BUILDING YOUR BOARD
(Bo Ilsoe, Partner, NGP Capital)
High-tech startup entrepreneurs with an ambitious goal are bound to move quickly from the individual enterprise or the LLC structure created with their co-founders to that of a stock company with a required governance structure, as they invite investors to fund their business. Whether the business adopts a two-tier structure, as is common in many European countries, with a Management Board and a Supervisory Board (SB), or a one-tier structure, with a Board of Directors (BoD), I shall consider in this blog both boards (SB and BoD) as the same, despite differences, the major of which is whether the managing leader sits with Board members or on another Board (two-tier). Board members in a one-tier structure are nominated by the Board and their nomination must be approved by Shareholders, while in the two-tier structure they are directly nominated by shareholders. The result is the same. There are too many similarities to focus on the differences. Both Boards have essentially the same function.
1. Role of the Board
a. Build long-term value for the company’s stakeholders
For a long time, maximizing shareholders value was the mantra of all businesses. Today a broader view includes all stakeholders, i.e. customers, employees, shareholders, and external stakeholders such as local communities. Long-term is the important word. Founders, CEOs and board members all must have the long-term value creation at heart.
b. Oversight
The Board must make sure that the mission of the enterprise is actively pursued. For instance, after a major disruption such as the one following the coronavirus outbreak, startups must not hold off any investment in tangible and intangible assets, such as talent, that are essential to their survival.
The Board also ensures that management complies with all legal requirements.
c. Guidance and Support
The Board provides guidance at the strategic level. Management can bounce back ideas when envisaging innovative business models, debating advantages of any potential strategic alliance, or the timing of a significant recruiting campaign. Board members support management by sharing their network, to help fundraising as well as to promote new business development or to initiate contact in a foreign market. Board members act as a safeguard for the CEO who, most often in startup, does not have a wealth of experience in strategic issues.
d. Risk oversight
The Board is responsible for overseeing risk management. This is a fundamental aspect of the Board. Too many startup entrepreneurs believe that a startup must take high risks and tend to consider business as a succession of bets. Boards can be extremely effective in instilling an approach to risk that is more educated, allowing for a decision-making process leading to a higher probability of success. First under the Board watch is to ensure that the business is on track for long-term sustainability through generating optimal cash flow with the resources on hand.
e. Review, debate and approve the strategic direction
Business plans or strategic plans are built to project an achievable scenario for the business in the long-term – typically three to five years –setting goals and milestones. As the visibility about the future quickly decreases as the horizon extends, these plans are living documents that are constantly amended in relation to unanticipated changes in the environment in which the enterprise operates. Board members are key in timely crafting with the CEO required changes in strategic goals or direction when needed.
The Board is required to review and approve the annual budget, make decisions on financing as well as on significant investment and divestment.
f. Monitor the strategic plan execution and evaluate results
Boards regularly review reports from the CEO on the progress made in executing the strategic plan. These reports highlight essential data on the market, and how cash has been used. A major item in startups refer to human resources, with constant updates not only on talent hiring but also on how talent is managed to be motivated and retained, and what issues may arise with an executive. Sharing this information genuinely with the Board is fundamental. Board members all have had experience with managing people. Their input is invaluable to find solutions in this area.
g. Review CEO performance
Evaluating the CEO performance goes down to making sure that the CEO did what he said he would do, in conformity with the mission of the company and the approved strategic plan, and did not take any decision that would jeopardize the long-term future of the company. Among the performance criteria, Boards want to see transparence in communications, the ability of the CEO to spell out clearly all options faced by the business when things do not go as planned, the strength to abide by “unpleasant” decisions made by the Board, the capacity to broaden her skills while running the business in domains that were not among her initial competencies.
The Board is setting the remuneration of the chief executive and the key members of the management team.
h. Dismiss CEO and Select Successor after evaluation
Last, CEOs are accountable only to the Board and can be dismissed or moved to another, more suitable, position. The Board then is responsible to attract and hire the new CEO.
