Best Practices for Board Observers and Board Members of a Private Technology Company

1. Best Practices for Board Observers and Board Members of a Private Technology Company Mark Radcliffe, Silicon Valley Office, DLA Piper LLP mark.radcliffe@dlapiper.comDisclaimer: This material is provided for informational purposes only, and the content should not be construed as legal advice on any matter

2. DLA Piper • 3700 lawyers in 28 countries and 66 cities • Private Equity Analyst: #3 law firm in venture financing worldwide in 2006 and 2007 (no ranking yet for 2008) • US coverage: Seattle/San Francisco/Palo Alto/Los Angeles/San Diego/Austin/Chicago/Boston/Atlanta/Reston/New York • Complementary practices • IP Licensing • Employment • Patent Prosecution • Trademark Prosecution • International Tax

3. Corporate Venture Practice • Clients • Siemens • VISA • Sony • Eastman Chemical • Pfizer • Qualcomm • NEC • Critical Issues • Venture capital • License/contract • Corporate opportunity doctrine • Corporate Training Program (Fixed price programs taken by VISA, Siemens, Pfizer and others) • Board Issues • Term Sheets • Down Round Financing

4. Overview • The Role of the Board • Board Observers/Board Members • Best Practices for Board Observers • Composition of the Board • Fiduciary Duties of Directors • Duties of Directors in Special Situations • Best Practices to Minimize Risks

5. The Role of the Board • Governing Standards: • State corporation law: • Delaware General Corporation Law (“DGCL”) • California General Corporation Law (“CGCL”) • Related case law • Corporate charter (certificate of incorporation or articles of incorporation)

6. The Role of the Board (con’t) • Bylaws • Contracts – Voting Agreement • Laws imposing liability on directors (OSHA, ERISA, etc.) • Additional standards applicable to public companies: • Additional provisions of federal securities laws • Exchange and Nasdaq rules • Publicly traded “best practices” • Definition of independence

7. The Role of the Board (con’t) • Basic Responsibility of the Board: “The business and affairs of the corporation shall be managed and all corporate powers shall be exercised by or under the direction of the board.” (CGCL, § 300(a))

8. The Role of the Board (con’t) • Duties of the Board of Directors Include: • Electing officers • Appointing independent auditors (although this is becoming a function of the audit committee in public companies) • Assuring the accuracy of financial statements • Establishing corporate plans and objectives and monitoring management’s performance

9. The Role of the Board (con’t) • Reviewing and passing on major corporate actions (acquisitions, declaration of dividends, etc.) • Counseling senior management • Establishing key corporate policies and programs and monitoring compliance (e.g. investment, public disclosure, environmental, etc.) • Approving financing transactions and other issuances of securities • Approving officer compensation and employee equity plans • Assessing takeover or merger proposals

10. The Role of the Board (con’t) • Delegation of Duties: • Corporate Officers: The Board may delegate management of the day-to-day business operations of the corporation to the corporation’s officers. • Committees: • The Board may delegate any powers of the Board, except for certain acts specified by statute, to committees of the Board.

11. The Role of the Board (con’t) • Typical standing committees: • Audit Committee • Compensation Committee • Nominating/Corporate Governance Committee (late stage generally) • Special committees: Special committees are formed to deal with specific transactions, particularly those involving conflicts of interest. • Proxies: Individual directors cannot delegate their Board duties or voting rights to proxies.

12. Composition of the Board • Number of Directors and Term of Office: • Minimum of three directors in California (for corporations with three or more shareholders); no minimum size in Delaware • Board size established by Bylaws: • Delaware: Board can amend bylaws to expand • California: Bylaws can allow variable size, within limits • Service until next annual meeting (California only) • Classified Boards; staggered terms

13. Composition of the Board (con’t) • Resignation and Removal: • A director may resign at any time • Removal by shareholder vote • Special rules: • Class or series voting rights • Classified board • Cumulative voting

14. Board Oberver/Board Member • Board Observer Duty Scope: Contract • Board Member Duty Scope: Statute • Fiduciary duties: loyalty/care • Contract • Role of Observer • Monitor portfolio company for investor • Assistance in relationship to corporate investor, use the “halo” effect • Shape product roadmap of portfolio company • Assist in portfolio company strategy • Sales strategy • International expansion

15. Critical Issues for Board Observer Letter • Attendance/information rights • Attend Board meeting/committee meetings • Obtain minutes • Obtain Board/Committee materials • Attendance exceptions • Attorney/client privilege • Information on relationship with corporate investor • Information on relationship with competitor • Acquisition by competitor • Third party information

16. Critical Issues for Board Observer Letter • Confidentiality • Terms of transaction • Relationship with other NDAs • Exception • Corporate opportunity doctrine • Red lights • Imposing “fiduciary duty “ obligations on observer • Too limited attendance/information rights • Exclusion from “real” Board meetings

17. Conduct of Board Business • Meetings: • Regular meetings • Early stage: Monthly/Bimonthly • Later stage: Quarterly • Special meetings: • Called by: • Chairman, President, Vice President, Secretary or any two directors (CGCL) • Persons specified in Bylaws (typically Chairman, CEO or majority of directors) (DGCL) • Notice: • 4 days mail; 48 hours telephone or electronic (CGCL) • As provided in Bylaws (typically 24 hours telephone or electronic) (DGCL)

