Welcome to The Director’s Dilemma. These case studies, created by Julie Garland McLellan, are based on real events together with three sample solutions from governance practitioners.
The Dilemma | Frank’s Answer | Julie’s Answer | Ian’s Answer
Philippa is a non-executive director of a medium sized listed company which found itself in financial difficulties. To raise money a placement with a new large shareholder was done at a slight discount to the then share price. Shareholders complained about this, and now as more funds are needed to grow, Philippa is unsure whether to back the proposed second placement or whether she should consider the views of disgruntled shareholders and push for a more complicated rights issue. What would you do?
The Dilemma
Philippa is a non-executive director of a medium sized listed company.
The company had financial problems last year and raised money by a placement with a new large shareholder. The shareholder took a 15% equity stake at a slight discount to the then share price. Some longstanding shareholders complained afterwards saying they would have liked to ‘top up’ their holdings at that price.
An AGM has been held and the issue of shares to the new shareholder was ratified. There was a substantial vote against this. It was obvious that many shareholders felt they had been denied a valuable opportunity. The new shareholder was given a seat on the Board and this was also carried but with a large vote against.
Now the market has recovered and the company needs to raise funds to expand. The Chair and the new shareholder are keen to do a placement which would be quick and relatively cheap.
Philippa knows that a rights issue is more expensive and that a prospectus is time consuming and distracting for management to create. She is unsure that shareholders will support another placement, believes she has a duty to consider the wishes of even the smallest minority shareholder as well as those of the large sophisticated investors, and knows some small shareholders want to participate in future raisings.
What should Philippa do?
Answers
Frank’s Answer:
At the AGM:
– The share issue to the new shareholder was ratified.
– The new shareholder was elected to the Board.
While some disgruntled shareholders objected, they were outvoted on both counts.
These shareholders have nothing to complain about (other than not being invited to participate last time) but rather should be grateful that this new shareholder bailed out the company in an emergency situation – a situation that likely would not have allowed enough time to include other shareholders, and which therefore would have risked their entire investment to delay.
Obviously the majority of shareholders were happy about it, so the action was taken and ratified.
It is the duty of directors to protect the best interests of public shareholders at large, not that of a disgruntled minority, no matter their number.
Since the market has recovered, this offers the opportunity for the company to expand, and it would be in the best interests of all shareholders to raise capital to facilitate the expansion, which in turn will boost earnings and hence the share price.
Philippa can make her feelings known. But she should vote in the overall interest of all shareholders, that is, an expedient placement, because all indications are that the majority of shareholders will again be in support, as they were before.
Frank Feather is President & CEO at NorthStar Stadium Resorts International, President & CEO at Geo-Strategies Inc, and Interim CEO/CFO at Fortune 100-500 Companies.
Julie’s Answer:
Before the company raises any money by any means Philippa must be sure that it is to be used as described. Have the problems that caused the difficulties been fixed? Is there evidence the fixes are working? What aspects of expansion are these new funds required for?
She then needs to ensure the Board has a robust process for making a decision about how much funding is required and how best to raise it. The new shareholder, as a shareholder, has a clear conflict of interest especially if he or she plans to take part in the placement.
Philippa and her fellow independent directors should assess the liquidity, spread, current shareholding and future needs of the company to determine what course of action will generate the best strategy into the future. The last capital raising was an emergency bailout and, under the circumstances, a raising from a single sophisticated investor was probably the most viable course. That does not mean it is the best course now. The costs and benefits of each possible method should be assessed and ranked. The Board will then be able to precisely explain to shareholders the method they have chosen.
My preference would be for a fully renounceable offer or an underwritten rights issue to allow existing shareholders to participate. There may be specific reasons to use another method, however, and Philippa must make certain that the new major shareholder does not gain control without a transparent process and a premium for other shareholders. She must also ensure that capital planning is performed better in the future so that emergency action is never again required.
Julie Garland McLellan is a specialist board consultant and practising non executive director.
Ian’s Answer:
For me, the issue is one of fairness and maintaining confidence in investment markets.
If a shareholder fears his stake can be diluted almost at the will of management, he will demand a greater risk premium for his investment thereby depressing prices and hindering the efficient operation of markets. It is thus better to use a rights issue.
In the UK this can now be executed in a matter of weeks and though it is likely to be more expensive than a placement, you may find that the process of writing the prospectus could inject some discipline and force management to really think through their problems in what appears to be a failing company.
As is so often the case in life, the easiest option is not always the best.
Ian Burrows is Investment Manager at Brewin Dolphin, one of the largest independent private client investment managers in the UK.