The Law and Other Anomalies

The accredited investor definition is the well-known standard to permit persons of reasonable liquidity to invest in unregistered offerings of companies seeking capital; it facilitates the so-called Regulation D offerings which raise about as much investment capital as to all public offerings combined (2014 data). The SEC this May 18 will conduct a meeting of its Advisory Committee on Small and Emerging Businesses to consider revisions to this vital definition. Here are some of the SEC staff recommendations for consideration:

There likely will be revisions to the economic parameters. The present individual requirements (family net worth excluding principal residence of $1 Million, individual earnings of $200,000 or family earnings of $300,000) should remain, although those minimums now may invoke caps on investment amounts; higher economics may be established to qualify for avoidance of investment caps.

If an older-definition accredited person has invested in a given company, that investor will be “grandfathered” as fully accredited as to that particular company.

The present sole definition of accredited status, which is economic, should be expanded for some sophisticated investors, including experienced investors based on various definitions, certain professionals and those who pass an “investor examination.”

Of course it is not clear which if any proposal will be adopted, but the SEC this year seems committed to a systematic review of the accredited investor definition.

It is company management which typically proposes, and almost always executes, an M&A transaction. What is the board of directors doing while all this is going on?

A panel at the May 10^th Breakfast Meeting of the National Association of Corporate Directors-New England explored major M&A pitfalls. The most important: a proposal of an acquisition transaction which is not in line with the strategic direction of the company. Sometimes CEOs and management teams get excited about an acquisition which is off on a tangent. It is the role of the board to be forceful in questioning any such transactions; is it truly strategic, is it large enough to divert the company, what is the rationale and why should we be doing it?

Sometimes a subcommittee of a board is named in order to pursue a transaction. It is important that the subcommittee keep the board generally informed; no one likes surprises. If, in a large company, smaller acquisitions have been delegated to management, without board input, nonetheless management should be attentive to keeping the board posted so that board members are not embarrassed by a lack of knowledge as to what is going on in the company.

Sometimes stock ownership in a company can impact thinking about acquisitions. In a company with a private equity investor, there is time pressure for exit at a certain point; other shareholders may have an interest in maximizing value over a longer period of time. Sometimes there thus is pressure to achieve an acquisition because the market may be rewarding acquisitions, attracting PEs to overpay in order to maximize early exit value. These issues need to be sorted out by the board.

The board should be attentive to cultural fit. What is the motivation, and style of leadership, of the target and its executive team? Is it overly aggressive, so as to cause the board to ask management to double-check financials and projections? Will there be, in fact, an appropriate fit of cultures?

Directors have the task of making sure that a company fully evaluates an M&A transaction; perhaps the company should walk away. After all, for any major acquisition, it is the board which ultimately must pass upon it. It is the board’s responsibility to grant or withhold approval based on strategic or economic considerations.

Tell me about your company’s board of directors. Is it, in the words of one panelist, “male, pale and stale”?

An expert panel at the Tuesday breakfast meeting of the National Association of Corporate Directors/New England explored techniques for making sure your board was correct for your company.

As boards tend to “hire in their own image,” there is a certain stagnation in board membership. Further, in public boards at least, people don’t turn over very quickly; only 7% of directors stepped down last year. But board diversity, in every sense, is highly desirable and proven by studies to benefit companies. How do you achieve it?

You must depersonalize the addition and removal of directors. If you need to replace someone on your board, it is not because you don’t value them or their judgment; it is just that you need different skill sets to deal with the company’s business issues.

Another technique is a rigorous program of board self-evaluations; most boards now evaluate at the board and committee levels but only 10% of public companies do a 360° analysis of each individual director. Advising a director as to how he or she is performing is not only good for the company, but also is a wakeup call for the director to either improve or to self-select off the board.

The panel also debunked the idea that you cannot find qualified women, or qualified diverse candidates ethnically, racially, geographically. All you have to do is look; there is quite a supply.

Larger company boards, with a tendency to look for CEOs, must get out of that habit; there are very few CEOs who are not white males. CEOs are over-shopped and women and minorities of great skill are “under shopped” when it comes to board invitations. Since activist investors are hunting for weak boards of directors at all levels, not just the largest of companies, it is important for boards to find the right people with the right skill sets and the right chemistry.

Finally, what about age and term limits? You don’t want to lose institutional memory, but you need to have age diversity. One idea: look at the average age and tenure of your board, don’t apply an age/tenure screen on any given individual. One panelist called this an “age/length of service matrix.”

Emerging life science companies always need money. Some seek non-dilutive money through research grants, government programs and the like. Others deal with angels and seed round and Round A investors.

Another source of possible funding, often over-looked, can be afforded through major drug and pharmaceutical companies. For example:

Johnson & Johnson has opened a facility in Cambridge (the geography is of course no surprise), which has a large investment fund, as well as access to incubator space (the space is at market rate).

Roche, similarly in Cambridge, has several programs; one is an investment arm but there are a couple of programs for fundamentally innovative technologies which are still primarily rooted in academia; they are willing, without equity claim, to support promising science on behalf of scientists still embedded in an academic setting.

The large and privately-held pharmaceutical company Boehringer Ingelheim has programs in Cambridge not only for investment but also for counselling companies and investors seeking to navigate working with larger pharmas.

Of course each company has its preferred technological targets, so approaches must be tailored. However, given the huge shift in emphasis away from drug development and internal innovation, to reliance on outside innovation, it is logical for these larger companies to nurture the external ecosystem. For example, at J&J in 2002 external drug development accounted for 20% of new products while in 2012 (last reporting year) it accounted for 50%; the statistics for the top ten pharmas are 16% and 33% respectively; at Roche 35% of all sales are based upon externally developed products.

Election years cause many CEOs to constrict their corporate plans.  It happens every Presidential election year.  It is most manifest among Republican CEOs.  It is not necessarily the most benign development for the health of the business.

This insight comes courtesy of Tom Sherwin, who ought to know; he is principal of CEO Resources, a firm devoted to coaching CEOs and with clients both in Massachusetts and nationally.  Is this generalization supportable, I had the temerity to ask over a pleasant lunch today?  Seems Tom’s office went back to check his own firm’s business level in election years.  Dips in his consulting business for his regular clients, reflecting corporate inaction, occurred during each Presidential election year; a spurt of activity followed, starting right after the election without regard to the prevailing party, including unleashing of long-discussed plans which were put on hold during the course of the election season.

Tom pointed out that he does not discuss politics with clients, it is not his business.  But the business dynamic is something he may counsel about, as it is predictable and seemingly not wholly dependent on the candidates or issues of the day.

Not often you learn something new and interesting and systemic at lunch.