With the IPO of the century turning out to be the public relations disaster of the decade, it’s worth considering whether Facebook’s venture capitalist board members made the right decision staying put through the offering.
At the time of its IPO, Facebook had three venture investors on its seven-member board: Accel Partners’ Jim Breyer, Founders Fund partner and angel investor Peter Thiel and Andreessen Horowitz’s Marc Andreessen. Now, all three are named as individual defendants in at least one class action lawsuit filed in federal court in New York, alleging that they signed a prospectus that contained “untrue statements of material facts” and failed to publicly disclose downward revisions for earnings forecasts, which were given only to “a handful of preferred investor clients.”
As it turns out, two of those VC board members – Breyer and Thiel – also sold stakes in the IPO, which they increased significantly several days before the May 18 offering.
Accel made $1.86 billion in Facebook’s IPO and still holds 152.3 million shares of stock in the social network. The firm increased the number of shares it contributed by 28% in the two weeks leading up to the debut, according to a May 16 filing with the Securities and Exchange Commission. Thiel and Founders Fund, meanwhile, sold 16.8 million shares, a 117% increase above what they had planned to sell two week earlier. They hold 27.9 million shares. Among the VC board members, only Andreessen Horowitz, which has 6.6 million shares, did not sell any stock in the offering.
Now, on the face of it, the decision of Facebook’s VCs to stay on the board through the offering isn’t anything unusual. True, many VCs do step down in advance of an IPO, as was the case late last year for Foundry Group’s Brad Feld, who departed Zynga’s board a month before the gaming company’s December offering. But staying is commonplace. For instance, Sequoia Capital’s Michael Moritz and Greylock’s David Sze are still on LinkedIn’s board, and Accel’s Kevin Efrusy remained a director at Groupon through its IPO before announcing in April that he will step down. Moreover, the Facebook VC directors are all experienced public company board members, with Breyer mostly famously associated with Walmart, Andreessen with Netscape, and Thiel with Paypal.
Nor is selling shares in an offering anything remarkable. Though it’s more common for VCs to hold all their shares, they often sell some in the offering. A survey of the six venture-backed IPOs immediately prior to Facebook, for instance, showed that for two of them – Envivio, a developer of video delivery systems, and Proofpoint, an email security provider – VCs unloaded shares. As for the three biggest pre-Facebook social media IPOs – LinkedIn, Groupon and Zynga – only Zynga had venture investors selling shares in the initial offering.
But while staying on the board post-offering and selling shares during an IPO are relatively common behaviors, they’re not always wise. In particular, conflicts of interest – or the appearance of them – can arise when VCs seek to exit stakes and serve out board terms at the same time. Staying on the board also means a VC may be named in lawsuits filed following the IPO. Given the number of securities class action filed each year, the possibility of being a defendant in one is not remote.
So what’s the appropriate course of action? I wasn’t able to track down an attorney or VC willing to talk on the record about the Facebook situation. But Craig Miller, a partner at Manatt, Phelps & Phillips, offered some more general suggestions for VCs in determining when is the appropriate time to give up a board seat.
“I would recommend that the venture fund investors step down from the board prior to the public offering,” Miller says. This doesn’t need to be done as soon as the company files to go public, since not all filings culminate in an IPO. However, he says, the VC board member should be ready to step down when the registration statement is effective, and it’s pretty clear the IPO is a go.
For VCs who stay on the board, it’s key to keep in mind that they have fiduciary duties to two parties: the portfolio company and limited partners in their fund. Those duties consist of three parts: a duty of care, a duty of loyalty, and a duty of good faith. More often than not, Miller adds, fiduciary duties to limited partners and portfolio companies are aligned. Both, after all, want to maximize shareholder value by building a successful company. But there are situations where they may conflict. For instance, if a company is seeking outside funding at terms that could impact prior venture investors, the VC board member should generally step aside in that decision-making.
What about balancing what’s good for the company in the short term and what’s best in the long term, I asked. For instance, what if VCs seeking to exit their investments make decisions that inflate the value of the company in the near-term, but cause damage down the road?
At the end of the day, directors must always be acting with care toward portfolio companies, Miller says, adding that he’s not aware of a case involving such charges. Because directors are presumed to be acting in the best interest of companies, he adds, they’re protected by the business judgment rule, which essentially requires a board member to show their decision was the result of a reasoned judgment.
Miller’s advice on balancing fiduciary duties is pretty much in line with a white paper published five years ago by a group of venture capitalists led by Levensohn Ventures’ Pascal Levensohn. The paper, entitled “A Simple Guide to the Basic Responsibilities of a VC-Backed Company Director,” advises that “the legal fiduciary duties associated with board service are duties to all of the shareholders, not just to the shareholder class in which a VC director’s firm has made an investment.” The paper also recommends that “VCs should openly address their expectations regarding a liquidity event” and that the board “should openly discuss the timeframes for exit options.”
Even in the event of a lawsuit, it’s unlikely venture firms will pay out of pocket for partner/board members who are named in suits as board members, Miller adds. Typically, they are covered under a portfolio company’s directors and officers insurance.