In September 2022, Jana Partners invested in Freshpet after the company’s shares fell about 74%. The company liked the company and its business very much, but felt that it was poorly run and needed a reshuffled board to achieve more focus and management accountability. Because Freshpet had a staggered board — one where a portion of directors stands for election each year — Jana was only able to nominate four directors to the board last month to replace the four whose terms expired in 2023.
Jana made many good operational and capital arguments in her case for change that alone justified the inclusion of one or two Jana representatives on the board. However, it is a big step from the addition of two new directors to four new directors. Replacing nearly 40% of the board isn’t something shareholders should do lightly, but it’s necessary in situations where poor performance isn’t just the problem but a symptom of poor governance, and that couldn’t be clearer at Freshpet.
Forget corporate governance violations like a transferred board of directors, which in itself is a red flag. Freshpet had unique and somewhat unprecedented examples of at least the board failing to hold management accountable and, at worst, serious conflicts erupting.
In 2020, Scott Morris, Freshpet’s President and Chief Operating Officer, co-founded Hive Brands, a grocery and retail delivery service focused on the sustainability and environmental impact of the goods it offers. Those goods include premium pet foods and treats that are in direct competition with Freshpet. I almost hesitate to bring up the “direct competition” point because it implies that if Hive weren’t Freshpet’s competitor, that would be fine. Obviously it wouldn’t be okay. Morris’ employment contract states: “During the term of employment, the officer will devote his entire time and energy to the business of the Company.” It also states that “the officer shall participate in non-competitive business or charitable activities for a reasonable period each month as long as such activities do not conflict with the manager’s responsibilities under this employment agreement”, but I do not believe that “activities” “include participation in Hive launch, fundraising and administration. Additionally, by Freshpets’ own definition, Hive is a competitor to the company. The same employment contract partially defines a competitor as “(i) engag[ing] in the manufacture, sale or distribution of (A) fresh, chilled, frozen or raw animal feed; or (B) dry pet food with more than 30% meat.” But you don’t have to be the famous legal scholar Laurence Tribe to figure this out: It’s highly improper for an officer of a public company to work for another company at the same time.
In addition, many standard employment contracts contain an assignment of inventions provision in which the employee agrees to assign to the company any property rights or other rights they acquire as a result of their work or services. Morris’ employment contract does not contain such a provision. However, this seems less of an oversight and more of an omission by negotiations. Section 7 of his employment contract regulates the non-competition and non-solicitation clause. Section 8 deals with confidentiality and Section 9 usually deals with rights in inventions. However, there is no such section 9. Instead, this section is a standard advertising provision. Moreover, this did not appear to be the case in the original draft treaty. Section 5(e) of the Morris Agreement of Employment states, “The confidentiality and rights to invention obligations set forth in Sections 8 and 9 of this Agreement shall survive termination of this Agreement pursuant to this Section.” Apparently someone overlooked it, a Remove cross-reference in document.
Ultimately, Morris gained a valuable stake in founding Hive, serving as Freshpet’s President and Chief Operating Officer and being paid by Freshpet to be “involved in all aspects of company development and day-to-day operations.” Between 2019 and 2021, Morris received $13.4 million in compensation from Freshpet while founding Hive. If the invention rights clause were left in the agreement, the company would have a very credible claim to its interest in Hive.
To make matters worse, Freshpet’s current vice chairman and former CFO, Richard Kassar, served as Hive’s vice chairman and CFO at the same time until August 2022. He later assumed the role of Freshpet’s interim CFO in September 2022, a position he held until December of the same year. Additionally, according to Jana, directors J. David Basto and Olu Beck served as a director and formal advisor, respectively, at Hive. Effective May 31, Basto has resigned from Freshpet’s board of directors, according to a filing with the Securities and Exchange Commission.
This situation appears to be inconsistent with the Company’s overall ethics policy, which states: “Team Members shall not engage in outside work or conflicting outside activities that have or may have a material impact on the Team Member’s duties to the Company; this includes sponsorship.” or interfere with the Company’s endorsement, damage the Company’s reputation, or otherwise compete with the Company.
Jana attempted to address this issue by speaking to Freshpet about improving corporate governance and adding new directors identified by Jana to the board. The Company could have accepted Jana’s offer to (i) replace two Freshpet-selected directors with Jana directors; (ii) address ongoing conflict and governance issues (including the overlap of certain officers and directors with competitor Hive); and (iii) giving Jana the opportunity to provide input and feedback on potential future CEOs. Jana even agreed to (ii) defer the above until the directors appointed by Jana have joined the board.
Freshpet’s Board of Directors should have considered this a godsend. Instead, the board went in the opposite direction, apparently attempting to create obstacles to a fair election, including speeding up the annual meeting by postponing it from autumn to July. This could be interpreted as an attempt to partially disenfranchise Jana and cement the incumbent directors. Jana was forced to spend time and money filing a lawsuit in Delaware Chancery Court, which she did on June 1st. Less than a week later, Freshpet restored the governance changes to what they were prior to Jana’s involvement, including moving the AGM to a date in October.
These types of tactics by Freshpet do three things: (i) they result in both Jana and the company wasting time and money unnecessarily; (ii) it creates self-inflicted distractions for management — the kind that companies generally complain about every time an activist starts a proxy fight — and (iii) it damages the board’s credibility with other shareholders and institutional shareholder services . Shakespeare referred to the unleashing of the “dogs of war” as creating a power which, once unleashed, is very difficult to control. With these ill-considered changes in governance anchoring, Freshpet did just that, even if it tried to undo it. The damage is already done.
Given the behavior and performance of the company, if it weren’t for a tiered board, I think Jana would have a good chance of getting the majority of the board seats. Only due to Freshpet’s entrenchment strategy is Jana limited to four nominees. If the company can settle for less than that amount, they should count their lucky stars, claim the best possible compensation, and focus on running Freshpet – Freshpet only.
Ken Squire is Founder and President of 13D Monitor, an institutional research service on shareholder activism, and Founder and Portfolio Manager of 13D Activist Fund, a mutual fund that invests in a portfolio of 13D activist investments. Freshpet is a holding in the fund. Squire is also the inventor of the AESG™ investment class, an activist investment style focused on improving portfolio companies’ ESG practices.