As the COVID-19 pandemic unfolds, directors and management teams of startup companies are faced with important decisions that could impact the long-term success of their companies. The following are key considerations for these directors as they perform their oversight role and discharge their duties to the company.
1. Health and safety
The first priority of every corporate director throughout the COVID-19 pandemic should be the health and safety of the company’s stakeholders. This includes not only employees and their families but extends to customers, suppliers and the general public. Every decision made by directors should have health and safety considerations at the forefront. Directors should communicate with management to understand the company’s approach to health and safety, including responses to government directives and recommendations from public health authorities.
2. Succession and contingency planning
The board should ensure that the company has an effective succession plan in place for its senior management in case they are unable to fulfill their duties. In addition, the board should have a plan in place in the event that a meeting quorum cannot be met due to COVID-19 and implement alternatives to traditional in-person meetings. Directors should review the applicable corporate statutes, securities laws and constating documents prior to making amendments to its meeting requirements.
3. Management incentives
One of the key roles of the board is to ensure management is properly incentivized. Directors should be especially attuned to significant decreases in the valuation of the company. For example, if the combined liquidation preference of outside investors is equal to or greater than the company’s current valuation, management shares (which are typically common shares) may have little or no value. This could create a misalignment of incentives between management and other shareholders. Further, the fair market value of the company’s equity may be difficult to determine given the current market turbulence and this could complicate decisions around granting equity compensation. Depending on the situation, directors may wish to delay these compensation decisions until the market settles or provide additional incentives to retain key personnel.
Directors should work with management to stay up-to-date on the company’s liquidity position. Even if a company’s revenue is not decreasing, liquidity may be impacted in other ways such as delayed accounts receivable or disruptions in its supply chain. Directors should be aware of the cash runway that the company has, and any mitigating actions being put in place. As things can change rapidly in this environment, the board should seek frequent updates.
5. Shareholder dynamics
Depressed valuations may lead to different pressures from different shareholder groups. In situations where there are multiple classes of shares outstanding, holders of subordinate equity may be more likely to push boards to take riskier strategic decisions, whereas preferred equity holders may be more interested in preserving capital. It is important to understand these dynamics so directors can continue to act with a view to the best interests of the company as a whole.
6. Employee compensation
Many management teams have had to make difficult employment decisions by reducing wages, or laying off or terminating employees. Directors should be kept informed of these decisions as Canadian directors may be personally liable for unpaid wages. Directors should work with management to ensure that employment counsel is retained and that such decisions have been carried out in accordance with applicable law.
The COVID-19 crisis has caused many investors to focus inward on their portfolio companies. As such, directors may wish to focus their attention on existing shareholders when raising capital rather than seeking outside investment. Directors may not be able to raise capital on favourable terms from new investors, particularly if the company is in distress.
8. Legislative relief
Directors should work with management to ensure they are fully-informed of federal and provincial COVID-19 relief programs. However, if a company does not meet the eligibility criteria for a program, there may be steep penalties for wrongly accepting support. These programs have evolved in recent weeks and directors and management should remain up-to-date with respect to new programs and changes to existing programs.
9. Renegotiation of contracts
Directors should inquire into any efforts by management to renegotiate material contracts. For instance, many companies impacted by COVID-19 are renegotiating commercial leases and in many instances, landlords may not be able to evict tenants or find new tenants. Given the unprecedented impact on the economy and the legal system, landlords may be willing to renegotiate payment terms, defer payments or provide other relief to maintain existing tenants.
If a startup’s finances are not negatively affected by COVID-19 and it has a long runway, directors should consider whether there are any opportunities in the market. This may include strategic M&A at discounted valuations, leverage in contract negotiations and hiring opportunities. This strategy should of course be pursued carefully and thoughtfully given current conditions.
11. Preparing for normalcy
It may be that the return to pre-crisis normalcy will take considerable time. In the interim, directors should work with management to implement a plan to swiftly adapt when the economy begins to recover. The recovery will likely be a gradual process. Directors and management should have a plan in place to, for example, prioritize opening certain segments of the business.
Read all our coronavirus-related updates on our COVID-19 guidance for organizations resource page.
To discuss these issues, please contact the author(s).
This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.
For permission to republish this or any other publication, contact Janelle Weed.
© 2020 by Torys LLP.
All rights reserved.