Produced by Julie Garland-McLellan, Consultant at AltoPartners Australia and non-executive director and board consultant based in Sydney, Australia.

Contribution by Stephen Dallamore, Director at Search Partners International / AltoPartners South Africa. Stephen was Global Chairman of AltoPartners from 2015 - 2020

This edition of the newsletter was first published on The Director’s Dilemma website and the full newsletter is available for viewing here. To subscribe to future editions of the newsletter, click here

The Director’s Dilemma - October 2021

This month we consider the implications of a board that is representative of shareholder interests rather than skills based when a company needs additional capital.

Lloyd is a director of an incorporated joint venture (JV) where all directors are nominees of the shareholders. The market for the company’s product is growing strongly. Profits are slightly above the original forecasts but can’t grow any higher due to capacity constraints.

The company constitution is very much a ‘plain vanilla’ document and directors are more likely to refer to the shareholders agreement to resolve issues that arise. The board is fortunate that the directors are experienced in the company’s operations, honest, and willing to make an effort to achieve good governance.

The JV is looking to expand operations and increase its capital to make the required investments. This is causing differences among the directors, as some work for shareholders who are willing and able to invest more equity, others work for shareholders who are willing to increase debt but not to put in more capital, and one shareholder who doesn’t want to expand this venture because that company no longer embraces projects of this nature.

The Board Chair has gone overseas to a new position and the role, previously held by the largest shareholder’s nominee, is now vacant. Lloyd’s employer has asked him to take on the role and lobby for the interests of the shareholders who want to expand. The largest shareholder has yet to announce a replacement for the former chair and, under the Shareholders Agreement, the board should select its own chair from among the directors.

Lloyd is unsure whether he should ask his colleagues to appoint him or whether that might trigger an increase in the tensions that have arisen between directors. How would you advise him to proceed?

Stephen’s Answer

Lloyd should first study the Shareholders agreement, particularly the “pre-emptive rights” clauses, which ensures current shareholders are able to purchase a Shareholder’s interest before this is offered in the open market. Additionally, he should understand the “share valuation” mechanism for any Shareholder who wishes to sell their shares, and know whether there are any “special resolution” clauses for important Shareholder issues that might prescribe a vote of 51% or 60% of the Shareholders should they wish to exit a Shareholder.

With this information Lloyd should approach the largest Shareholder first, whose nominee was Chairman, and point out that the Shareholders agreement clearly states that the next Chair must come from the current directors and offer his services as Chairman, as this is a strategically viable choice. He should then suggest that his plan would be to expand the business with a blend of debt and equity – for example 30% to 70% - taking into account all remaining Shareholders’ wishes.

Armed with a positive response from the major Shareholder, he should approach each Shareholder separately and share his plan. The Shareholder who no longer embraces the project should be approached last and their exit agreed in line with the terms of the Shareholders agreement they signed.

Once this is done, Lloyd should:

• convene a board meeting of all Shareholders,
• have his election as Chairman ratified,
• agree on the terms and conditions of the sale of the Shareholders interest who no longer embraces the project, and
• agree on the funding of the expansion, with the appropriate balance between equity and debt, so all remaining Shareholders’ interests are catered for.

This would allow the business to expand its capacity with the right balance of equity and debt and enable the company to continue growing its profits.

Julie’s Answer

The governance of joint ventures is hard. Shareholders are often constrained within an agreement that was fine at the outset but that lacks liquidity and easy exit/renewal of shareholders to allow changes in growth, profitability, capital requirements, or strategy.

Lloyd needs to read his constitution carefully - what constraints does it place on the duties of directors to act in the interests of the organisation rather than any stakeholder or group of stakeholders? What are the precise mechanisms for chair succession? Do the shareholders need to vote on expansion and additional investment, or can the board decide and simply seek investment support from the shareholders who can provide it?

Then he needs to consider the expectations of his board. If the largest shareholder’s nominee was the former chair, what does the constitution say about how future chairs will be selected? Is the board waiting to see if the shareholder will appoint a director before they make their election (which would be fair, if perhaps a little slow) or are they expecting to accept that shareholder’s nominee as their chair?

When he understands the ‘in-company’ issues, Lloyd needs to understand the shareholder issues. He needs to listen to each shareholder and demonstrate that he understands and empathises with their feelings.

Then he needs to do his duty and work out what is the right path forward for the company. If taking the chair role seems like the best path for the company and it is within his capability to do it well, then Lloyd should put himself forward as a candidate. If he thinks he lacks the ability to lead at this time he should hold back and support another chair candidate.

Then, when the board has reached a decision about what to do, Lloyd can add further value by helping them to explain to shareholders, succinctly yet transparently, with empathy but no apology or defensiveness, what is in the best interests of the company. That explanation must be forthcoming even if the shareholders have no power to veto the decision.