Call it an Enron backlash. Call it shareholder rage. Whatever you call it, it’s prompting venture capitalists to question whether the increased risk of facing angry, lawyered-up shareholders is worth sitting on the board of a publicly-traded company.
Case in point: David Strohl, a general partner at Greylock and a director at Legato Systems Inc. (Nasdaq: LGTO). The software developer recently paid $88 million to settle a civil suit alleging that it had inflated its revenue between May 1999 and December 2000. An investigation by the Securities and Exchange Commission of two former Legato executives continues, as do allegations of widespread fraud at other high-tech companies. Strohl declined to comment.
It would be poor form for Strohl to step away from Legato now, but his peers are already walking. In the last five months, a growing number of customers of Chubb & Son’s VC insurance unit have given up public board seats “or are only looking at those seats that have a strategic importance,” says John Burkhart, Chubb’s worldwide product manager for private equity and VC. “I think you are going to see a wave of individuals in the near future who will give up their seats.”
Burkhart has 230 VC firms with 1,200 partners as clients. He estimates that about 10% of the firms he insures have partners sitting on public boards. In every case, the firms with public company directorships manage funds worth $1 billion or more.
VCs who sit on public boards are finding it more difficult to get insured. “If we come across a firm with a habitual problem of sitting on public boards, there is a good chance where we wouldn’t offer them coverage,” Burkhart says. Chubb has in fact turned an undisclosed number of VCs down. Those who are lucky enough to get insured pay the price. On average, the cost is about 10 times higher for someone sitting on a public board than it is for a director at a private company, he says.
So, is it worth it? To be sure, a public company board seat looks good on a VC’s bio, but in these days of dismal returns, are public company directorships a good use of money and time? Dick Kramlich, general partner and co-founder of New Enterprise Associates, says the answer is no, given the increased scrutiny of public boards.
“All the mis-doing of the last year is accelerating an existing trend [to exit public boards], and probably accelerating it big time,” Kramlich says. “They have just exacerbated things; there is a huge exposure for anybody who is on a public board.”
“Our first fiduciary responsibility is to our limited partners, and you should leave a board when you have paid out shares to your LPs,” he says. That said, Kramlich sits on the boards of two public companies: Silicon Graphics Inc. (NYSE: SGI) and Juniper Networks (Nasdaq: JNPR). Kramlich says he felt a responsibility to stay on the board of struggling SGI because it was “in jeopardy.” As for Juniper, NEA had an ongoing interest in the company. This is his last year on both boards.
Lawyers Know Best
Carl Metzger, a partner and litigator with law firm Testa, Hurwitz & Thibeault, says that VCs are becoming prey for shareholder attorneys for no other reason than the publicity their companies received in the Internet boom and bust. And when attorneys think of VCs, they think of one thing – deep pockets. “The principal risk is securities class-action suits, but it is becoming more common, not less, for individuals at companies to be named as defendants in all kinds of litigation,” Metzger says. “It can run the gamut from breach of fiduciary duty claims of various types to a significant risk of claims in the M&A context.”
Metzger’s job once he gets to court is to convince plaintiffs that although his VC clients may have deep pockets, they have short arms and no one is getting a nickel. In most cases, Metzger says, it is individual VCs who are being named as defendants but there are occasions when venture funds are also named.
To avoid a trip to court, Metzger advises his clients to stay off public boards. “Unless there are substantial business reasons that justify staying on the board, they should get off,” he says. “Our clients are less likely to serve on the board of public portfolio companies than they used to be, and the risks are only increasing.”
Forever on Board
For all the present risk and the dangers yet to come, there are still VCs who aren’t shying away from public boardrooms. Flip Gianos of Interwest is one. Gianos sits on the board of Xilinx (Nasdaq: XLNX) and T/R Systems (Nasdaq: TRSI), and he has no intention of giving up either seat. The attitude at Interwest, Gianos says, is to remain on boards in public companies in which the firm still holds stock. That’s the case with T/R and some biotech investments. While Interwest no longer holds a stake in Xilinx, Gianos says he keeps his seat because it gives him “visibility into the [semiconductor] industry. And, frankly, I am not too worried about them getting sued.”
Like Gianos, Promod Haque, a general partner at Norwest Venture Partners, says he has no intention of giving up his seats on four public companies: Extreme Networks (Nasdaq: EXTR), Redback (Nasdaq: RBAK), SPSS (Nasdaq: SPSS) and Primus Knowledge (Nasdaq: PSKI). During an economic downturn, VCs are more necessary to help guide a small public company through tough times, Haque says. He adds: “You’ve got to make sure that these companies are on solid footing and that you have fulfilled your responsibility, so that you can leave with your head held high.”
There are a lot of LPs that might have a quarrel with that. VCs are supposed to bring a company public when it is ready to go it alone. Once it’s public, and everybody on the private equity side gets paid, their job is done.
Mark Gilles, a principal at buyout fund Tangent Fund Management, says he has seen VCs stay on boards past their useful life. He says that once a portfolio company goes public and shares get paid out, the VC should bail. “If you are John Doerr, that’s one thing, because he almost transcends his background as a VC,” Gilles says. “But how many VCs like that are there? I think there are a lot of cases where they are not adding any value at all.”
Contact Michael Copeland
Carolina Braunschweig contributed to this story.