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Boards

Boards

Why activist shareholders travel in packs

Have you ever wondered why activist shareholders travel in packs? It’s because they are significantly less effective alone—just like any other minority on a board.

Activists (often hedge funds) accumulate a position in a stock because they want to make change happen at a company and, by making change happen, they will make money on their investment. It may be that they think the company is being mismanaged and so is undervalued against its potential. It may be that they think it should be broken up and the pieces sold off. Or it may be they think the board is incompetent and by driving change they can increase shareholder return.

Daniel Loeb, who runs the hedge fund Third Point, is currently in the news for the aggressive strategy he pursued to get onto the board at Yahoo!. He accumulated 5% of the stock, demanded 3 seats on the board, was rebuffed, found a fatal flaw in new CEO Scott Thompson’s inaccurate resume, and then used that chink to drive a wedge into the board room for himself and two of his nominees. Dan has become famous for his investment track record and his pithy letters eviscerating the management and boards of the companies he targets.

Carl Icahn has a long history of launching campaigns against companies, and like Dan, often wins—like he is doing at Chesapeake. Shareholders delivered a bruising rebuke to Chesapeake Energy’s board on Friday and although the board had agreed to replace 4 directors with Icahn’s and Southeastern Asset Management’s hand-picks, shareholders still withheld their votes from two key directors. In this case, two activists (Icahn and Southeastern) teamed up and acted as the lightning rod to help shareholders express their dissatisfaction with the board’s oversight of the company.

But why, you may ask, do they travel in packs of 3 or 4? Dan Loeb is a smart cookie and no shrinking violet—why does he need to bring two of his guys onto the Yahoo! board with him?

The answer lies in how inefficient and/or difficult it is to be alone and an outlier on a board. Boards aim to be collegiate, making sure diverse opinions are aired while also providing good financial oversight of the company. They want to get to unanimous recorded decisions in the end (no matter how contentious the internal discussion) and disruptive behavior is frowned upon. If you want to make change happen as a board member you need to develop support from other board members first or there will be no further discussion or vote.

If you are an activist that wants radical change, that very change is probably unpopular with management and the existing board or you would not be agitating for it as an outsider. Your new ideas will die on the vine unless there is someone else in the room to pick up your idea, expand on it, help you build momentum and overcome objections and, in the end, second your motions to ensure a vote.

Further, if you can get three people on the board together with the same purpose they can create significant momentum behind an idea. And sometimes, these activists can take advantage of directors’ natural tendency to act as individuals, and so create divisions among directors who have not yet figured out the need to unite.

This is why Starboard Value (which owns 5.3% of AOL) is proposing three nominees to the AOL board to challenge the strategy. They are also trying to line up proxy advisory firms ISS and Glass Lewis to support their new board members as this will influence how major shareholders vote. They want to be sure that if they get elected they can force a change in strategy at AOL by acting as a team on the board.

When you’re a voice of one it’s very hard to make change happen. It takes two to get a discussion going, and when you are just one it is too easy for you to be shut down—or if you will not back down—be labeled as disruptive and so have your effectiveness reduced. Activists know this and so, like any smart hound on the hunt for a kill, they travel in a pack. They show us the importance of having a group to represent alternative points of view on a board.

Odd, then, that so many Silicon Valley companies whose major customers are women have no women on their boards (like Facebook), or, if they have one, check the box and think they are done. Especially odd since we also now know that having women directors on boards improves return on capital for shareholders.

Because of the nature of how boards work, having token representation, whether it’s an activists point of view, or gender-based point of view, is not enough. Activists are showing us the way. It’s time to get more qualified women onto leading technology company boards.

Boards, Leadership

How to understand your board’s baffling behavior

Boards don’t behave like management teams and their sometimes seemingly baffling behavior can be an irritant to management. But if you can get inside the head and motivation of a board member you can, with a little distortion of the nth dimension, understand their behavior.

