What’s a VC Doing on a Public Board? –

You read a new version of it daily: Public companies being investigated for accounting fraud. During the ensuing investigation, the company’s board of directors is thrown into the hot seat, squeezing in next to top management. “What the hell were they doing when all of this was going on?” cry angry shareholders and politicians. And, shareholders’ attorneys ask: “Shouldn’t they be made to pay?”

Those questions are prompting venture capitalists to ask themselves a question of their own: Is it worth the risk to sit on the boards of publicly traded companies?

Look at the situation of 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. Even though Strohl wasn’t on the hook for a settlement, he 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 & Sons’ 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.”

Are You Covered?

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 we wouldn’t offer them coverage,” Burkhart says. Chubb has turned down an undisclosed number of VCs. Those who are lucky enough to get coverage 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, Burkhart says.

So, is it worth it? 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.”

No. 1 Responsibility

“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. (SGI) and Juniper Networks. 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.

“Pretty soon, there will be no reason anybody in their right mind would ever want to be on a [public company’s] board,” says Charles Beeler, general partner at El Dorado Ventures. “It’s going to be like jury duty.”

In return for little compensation, directors have unlimited liability, and in court cases popular sentiment currently favors the “little man,” Beeler says.

Feeding Frenzy

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 firms received in the Internet boom and bust. When attorneys think of VCs, they think of 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 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, he 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.

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. Philip “Flip” Gianos, a general partner at InterWest Partners, is one. He sits on the board of Xilinx and T/R Systems, 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, Redback, SPSS and Primus Knowledge. During an economic downturn, small public companies need VCs to help guide them, Haque says.

Limited partners are of a different opinion. LPs generally don’t like VCs to sit on public boards for extended periods after an IPO, according to participants in VCJ’s LP roundtable discussion (see Cover Story, page 18). Besides the exposure to lawsuits, sitting on a public board isn’t in a venture capitalist’s best interest because it distracts the VC from his or her primary job: building successful private companies, the LPs say.

Time Better Spent

Paul Yett, a principal with fund of funds Hamilton Lane (and not a participant in the LP roundtable), says that public board seats may take too much time away from what a VC is paid to do. “My question would be whether they can continue to invest actively in the private equity world if they are sitting on 10 public boards,” he says.

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.”