In the beginning, taking on a Directorship looks like a good idea: a chance to lend time and expertise to a young high-tech company, mentoring the executives, advising on strategic and operational issues, and maybe even making some money on the options at exit time.
But several months in, the situation has become desperate: the company is in trouble, milestones have been missed, there is dissension in the ranks, and the company is running out of money. Directors are putting a lot more time into the company, and none of it is fun. They may also be worried about their personal liability. So, should a Director stay or should they go?
This is the most critical decision that any Director can make. There is a lot riding on it: money, time, reputation, stress, and not necessarily in that order. If a Director decides to step down, it should only be done as a last resort, as it can send a strong negative signal about the company’s prospects. Here are some points to consider in making your decision:
Reputation: As soon as someone takes on a directorship, 100% of their credibility is on the line. If the company does well, directors will get some of the credit. If it does poorly, most of the blame will go to management, but directors can also be (rightly) chastised for not doing their job. If Directors stay the course when times are tough, they will earn more accolades than by backing out. Provided that a director can positively influence events (more on this below), it is better to stay.
Time: When things were good, a Director could probably do their fiduciary duty in a couple of hours per week. Now that the company is in trouble, it takes a lot more time. Directors can reduce their time commitment by refusing to take on management’s responsibility. If managers can’t manage, replace them. However, if you can’t replace them, you will need to review the management team more closely, which will unfortunately take more time.
At the point that increased time demands begin to seriously interfere with a Director’s other commitments, the Director needs to act before the strain affects all their other responsibilities. If a Director truly cannot devote the time required, he or she may have to step down.
Probability of success: Directors need to dispassionately assess whether the problems within the company can be fixed. Speak with management and request a workout plan for the Board’s consideration and approval. Review it critically, query management’s thinking, and assess the potential outcomes, the probability of success, and the risk of execution. If there is a reasonable chance to save the company, then Directors should stay the course and advise management in the implementation of the survival plan.
If the chances of saving the company hinge on a combination of several low-probability events, then a dispassionate Director may rightly conclude that prospects for survival are slim. If the Director is unable to persuade the company to adopt a better strategy, then he or she may resign in good conscience.
Mistaken strategy: Discussions and disagreements are healthy and important for a board, as they help to ensure that issues are fully considered. However, on major points of strategy, all Directors must support the Board’s final decisions. If a Director is fundamentally at odds with the direction or actions of the company, then he or she may need to resign on principal.
Personal liability*: Directors are personally liable for unpaid wages and all required remittances to the government which are incurred while they are a Director, including source deductions (income tax, CPP, EI), GST, PST, and HST. If a Director discovers that the company is behind on any of these obligations, he or she cannot escape the liability incurred up to that point by resigning. (This can come as quite a shock.)
To prevent this problem, Directors should, from the outset, require management to deliver regular reports on the status of all government remittances, and outline whether the company can meet its payroll and other obligations. One method for Directors to mitigate their personal liability is to require that all remittances and obligations be paid out on every payroll if a company is in financial trouble. This action reduces the amount of liability that may arise. Directors can then make the decision to stay or go at the end of each payroll period, if liability is a driving concern.
Options under water: Typically, the only compensation for a Director is his or her options package. When the company is in trouble, the options may be worthless and unlikely to recover for a long period, if ever. However, this is never a reason to resign. A Director’s duty is to the company and not to his or her net worth. Furthermore, a Director’s reputation would suffer greatly to cut and run simply because the options are under water.
Confidence in management: Directors are only effective when there is mutual trust and respect amongst the board and management. However, these bonds may be ruptured if management is perceived to be making poor decisions, acting unethically, or ignoring the advice of the board. Broken trust is almost impossible to rebuild.
As well, in early-stage technology companies, the founders are often critical to the progress of the company because of their domain knowledge. The founders cannot be easily replaced in the short term and, if they hold the majority of the shares, they cannot be replaced at all.
Without trust, Directors cannot advise and influence management, and their impact is thus reduced. They cannot effectively exercise their fiduciary duty to act in the best interest of the company. At this point, either management or the Director must go. If management is secure, then the Director as no option but to resign.
In most cases, a Director is compelled to stay on because of their duty to act in the best interests of the company, and because the Director’s reputation might suffer if he or she were to cut and run prematurely. As mentioned above, Directors can be insulated from liability with proper planning and reporting.
However, in the case where a Director is fundamentally opposed to the company direction, or Directors and management have lost trust in each other, a Director cannot be effective and resignations must follow.
*Note: Nothing in this article should be construed as providing legal advice. Readers are cautioned to seek legal advice only from competent, licensed professionals.
This article first appeared in the Fall 2009 edition of The Hire Standard – the newsletter of Corporate Recruiters, British Columbia’s leading recruiters of high technology talent.