Whether it’s a public company board, a start up board or a non-profit board there are perspectives a board member has that give them a very different view than the senior management team:

1. They don’t live it every day. Some board members do a better job than others of learning and remembering the critical aspects of your business, but if they only attend meetings once a quarter (or even once a month in the start up case) your business will have moved by leaps and bounds between each meeting and you have to take the time to back up and fill in the gaps for them.

2. Reasonable people given the same information will often make the same decision. But given that your board does not have all the same information as you, they will not instantly come to the same conclusion as you. They are not being difficult, they just don’t have the same info. And, short of a Vulcan mind meld, you are always going to know more details than them, so be patient.

3. Good governance on a public board requires a board to have diverse opinions and deliberate – it’s all part of good process. That then means they are not going to agree with you, in fact at least one of them should be disagreeing with you and challenging you at times or they are not seriously deliberating. Some board members disagree “just because” as a way to shake up the conversation and see what falls out. It’s all part of the process, not about you.

4. Really good board members have a laser like ability to figure out what you are most defensive about and then pick at the wound. It’s a way of testing and needling the CEO to understand what the real dynamics of a difficult situation are. It’s meant to be helpful.

5. Being defensive is like a red rag to a bull. When a CEO has a defensive “don’t question me” reaction to a challenge it’s infuriating to the board member because a) it’s the board member’s job to question and b) it signals that the CEO is not on firm ground with his/her position, knows it and attacks back to try to stop the line of inquiry. As a CEO it’s bad, bad behavior. I cringe inside every time I do it!

6. The board’s most solemn duty is the selection of the CEO. Boards are always, always thinking “Is the person in the job the best person for the job right now?” Their duty is to the shareholders, even in a private company, and the selection of the leader is the greatest impact they have on the return to the shareholders. As CEO you just have to get comfortable with it, and help the board question you, and engage you in a continuous succession planning analysis. The day will come when you may not be the best person – for any one of a thousand reasons including your own – so get comfortable with the discussion.

7. Different board members have different roles to play. Some are financial – they may well ask remedial questions as they seek to understand your products, but if they are a former CFO and running your audit committee – God bless them! Some are technical and may question your go-to-market strategy but be a great resource for you when it comes to evaluating a technology. But just because they have a deeper set of skills in one area and less in others it does not mean they always remember that.

8. Your board are not your friends. Remember pt #6. They are your advisers, your ultimate employer and the representatives of your shareholders. While they may be fun to have dinner and play golf with outside the meeting they are not your friend inside the meeting and you can get smacked in the meeting if you forget that. Want to complain to someone safe? The only safe person in the room is your outside counsel (your lawyer) once you tell him the conversation is confidential.

9. Your board may have their own fears and issues about being on your board which can show up as baffling behaviors in your meeting. One board member (of a currently high profile and controversial public board) told me about the reputational risk of being on a board that should have been interesting and fun but has now turned into a public pillorying. The problem is by the time the going is rough it’s hard for the board member to resign if the company actually needs his/her help. You can’t know what challenges they are facing so don’t assume their behavior is always about you.

10. Your board’s job is not to motivate your team. In fact they can do quite the opposite when they get on a tear on an issue. Your job is to be the buffer between your board and your execs and if one of your execs can’t handle the challenging, difficult decisions, don’t have them in the room. Or tell them to grow up and grow a thick skin.

So if they are baffling you, or annoying you, or confusing your team take a deep breath and remember they are probably good people trying to help the company. And never forget the old proverb “With the rich and mighty, always a little patience”.

For help on your meeting – refer to my How to Run a Board Meeting post.

I sit on the boards of FirstRain, JDSU, Rambus, the Anita Borg Institute and Planned Parenthood Mar Monte. No one board is special – these behaviors show up across the spectrum.

Boards

Netflix and how last minute filings can bite you

Filings, like any other piece of finished work, have a tendency to go to the last minute but in the case of your 10-K it’s a mistake to let that happen.

Case in point – Netflix last week. They filed their 10-K just 36 seconds before the Friday night SEC deadline and so Michelle Leder – the author of the footnoted.org blog – went digging for dirt. She has an assumption, often proven to be correct, that last minute filings are last minute precisely because they are contentious in some way. She calls them the “Friday night dump”.