18. Conduct of Board Business (con’t) • Conduct of Meetings: • Location: may take place anywhere • Quorum requirements: • Typically, a majority of authorized number of directors • Can be reduced to one-third (but no less than two) by Bylaw • Participating by conference call is permitted • Voting requirements: • Vote of majority of directors present when a quorum is present • Special requirements in conflict of interest situations

19. Conduct of Board Business (con’t) • Other Board formalities: • Preparation and review of minutes • Action by written consent • Must be unanimous • Action by Board committees (most types of decisions can be delegated)

20. Fiduciary Duties of Directors • The Duty of Care: “A director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, . . . with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.” (CGCL, § 309(a))

21. Fiduciary Duties of Directors (con’t) • Discharging the duty of care: • Avoid acting in haste • Review all available material information • Retain competent advisors or experts, where appropriate, including counsel and investment bankers, and consider their advice • Ask questions of management and actively probe and test information presented • Make sure the Board’s deliberations are documented carefully • What not to do: Smith v. Van Gorkom

22. Fiduciary Duties of Directors (con’t) • The Duty of Loyalty: “A director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, in good faith, in a manner such director believes to be in the best interests of the corporation and its shareholders . . .” (CGCL, § 309(a)) NOTE: Duty of confidentiality is a subset of duty of loyalty.

23. Fiduciary Duties of Directors (con’t) • Situations raising duty of loyalty issues include: • Transactions between the corporation and the director (or another entity in which the director has a financial interest) • Competition with the corporation by the director or affiliated entity • Appropriation of a corporate opportunity by the director or affiliated entity

24. Fiduciary Duties of Directors (con’t) • “Safe Harbor” provisions: • Full disclosure of material facts and • Good faith authorization by disinterested directors or disinterested shareholders or • The defendants sustain the burden of proving the contract or transaction was just and reasonable

25. Duties of Directors in Special Situations • Directors Representing Investors: • Duties of Directors are separate from the rights and duties of the shareholder • A director designated by an investor to serve as a director owes duties of care and loyalty to all shareholders: • You are a director, not the “XYZ Fund director” • You, not your colleagues or superiors, have the responsibilities of Board membership • You have no more or less responsibility or power than other directors based on the percentage ownership of the corporation held by XYZ Fund

26. Duties of Directors in Special Situations (con’t) • Down-Round Financings • Financially troubled companies: shift to fiduciary duty to creditors, not shareholders only • Merger & acquisition • “Interested” party transactions

27. Duties of Directors in Special Situations (con’t) • Mergers and Acquisitions: • General duties of care and loyalty apply • Heightened “Revlon” duties apply in: • Cash-out acquisitions • Other “sale of control” transactions • Where “deal protection” devices are used • Revlon duties: “the maximization of the company’s value at a sale for the stockholders’ benefit.”

28. Fiduciary Duties of Directors: Business Judgment Rule • The Business Judgment Rule: • A presumption in favor of Board decisions: “[The business judgment rule] is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the Company.” Smith v. Van Gorkom.

29. Fiduciary Duties of Directors (con’t) • Rationale: “Because businessmen and women are correctly perceived as possessing skills, information and judgment not possessed by reviewing courts and because there is a great social utility in encouraging the allocation of assets and the evaluation and assumption of economic risk by those with such skill and information, courts have long been reluctant to second-guess such decisions when they appear to have been made in good faith.” In re J.P. Stevens & Co. Shareholder litigation.

30. Fiduciary Duties of Directors (con’t) • Rebuttal of presumption: • Breach of duty of care • Breach of duty of loyalty • Where the presumption of the business judgment rule is rebutted, the directors must prove the transaction was “entirely fair”

31. Best Practices for Observers • Board observer is from venture group, not operating unit • Corporate venture unit has confidentiality procedures in place • Early disclosure of potential conflicts • Understand role: you are not a Board member • Sensitivity to Board dynamics (sometimes you can act like a Board member) • Use of best practices by Board • Training • Red lights • Attempt to impose “fiduciary duty” obligations • Limited information/attendance rights (for example, lack of committee attendance rights) • Exclusion from “real” Board meetings

32. Best Practices to Minimize Risks • Ensure that Board procedures are in place to facilitate discharge of the duty of care: • Regular Board meetings • Where possible, distribution of materials 2 days in advance of meetings • Agendas that focus on key performance metrics and measure performance against objectives • Periodic in-depth meetings on corporate strategy • Encourage regular dialogue between the CEO and directors; avoid surprises at Board meetings • Encourage dialogue among independent (non-management) directors • Hold regular executive sessions without management directors

33. Best Practices to Minimize Risks (con’t) • Directors discharge duty of care by: • Diligently reviewing Board materials • Insisting on careful and deliberate review of important Board actions • Insisting on ongoing review of financial controls • Seeking the advice of counsel and other experts where appropriate • Dissenting where appropriate • Ensuring that minutes and written board actions are accurate

34. Best Practices to Minimize Risks (con’t) • Directors discharge duty of loyalty by: • Adopting procedures for the protection of confidential information and communications • Being alert to potential conflict of interest situations involving XYZ Fund or other directors or their affiliates • Ensuring that all material facts regarding XYZ Fund-related transactions have been disclosed, and not participating in deliberation or voting on them

35. Summary • Board Observer Rights are Negotiated • Avoid the “Red Lights” • Make sure that you have implemented “Best Practices” in your organization • Understand the role and responsibilities of Board members • Think like a Board member (i.e. disclosure of conflicts) but don’t act like one unless permitted by Board dynamics • Remember: key role is liaison to corporate investor