Many companies take the view that a Director is required to act in good faith in the best interests of the company, to be fully informed of the material issues, and to protect the interests of the shareholders. Once appointed, a Director invests their time and expertise and has 100% of their personal reputation riding on their performance as a Director and on the success of the company. If the Director is giving reasonable efforts to the task, nothing more can be gained by requiring him or her to invest personal money as well. Many Directors take this point of view and resist investing their own money, whether or not they can afford to.
Some might argue that a personal investment creates a conflict, as the Director’s duty to serve the best interests of the company may not always serve personal interests. For example, if the company is performing poorly and needs investment, it may be priced well below the price at which the Director invested. There is a conflict between the Director’s personal desire to preserve his or her position, and the need of the company for cash.
In small tech companies, the requirements of Boards and Directors are onerous. Because of the inexperience of management and holes in the management team, Directors may need to invest more time and energy to bridge the gaps. Inevitably, the company will face a crisis from time to time, whether it is strategic, financial, an issue of governance, or a disagreement among the Board or with management. It is all too easy for a Director to resign in the face of seemingly irreconcilable differences, or the challenges of survival and growth in a tech company.
But if a Director has made a significant personal investment, the stakes are higher. He is less likely to resign, and/or less likely to be forced off the Board. Further, in recognition of the significant investment in time, energy, and personal capital required to be an effective Director in a start-up tech company, Directors are also compensated higher.
Therefore, a Director who resigns not only loses oversight of his personal investment, but also walks away from significant equity compensation. There is a much greater personal onus to weather the storm and continue to resolve the critical issues.
While a committed Board should benefit the company by forcing solutions to difficult issues, it can also backfire. Where there are opposing entrenched positions on important issues, and no one steps aside, the consequences can be severe. Paralyzed by Board fracture, the company often has no conclusive mandate. Often significant time and energy of the management team, and the CEO in particular, are spent attempting to resolve Board issues for which they are usually ill-equipped and always at a power disadvantage. Companies have failed in the process.
The arguments for and against Director investment are not clear-cut. However, the arguments in favour of requiring Directors to invest are stronger and companies that institute this practice would likely not be criticized.
This article first appeared in the Winter 2011 edition of The Hire Standard – the newsletter of Corporate Recruiters, British Columbia’s leading recruiters of high technology talent.