In this case the gem she found was Netflix’ stated need to ““repair the damage to our brand”. Ouch. From a fantastic, positive, much-loved brand to having to file that their business results may be negatively impacted from their self-inflicted wounds. And it’s an unusual risk that Michelle was not able to find in any other 10-K’s

You can see the web spikes caused by Netflix’ fateful decision to split their service and dump DVDs – and then reverse the decision – below. What a PR nightmare.

Of course, the gem Michelle found was in the Risk Factors section of the 10-K – and this section is written by their lawyers as a CYA against shareholder lawsuits. But the addition of new risks usually gives you insight into what senior management is worrying about (or being told to worry about by their outside council).

Boards

WSGR and conflict waivers in Silicon Valley

I’ve used Wilson Sonsini as my outside counsel for more than 15 years now. Like many a tech CEO, I was introduced to Larry Sonsini very early on as a green CEO, grew up with the firm, stayed loyal because of their incredible advice, got frustrated by their lack of follow through on the small stuff, and became fast friends with several partners at the firm. A very typical Silicon Valley tech story I have in common with CEOs at large and small companies in the valley.

But because WSGR is so successful in tech they often find themselves on opposite sides of a conflict and have become masters of the “conflict waiver”. Both parties sign that it is OK that the same firm represents both sides because different partners are in the lead and they promise not to talk between the sheets (so to speak).

Which is why when @alacra1 (that’s Steve Goldstein) tweeted out this cartoon I laughed out loud. If you have ever done a lot of business with WSGR you’ve seen this movie.

Thanks to stus.com for the brilliant cartoon.

Boards

It’s not a bubble – the difference between valuation and long term value

Living in Silicon Valley, running a software company with big ambitions I hear the question a lot. Is this another tech bubble? Isn’t is going to burst again?

The short answer is no.

Pundits covering tech tend to confuse valuation with long term value. We may well be in a valuation bubble but unlike the 2000 tech bubble the companies in question have deep, sustainable revenue models.

There are certainly some high valuations – per Fred Wilson’s view of frothy valuations in April – and these are driven by investor demand. As Father Guido Sarducci so wisely said in the 5 minute university, Economics is about supply and demand. When a few companies have sky high valuations in the public and private markets VCs are chasing good ideas with too much money again and so the early stage and later stage valuations may be getting silly for most companies, but some will be worth it.

Valuation is very different than long term value. Technology, and in particular software, is where long term sustainable value is being built. And when I say long term I am thinking hundreds of years. Marc Andreesen wrote very eloquently about this in the WSJ on Saturday in his essay Why Software Is Eating the World. We are at the beginning of a long era in which technology will reshape every aspect of our lives in ways we are just now beginning to see.

Just as the Industrial Revolution developed over more than 150 years in the 18th and 19th centuries and reshaped machines, industry, transport and the very nature of where people chose to live and work, technology is now reshaping the way we communicate, are entertained, where we live and work and shop and it is rewiring our kids brains for a new world. I’ve believed this for 20 years and the ups and downs of the tech world over that period have done nothing to dissuade me from that belief because technology is steadily, consistently and dramatically changing our lives. (Want to get some perspective on the 150 year change last time around – spend a day in Ironbridge in Shropshire, England.)

It’s happening right now because the pieces are now in place. As Marc writes “Six decades into the computer revolution, four decades since the invention of the microprocessor, and two decades into the rise of the modern Internet, all of the technology required to transform industries through software finally works and can be widely delivered at global scale.”

The cost structure is right, the technology base is ready. In FirstRain’s case we have built a highly disruptive technology that changes the way business people use the web for their critical decision making. As Roger McNamee says in his thought provoking talk “Everything is Changing”, Google’s approach to indexing has peaked. People want apps designed for their specific need (he cites his investments like Facebook and Yelp), not one app for all needs, and they want it on their device of choice – which is a smartphone or an iPad. In our case the business need is even more specific than that. Our users want a business web app so they can tap into the breadth, currency and power of the web as a data source, but they want it tailored to their specific business and role, and they want it in a cost effective way.

