants. What does the founder want? What’s the management team want? What does each of the directors want and what do the VC funds want? And so you start those conversations early on and, and figure out where you’re going to need to end up.

[00:44:50] Jeremy Winter: And then you start your searches and, and people can roll at various times, but it’s, uh, it’s political and it’s emotional, but it starts with early conversations and getting everybody aligned on what the public company board should look like.

[00:45:03] Michelle Gasaway: And there is a cadence, especially for VC investors, you know, they’re, they’re professionals in this situation.

[00:45:08] Michelle Gasaway: They’ll invest in a company. The IPO is a huge moment for them and their investment. And then that’s their liquidity. That’s the goal. They’ve taken their company from early stage, grown it to IPO, and it’s now going public. And so then, you know, their model is, you know, you sort of go on to the next one. Um, and so it’s a little bit different than, you know, especially, but then you also, as Jerry said, have the friends and the family

[00:45:30] Michelle Gasaway: on the board. And some of them may stay, but some of them, you know, may not be the right fit for a public company. And, and, and there can be a lot of emotions and, and feelings on that side as well as, as people, you know, just look to move through what’s really a transformational and pivotal point in any life of a private company that’s going public.

[00:45:48] Jeremy Winter: But then you ring the bell and then they’re all happy tears.

[00:45:52] Doug Chia: I was gonna say. Yeah. Um, so, uh, and it sounds like some of these directors who were in the pre IPO, maybe they’re asked to stay on for some brief period of time or like a few years or something like kind of a transitional type director, is that pretty well established?

[00:46:15] Jeremy Winter: It happens sometimes. Uh, it, it depends on what role they’re serving and, and why they would be needed. I think that, uh, in some cases it depends on when their, their fund wants to begin to have the flexibility to sell down. Um, if that’s right after the, the lockup period ends, then you probably don’t want the director on for very long.

[00:46:33] Jeremy Winter: And if they’re not gonna be on for very long, why would they take liability on the, the IPO registration statement? So they’ll typically roll off right beforehand, but you know, if, if the investor wants that director on the board for a little while longer, then perhaps they roll off at the first annual meeting and

[00:46:49] Jeremy Winter: do not, you know, run for reelection.

[00:46:52] Doug Chia: I gotta imagine that the biggest trick is finding independent directors because if you have, you know, most of these people are picked, either picked by the founder or there because they’re large investors. You have to have a majority of independent directors. And, um, in the, this United States these days, it’s usually all independent directors except for the, the CEO.

[00:47:17] Doug Chia: So. Uh, I gotta imagine the, this is like, you know, the recruiters are all over this.

[00:47:24] Michelle Gasaway: Yes. And that’s why we, we asked companies to, don’t underestimate the time. Think about it, be thoughtful about it. Leverage your contacts. Leverage your investors. They all know people, right? The VCs know people, executives know people.

[00:47:37] Michelle Gasaway: Founders know people. So think about what your objective is with your board. Think about what experience you’re looking for, um, what skills you’re looking for and don’t underestimate the time it will take to, you know, put your board together. Um, but you know, definitely we, we tell people, you know, get the search firm going early, um, but also leverage your context and, and talk to your investors.

[00:48:00] Doug Chia: Have you ever seen a situation where all the IPO direct, pre IPO directors are saying “I wanna stay on the board, but as board observer.”?

[00:48:08] Michelle Gasaway: I’ve never seen that.

[00:48:10] Jeremy Winter: I haven’t, but it’s possible they just didn’t tell me.

[00:48:13] Doug Chia: That would be, that would be a weird one. Um, so anything, you know, anything else you, you wanna talk about with regards to this, uh, kind of pre IPO transition to, to becoming a public company for, as it as it relates to board composition or structure?

[00:48:33] Michelle Gasaway: I would just say, you know, really be thoughtful about it. We’ve talked about don’t underestimate the time, don’t underestimate the importance, um, not just of, you know, ticking the requirements or I need this many independent directors. I need this experience. This person has cybersecurity check, risk management check.

[00:48:50] Michelle Gasaway: But really thinking about it as part of your overall going public story, when you go out there and you present the company as a public company to the market the first time, who is on your board and the dynamics of your board are, are very important and investors will pay attention.

[00:49:05] Jeremy Winter: And, and governance should never get in the way of a successful IPO.

[00:49:09] Jeremy Winter: I mean, if a, if a company has made it to that stage, it should be a, a moment of celebration. And once you’ve decided what it is you want your public company board to look like, it’s important to initiate the conversations with the various stakeholders, the, the investors, the existing board members early on so that there is no

[00:49:25] Jeremy Winter: no, no consternation, no, uh, resentment at the time that you go to implement the, the new public company board, it should be a very seamless exercise and only tiers of happiness in the end.

[00:49:35] Doug Chia: So you’re, you’re basically, yeah. You’re gonna go IPO you, you’re trying to attract investors on the on the road show,

[00:49:43] Doug Chia: and you’re not just saying, okay, here’s our management slate. It’s also, well, here’s who’s gonna be on the board and give you confidence that this is, uh, gonna be a company with adult supervision. Um, and we’re not gonna have this director to be named later, type of thing. Well, I think that’s, uh, we will wrap up with that.

[00:50:04] Doug Chia: So, uh, Jeremy and Michelle, thanks so much for, for joining me today.

[00:50:09] Michelle Gasaway: Thanks for having us. This was great.

[00:50:11] Doug Chia: So that concludes this episode of The Public Company Series Podcast, powered by OnBoard. I’d like to thank Jeremy Winter and Michelle Gasaway of Skadden for sharing their insights, and I encourage you to read their chapter of the book entitled The Board Observer: Considerations and Limitations, which you can find in the book

[00:50:33] Doug Chia: Board Structure and Composition part of the Public Company Series published by the New York Stock Exchange and JP Morgan. And you can read and download the entire book at www.nyse.com/pcs. To learn more about OnBoard, visit www.onboardmeetings.com. For additional resources, visit www.publiccompanyseries.com and don’t forget to subscribe to receive all the new episodes of the Public Company Series podcast and rate us and leave a review.

[00:51:08] Doug Chia: I’m Doug Chia, and we’ll see you next time.