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21 April 2022

Should an investor be a director?

Some investors will seek to be a director so that they have can have greater access to information and the opportunity to influence their affairs. However being a director is not without risk, and there are a number of issues you should consider before taking up a director appointment.


Can an investor be a director?

Yes. Most companies will permit a significant investor to be appointed as a director, provided their investment or shareholding is a above a specified threshold. The company's constitution or shareholders agreement will explain who can be a director.

If you would like to make sure you have the right to be a director for as long as you are a shareholder, this should be specifically addressed in the company's constitution or shareholders agreement.

Why do investors want to be directors?

Directors have access to far more information than shareholders, and have a much greater opportunity to influence the company's affairs. Many investors seek to become directors so that they feel like they have a greater level of control over their investment. 

Contrary to popular belief, shareholders generally have poor rights when it comes to accessing information about the company. For some companies (and absent a court order), shareholders may not be entitled to inspect anything other than the company's shareholder register, any options or debentures register, and the company's minute books. 

In contrast, company directors are exposed to a range of information about the company, and regularly kept abreast of the company's affairs, purely by attending directors meetings and carrying out their duties as directors. 

Whereas a shareholder can generally be thought of as a passive investor, a director plays an active role in key-decision making and influencing the company's affairs. Being a member of the board means that:

  • you will spend time regularly with the company's executive directors and any other significant shareholders who have a board seat, 
  • you will be exposed to a range of information about the company that would not normally be disclosed to shareholders, 
  • you will have the opportunity to influence and potentially even decide key management decisions, and
  • you will be able to call director meetings, and possibly shareholder meetings, depending on the company's constitution.

Guide to investing in a private company

 

What are the risks of being a director?

Directors have a number of duties that do not apply to shareholders. Whereas shareholders can generally act in their own interests (for example, in exercising voting rights), directors are subject to a number of strict obligations. These include duties to:

  1. act with reasonable care and diligence,
  2. act in good faith, in the best interests of the company and for a proper purpose,
  3. not improperly use information or their position as a director,
  4. avoid conflicts of interest,
  5. prevent insolvent trading, and
  6. comply with various statutory duties relating to financial record keeping and reporting.

Putting to one side issues around potential reputational damage, directors can be exposed to personal liability for breaching these duties, and for other breaches by the company of its statutory obligations (for example, in relation to major work health and safety breaches or for non-compliance by the company of its obligations in relation to tax).

In addition, directors can face a host of penalties for serious breaches, including fines, disqualification from being a director and potentially even gaol time (quite apart from potential reputational damage), causing mistrust in the eyes of regulators and investors.

Is being a director worth the risks?

In deciding whether to become a director, you will need to perform a balancing act. The balance will look different for different types of company. 

For example:

  • If the company already has a large board with a number of experienced directors, query how much you will be able to add at board meetings and whether your vote will make any difference.
  • If the company's senior managers are relatively inexperienced, the company may benefit by having experienced commercial minds on their board of directors.
  • If the company operates in a high risk industry (eg an industry with major safety hazards), the directors' exposure to personal liability may be higher than in other industries.

What are the alternatives to being a director?

Directors are in a unique position, given their ability to influence and make decisions, and also given the duties that attach to the position. However there are alternatives that are worth considering. For example, if your main concern relates to:

  • access to information, you may seek for the shareholders agreement to be amended to ensure that the company is required to provide regular reports to shareholders, as well as notification of any key events (good or bad),
  • decision-making, you may seek to amend the shareholders agreement so that certain key decisions be referred to the shareholders (eg changes to senior executive remuneration, decisions to take on major debt, decisions to raise capital),
  • being able to monitor the board, you may wish to seek the right to appoint a board observer, or for the company to set up an advisory board. (Read about the differences between an advisory board and a board of directors here.)

It is also important to keep in mind that, even if you are not appointed as a director formally, you can still be deemed to be a director (known as a 'shadow' or 'de facto' director) if you are effectively acting as one.  Consequently, if you are keen to avoid the duties and potential personal liability that can apply to directors, it is important that you do not do anything that could result in you being treated as a director.

How can you limit your exposure to personal liability as a director?

If you decide that you would like to be appointed as a director, there are several things you can do to limit your exposure to personal liability in the instance that something goes wrong. They include:

  1. Keep your duties as a director in the forefront of your mind. This may sound obvious, but keeping your duties in mind is one of the best ways to ensure you don't breach them. For an investor, perhaps the key duties to remember are the duties of diligence, the duty to act in the company's interests and the prohibition against misusing information.
  2. Make sure the company has Directors and Officers (or 'D&O') insurance. This insurance is designed specifically to protect directors against certain types of claim. You should also familiarise yourself with this insurance, and understand its limits. Although D&O insurance can help to reduce your exposure, there will be certain types of claim that will not be covered by D&O insurance, such as criminal conduct and insolvent trading.
  3. Obtain a Deed of Indemnity from the company. An Officer's Deed of Indemnity & Access is a deed signed by the company (and/or its parent company) to give express rights and protections to its officers. It provides indemnities in respect of claims that arise in connection with a person acting as an officer of a company and affords specific rights of access to the company's books and records, including in respect of the period after you cease to be an officer.  You can read about deeds of access and indemnity here.
  4. Think about your personal asset structure. If you intend to be a director of multiple companies, or if you will be a director of a company in a high-risk industry, it is important to ensure that your affairs are structured in a way that means that they are protected from any potential claims. This typically means ensuring that your assets are held by third parties (often trusts) in which you do not have any direct personal interest. This type of structuring means that your assets will be out of harm's way, even if a claim is made against you.
  5. Resign if the need arises.  If you are unable to fulfil your duties as a director, or if you have concerns about the company's position or the direction it is heading, you should consider resigning. You will continue to assume (and accumulate) personal exposure - including for potential insolvent trading claims - for as long as you continue to be a director.  
About the Author

Bridgit Masson | Senior Associate

Bridgit is a commercial lawyer whose practice is focused on transactional matters in the construction and technology space.


bridgit.masson@turtons.com | (02) 9229 2903

About Turtons

Turtons is a commercial law firm in Sydney with specialist expertise in privately owned construction and technology businesses.

Bridgit Masson | Senior Associate

Author

Bridgit Masson | Senior Associate

bridgit.masson@turtons.com

Bridgit is a commercial lawyer whose practice is focused on transactional matters in the construction and technology space.


bridgit.masson@turtons.com | (02) 9229 2903

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