Marc and Roger are just two rockstars in silicon valley but most people here agree with them (and not just because we are all drinking the same koolaid). Yes we are dealing with some higher valuations, maybe that is a bubble, but the long term value being built in technology is real, and software is where it’s at. And what makes it even better is it a continuously exciting place to build a career, or even a company.

Boards

Today’s tech bubble: Sell or IPO your company?

If you had the chance to sell your tech company for a great price would you – or would you play the long game?

This is a decision successful entrepreneurs end up facing and is a question for some tech entrepreneurs right now as we go through what is arguably another bubble – and there are some very interesting cases to think about – and think what would you have done?

Consider the Huffington Post: A success story to most people – purchased by AOL for $315M in February at a 6.3X multiple of $50M in revenue and very small profits. The last investor, Oak Investment Partners, tripled their money in just over 2 years which is a great result for a late stage investment decision. And yet, as Jeff Bercovici of Forbes writes in his somewhat damning review of the HuffPo/AOL honeymoon, the difference in interests that can appear between investor and entrepreneur in very visible in this case.

Fred Harman, the Oak partner who made the HuffPo investment, told Forbes “Our goal was an IPO rather than building up the company to be acquired by another media company” and that he and the HuffPo CEO Eric Hippeau “were still inclined to roll forward as an independent company out of the belief that The Huffington Post could continue to rapidly scale and be the dominant social news company on the Web”. But for Arianna, AOL meant personal liquidity and a much larger stage and budget to build her dream with.

(full disclosure: my current company FirstRain is funded by Oak. They like to swing for the fences – as do I)

In contrast look at Zillow, which went public last week and, on 2010 revenue of $30.5M, now commands a valuation of greater than $1B. Is this valuation a surefire sign of a tech bubble? On Seeking Alpha screener.co writes that “The vast difference in valuation between a recent tech IPO and similar publicly traded competitors is not limited to Zillow” – Pandora’s valuation is almost as shocking as Zillow’s and outrageous in comparison to their comp RealNetworks. So long term public valuation (and so the team’s return) is at risk here.

In the enterprise social media space, Radian6 decided to sell to Salesforce instead of taking the long road. At a valuation of $326M and 10X revenue Techcrunch thinks SFDC overpaid but 10X trailing revenue is a terrific valuation for an enterprise software company and being integrated into Salesforce takes all the return risk out for the founders – plus SFDC smartly put additional options on as an earnout over 2 years (not unusual when a public company buys a private company and wants to keep the founders around). But also consider that maybe Salesforce creates a larger platform with deeper pockets for the Radian6 team to execute their vision on.

And waiting in the wings we have Groupon. They did not sell to Google last Fall for $6B and, if they can get over the questions about their business model and profitability, hope to IPO for $20B – and are lining up enough banks to make it happen.

All this leads to questions of timing – are today’s valuations fashion driven because tech IPOs are hot now? – and what would you do if it was you? I’ve been there, it’s a gut-wrenching decision.

If you sell:
+ You get secured liquidity and wealth for you and your team (especially if you are bought for cash)
+ You play on a larger stage, often with a larger budget
+ You may get access to many more customers on a larger platform
+ You create long term job security for your core tech team
– You lose final authority on strategy and budget
– Many members of your team (non tech) may lose their jobs
– You lose the essential joy of building your own venture

If you go public:
+ You get significant capital to grow your business with
+ You stay in charge (for now…)
+ Your investors get a great return in 6 months (after the lockup comes off)
+ You may get a significantly higher return over a longer time period
+ You continue to drive the strategy and M&A to execute you and your team’s vision
– Limited liquidity for you or your team for the foreseeable future
– You are running a public company (no picnic!)
– Your return is not secure, you are subject to volatile markets

… and there are many more pros and cons…

One of the best pieces of advice I got was to, in the end, focus on how my management team is successful and makes money from their hard work. Not my ego or my net worth. Not my investor’s return. My team, the ones who built the company with me. If they make money, everyone else will make enough.

