GROW SMART SESSION II: CORPORATE GOVERNANCE Jeffery K. Mitchell Blacksburg, Virginia Office

The Grow Smart Series  5-part series  Practical Strategies Raising Capital Corporate Governance Employee Strategies Employee Incentives Protecting IP  Sponsoring Organizations

Why is corporate governance important? “[O]ur most recent experiences with corporate malfeasance suggest that governance has strayed from the way we think it is supposed to work. By law, shareholders own corporations, and corporate managers ideally should be working on behalf of shareholders to allocate business resources to their optimum use.” Former Chairman of The Federal Reserve Board Alan Greenspan May 8, 2003

Corporate Governance Defined  Internal systems that establish the relationships between the corporation and its stakeholders Shareholders Management Board of Directors Employees Creditors Vendors Government/Regulators  Policies, statutes, rules, practices  Values and ethics

Bad Corporate Governance

Corporate Governance - Sample Corporate governance at Microsoft serves several purposes: To establish.. management accountability... To provide structure…to monitor performance… To strengthen..our culture of business integrity… To encourage the efficient use of resources, and To require accountability for the stewardship of those resources. –

Why Should Private Companies Care?  Piercing the corporate veil Personal liability  Clarity and accountability Better results Avoid problems Stronger market reputation

Piercing The Corporate Veil  Two theories that enable third parties holdings owners responsible for corporate obligations Alter Ego Theory –Distinction between corporation and shareholders Instrumentality Theory –Use of corporation for personal gain  Fact basis determination

Piercing the Corporate Veil - Examples  Depositing corporate funds in personal account  Executing contracts in personal name  No corporate formalities – stock purchase, annual meetings, bylaws, minute book  Fraud

Corporate Governance Matters for Private Companies Too...  Public company federal laws do not apply to private companies Sarbanes-Oxley Areas of concern the same  Reduce risk of fraud, embezzlement  Greater market reputation Investors Banks  Process predictability

For A Stronger Company...  Shareholders delegate authority to the Board of Directors which delegates to the management  Separation of ownership and control  Clear expectations  Responsibility and Accountability  Exit Strategy  Private Equity Market  D&O Insurance

Corporate Governance Controls  Internal Control Factors Board of Directors Separation of duties Separate individuals Checks and balances  External Influencers Statutes Audits (Financial, Operations) Competition/Market Agreements –Shareholders Agreement –Financing Agreements –Customer/Strategic Partner Agreements

Role of Board of Directors  Effective governance over the corporation’s affairs  Balance diverse constituencies  Oversee management  Long-term strategy development  President/CEO evaluation  Appropriate committees (audit, compensation)

Sample Director Qualifications  Exhibited behavior that indicates a …highest ethical standards...  Business, governmental, non-profit or professional experience… policy making…operational level…  Special skills, expertise and background...complement the existing directors...  Financial expertise …  Will effectively…take into account…legitimate interests and concerns of all of the …stakeholders  Will challenge management…  Able to devote sufficient time and energy. –Citigroup Inc Corporate Governance Guidelines (as of May 27, 2008)

The VA Business Judgment Rule General standards of conduct for director. A. A director shall discharge his duties as a director, including his duties as a member of a committee, in accordance with his good faith business judgment of the best interests of the corporation. B. Unless he has knowledge or information concerning the matter in question that makes reliance unwarranted, a director is entitled to rely on information, opinions, reports or statements, including financial statements and other financial data, if prepared or presented by: 1. One or more officers or employees of the corporation whom the director believes, in good faith, to be reliable and competent in the matters presented; 2. Legal counsel, public accountants, or other persons as to matters the director believes, in good faith, are within the person's professional or expert competence; or 3. A committee of the board of directors of which he is not a member if the director believes, in good faith, that the committee merits confidence. C. A director is not liable for any action taken as a director, or any failure to take any action, if he performed the duties of his office in compliance with this section. D. A person alleging a violation of this section has the burden of proving the violation. -- § Virginia Code

Conflicts of Interest  A conflict of interests transaction is a transaction with the corporation in which a director of the corporation has an interest that precludes the director from being a disinterested director.  A conflict of interests transaction is not voidable by the corporation solely because of the director's interest in the transaction if any one of the following is true: 1. The material facts …. were disclosed or known to the board of directors... and the board of directors.. Approved.. the transaction; 2. The material facts of the transaction and the director's interest were disclosed to the shareholders... and they authorized... ; or 3. The transaction was fair to the corporation. -- § Virginia Code

Governance Document Review  Articles of Incorporation Complete and Comprehensive Accurate to current situation  Bylaws Shareholder Meetings Policies and procedures for Board of Directors Established processes –Election –Reporting –Information Annual meeting format  Shareholders’ Agreement  Information Rights Agreement

Corporate Minutes  Permanent, official record of actions of shareholders, directors or committees  Prima Facie evidence of the facts they set forth  Statutory requirement  Avoid future misunderstandings WHEREAS (why are we acting, what is the “background”) RESOLVED (the action taken) –Approve –Adopt –Ratify

Executing Agreements  Signature block MY COMPANY, INC. By:________________ Name, Title  Corporate resolutions Major transactions Evidence of corporate action

Action Steps For A Private Company  Create/Review Board of Directors Board of Advisors  Have written policies/agreements Bylaws Shareholder Agreements Information Rights Agreements  Consider an audit Establish sound financial procedures  Establish and re-enforce a culture of honesty Adopt a corporate statement on ethics  Create accountability

Corporate Governance … A Check-Up Organizational standing Organizational document review Internal audit review Management responsibilities review Board of Directors understanding/training Cash management/operations Management Ethics policy

Conclusion...  Watch for future events March 24: Smart Employee Strategies April 7: Employee Incentive Plans April 21: Ten Strategies for Protecting Your IP  contact for LeClairRyan: Jeff Mitchell  contact for SWVTC: Shannon Blevins Esther Bolling  Questions & Answers

Thank You!