Understanding how to navigate Related party transactions (RPT) is crucial for both founders and investors to ensure transparency and the overall health of the company. These relationships are fairly common in the business landscape, particularly in startups where founders and their networks often play multiple roles. While these transactions can offer benefits, they also carry the risk of conflicts of interest and potential governance issues.

What Are Related Party Transactions?

Related party transactions involve dealings between a company and individuals or entities that have a pre-existing relationship with the company. These parties can include:

• Founders and their family members
• Key executives in the company and their families
• Entities in which these individuals have a significant interest
• Companies with common directors or significant shareholders

Examples of common transactions with related parties are:

• Sales, purchases, and transfers of real and personal property
• Services received or furnished, such as accounting, management, engineering, and legal services
• Use of property and equipment by lease or otherwise
• Borrowings, lendings, and guarantees

Why Are RPTs Important?

RPTs should be a cause for concern because they often lack independence, leading to terms that may not reflect what would be agreed upon in a competitive, unbiased market.

• Conflict of Interest: Decisions might be influenced by personal relationships rather than the best interests of the company.
• Governance Risks: Lack of transparency can erode trust among shareholders and stakeholders.
• Financial Risks: Transactions may not be economically favorable to the company, impacting its financial health.

What Should Founders and Investors Check For?

1. Disclosure:
• Full and timely disclosure of all RPTs is crucial. This includes the nature, terms, and parties involved in the transaction.
• Founders should maintain a comprehensive list of related parties and update it regularly.
2. Approval Process:
• Establish clear policies and procedures for approving RPTs. This often involves board approval, particularly from independent directors who have no vested interest in the transaction.
• Some companies set up a related party transaction committee to review and approve these transactions.
3. Fair Valuation:
• Ensure that RPTs are conducted at arm’s length. Engaging third-party valuation experts can help in determining fair market value.
• Comparing the terms of the RPT with similar transactions in the market can also be a good practice.
4. Documentation:
• Maintain thorough documentation of the rationale behind the transaction, how it was approved, and how it benefits the company.
• This documentation can protect the company in case of future disputes or audits.
5. Regular Audits:
• Conduct regular internal and external audits to review RPTs and ensure compliance with established policies.
• Investors should scrutinize audit reports for any red flags related to RPTs.

Acceptable Reasons for RPTs

While RPTs can be fraught with risks, they can also be beneficial under certain circumstances:

• Operational Efficiency: Leveraging related parties can streamline operations, reduce costs, and utilize existing relationships and networks effectively.
• Access to Resources: Startups might access crucial resources, expertise, or capital from related parties that might not be available elsewhere.
• Business Continuity: In some cases, related parties might step in to support the company during difficult times, ensuring business continuity.

Conclusion

In conclusion, related-party transactions can be a sensitive topic in the boardroom. To minimize the risks associated with these transactions, companies need to establish clear guidelines, and procedures and disclose the transactions in a transparent manner. Shareholders must also be fully informed about potential conflicts of interest, and the board must ensure that the company's and its shareholders' best interests are always prioritized. By taking these steps, companies can minimize the potential for conflict and ensure that related-party transactions are conducted in an open, fair, and transparent manner.

By ensuring transparency, fairness, and regular oversight, founders and investors can manage related party transactions effectively, protecting the company’s interests and fostering a culture of trust and integrity.