Boards

Are LinkedIn’s bankers greedy or stupid… or making a market?

A lot has been written about the frothy LinkedIn IPO in the last week and the investment bankers can’t win either way but I believe in the end they are doing their job and making a market.

On one end of the criticism you have Evan Newmark at the WSJ saying that IPO buyers are LinkedIn Stupidity. He wrote that “tonight’s IPO buyers need not worry. Common sense generally has little to do with the IPO market – and absolutely nothing to do with the LinkedIn IPO” and accuses Morgan Stanley of jacking up the price 30% at the last minute because they find they can, because of demand, not because of the intrinsic value of the stock.

On the other end you have Henry Blodget arguing that the bankers are screwing the company our of millions of dollars of gain because “IPO “pops” like LinkedIn’s–which are generally celebrated as a sign of success–are actually bad: They rob the company and its existing shareholders of cash that is rightfully theirs and they steer it into the pockets of favored money management clients who don’t need or deserve it.”

In the end the bankers hold all the cards and have to make a risky, gutsy judgement call on what the market will do to the stock the next morning. I’ve personally been in the situation of negotiating the final price with the bankers – and the allocation to their favorite customers – in the 11th hour. My goal as CEO was to ensure we got the best price we could for the stock we were selling (in our case a 20% uplift to $12 from the original $10) and yet ensure we were not so greedy that we overpriced the stock such that it would drop the next morning – and it was not an easy conversation. (I remember how good the first martini tasted afterwards!)

LinkedIn was the first big, frothy social media company to go public – and it has zero profit in 2011 and slowing growth. It would not be unreasonable to be conservative on the initial pricing, despite the book demand for the shares. Look at what’s happening to Freescale Semiconductor today “shopping its deal to investors at a price range of $18 to $20, instead of its original level of $22 to $24.” Freescale is selling at a price below what it’s private equity buyers paid for it, and lowering the price at the end of it’s IPO roadshow.

There is huge psychology in the pricing of an IPO stock, and the capital markets team at the bank are making a future market. If their best customers make money early on in a new stock they are more likely to listen to the bankers when they come around with their next IPO. It’s a hustle and whisper – “Hey remember how you doubled your money on LinkedIn on the first day – well I’ve got another one, it’s call Twitter, and it’s going to be even hotter. This book is going to be even more oversold.” And a terrific first day price gain also attracts uneducated retail investors who think because it’s hot today it’ll be hot tomorrow.

LinkedIn was probably hot from day one because so many of the potential buyers are also users and experience the value every day. But I had a different experience on the way to having my Simplex stock open at $12 and close at $22 on the first day.

We were half way through the road show – about 10 days of pitching 7-8 times a day at that point and there were no orders in our book. It was May 2001 and there had been no small tech IPOs post dot.com crash so we were breaking new ground and our CSFB bankers and capital markets team were downright skittish.

We were headed to New York and I kept asking the bankers if we had a meeting with Paul Wick at Seligman yet – I knew him and knew he understood our space (EDA) so I was confident he’d “get it” but they could not get him to agree to a meeting. So I called Paul’s office, and left him a message personally asking him to take a meeting.

Paul couldn’t take a one-on-one but took the unusual step (for such a high profile guy) of coming to an open lunch to hear me pitch. With about 50 people in the room he sat right at the front and watched me intently the whole time. I think he asked one question at the end and then left. I had no idea what he thought – good or bad. It was intense.

But according to the CSFB sales team Paul left the room, walked up to the sales guy and said “I’ll take 1 million shares” (this was out of a float of 4 million we were selling). And that set the snowball rolling. The sales guys whispered to their clients “Paul Wick is in” and within a couple of days we were 11X oversold – creating the market for our stock in the days following the opening.

That is the bankers job. Connect the company with institutional shareholders who have the capacity to buy on the IPO and some will flip and some will accumulate in the first few hours of trading. And it’s what Morgan Stanley et al just did for LinkedIn, and more importantly what they just did for the next ten hot new IPOs from Silicon Valley that want to raise money in the public markets this year.


Me with my management team (Luis Buhler and Aki Fujimura) on May 1, 2001… finally relaxed after pricing at $12, and before heading to New York to watch the stock open… and climb to $22 on the first day.

Boards

Insider trading between Rajat and Raj – you really can’t make this stuff up

Sometimes news comes along that is so out of line I would believe it was fiction unless I saw it with my own eyes – you just could not make this stuff up!

Today Rajat Gupta – a highly respected former McKinsey senior partner and former board member at both Goldman Sachs and Proctor and Gamble was charged by the SEC with insider trading. What is astonishing about this charge is the SEC’s press release reads like a soap opera.

For example – Rajat is on a Goldman Sachs board call discussing clearly material events (Berkshire Hathaway’s investment in Goldman), within one minute of the end of the call he calls Raj. With minutes to go until the market closes, Raj buys 175,000 shares of Goldman, which he then sells the next day after the news is public.

Seriously! A Hollywood script writer could not have made this stuff up and been credible. Thanks to Business Insider for the minute-by-minute analysis of the calls placed between Rajat and Raj and the subsequent trading by Raj’s firm Galleon. It happened more than once!

I won’t take a position on whether Rajat is guilty or not – in the US he is innocent until proven guilty – but the optics are terrible whether they were talking about business tips or cooking recipes. And as a board member you are wise pay attention to both substance and optics because it is so easy to be misunderstood with 20-20 hindsight.

Boards

Insider trading – why is everyone shocked?

In theory the principle behind insider trading has not changed in 30 years – as evidenced by Hollywood’s first major attempt at telling the story in Wall Street in 1987. But in practice the process through which companies communicate, and the SEC investigates, changes continuously.

Witness the recent investigations into Expert Networks and Corporate Access and their possible role in providing insider information to hedge funds. Investors have always wanted to talk directly with company management to get a better understanding of a company and it’s prospects.

Before Reg-FD sell-side analysts would get preferential access to company management – and often get help with their models and their descriptions of the company’s strategy and it’s progress. 20 years ago a sell-side analyst might send you his model and research report a few days in advance of publishing and you could give him feedback. In the early 90s when I was VP Marketing at Synopsys the sell side analysts would send their reports to me and the CFO in advance to have us edit and correct them before they were published.

Then Reg-FD came along and it became illegal for management to give the sell-side advanced information.Fast forward 5 years and we have two types of “access”. The sell-side organizes access to management for their best clients – hosting management for a couple of days in New York or Boston and wheeling them into one-on-ones and high end restaurants.

In contrast Expert Networks hook the buy-side up with experts in the field they are researching and the smart ones put recordings and controls in place. In both cases no insider information is supposed to be shared but come on… they are two versions of the same thing. People talking to people to get understanding, color and tone. You can watch a CEO and his team, especially in the down times between meetings, and get a good sense of their outlook.

The SEC can and will get all over insider information – and the mess at Galleon is evidence of what can happen if you play fast and loose. I’ve met with them, and firms like them, and you have to be on your toes to not break the rules. To whit, one meeting I was in with my CEO and a hedge fund PM two weeks before the end of the quarter (more than 5 years ago) and I watched in amazement as they talked in code and clearly conveyed the pending results.

My favorite example – my customer (a portfolio manager) who was invested in a large public company whose CEO was a reformed smoker. She sold when she saw him smoking, and bought when she saw him being able to quit for a while. It was a fool proof strategy for years.

I’m glad the SEC is all over insider trading and trying to keep ahead of every new loophole that develops. The fast and loose times of the late 90s were not good for any but the few who sold tech at the top. But it’s got to be a continuous improvement process, not a stop and start process based on public sentiment. Any time there is great wealth being created (as we have seen and will continue to see in hedge funds) we should expect to see the creative few bending the rules and trying to get an unfair advantage. It’s human nature.