2. Board Members
“Building a great company is all about the people and the members of the Board are just as important as the early employees” (in Startup Boards, by Brad Feld and Mahendra Ramsinghani, 2014) Board members must seek the company’s best interest. Their selection, whether they are appointed by the founders or by investors or by both, is a meticulous process, paramount to achieve success. As the company evolves, so do Board members, as expertise required to assist and guide an early-stage startup CEO is different than the one expected in a growth-stage startup. A good Board member helps making the right decision at the right time. He must be outspoken when discussing ideas, yet he must avoid conflict with other members to foster decisions made by consensus.
a. Chairperson
The chairperson has a special role as the leader of the group who watches over the good performance of Board meetings, how the meeting agenda is respected while making sure that time is well spent by focusing on important matters. A startup chairperson is, in almost all Boards, someone with a mature experience as an ex-startup CEO, who has been successful in a fast-growth environment and is appreciated for her soft skills. More often than not she acts as a mentor to the CEO.
b. Investors Representatives:
Major investors are expecting to elect a Board member to participate and vote on strategic matters. In a seed round one angel is entitled to represent the whole group of angel investors. Following A round, institutional investors seek a Board seat. Multiple round funding may extend the size of the Board if Board mandates are long. Founders must be firm when it comes to negotiate terms with institutional investors. Only the large investors, not all investors, have reasonably acquired the right for representation. As you do not want the Board to become too big, it is customary to provide a term to Board mandates, allowing for well-planned exits of early members. Venture capital investors generally participate in small Boards where co-founders are not members anymore, and one angel only may still be around. Venture capitalists bring a wealth of relevant experience to issues debated in the Board. Participating in Boards of high-growth ventures is what they do. However, vigilance is of the essence as in some cases, they follow their fund interest first (see our Blog). Make it part of your due diligence process to inquire about Board members behavior in startups where a venture capital firm you are in negotiation with has invested.
c. The independent member
To avoid a Board where investors or founders put their interest above that of the company, it is advised to invite an independent Board member. The obvious advantage is their objectivity in giving professional advice and making decisions that are best for the venture. They bring a different perspective than insiders, coming from a different background than other members. Ideally you would want someone with skills that complement insiders’ expertise. When looking for such a member, you first ensure that she embraces your vision for the long-term future of your business. Retired, or former, startup CEOs from another tech industry are particularly sought after for the role as they have an uncanny set of reflexes on operations that will help your company move faster. It is essential that the independent Board member increases the diversity of the Board, opening windows of opportunity when no one had seen them. Bring a savvy marketer or a finance expert if your Board is packed with engineers obsessed with products, as your Board will benefit from understanding new points of view, enriching the decision-making process.
d. The founder as Board member
Founders are Board members from the inception of the Board and last as long as their stake in the company remains significant – typically 10% or more together with the co-founders- and their contribution is deemed relevant. My experience, watching tens of founders participating in Board meetings, is that founders may have the same bias than investor representatives. In fact, they are de facto representing a non-monetary investment in the venture. Separating their interest from the company interest is difficult in some instances.
e. Board observer
Last, startups who are funded by several venture capital firms may grant the status of Board observers to representatives of quality investors whose investment is not significant enough to allow for the election of a Board member. The observer, as its name suggests, does not vote on resolutions. However, by attending the meetings, she gains knowledge on the issues debated, and is permitted to interfere on matters she has experience, just as an expert invited to present a subject matter. Observers are rare. They do not attend all meetings. In my first investment as a venture capitalist, decades ago, I was designated as a Board observer in an early-stage California company, as three venture capital investors had invested significantly more than the institution I represented. The three ones had secured a Board member each. As a rookie investor in high-tech startups, I found it quite enlightening.
3. Committees of the Board
Most Boards form committees composed of a restricted number of Board members (typically 2 to 4 depending on the size of the Board). Each committee receives delegation from the Board to exercise certain functions and provide preliminary statements that will ultimately be presented to the full Board for decision. This avoids holding lengthy Board meetings, as part of the debate on some issues is handled prior to the meeting in another setting. There is no limit to the number of committees that can be created, and committees are not necessarily lasting as long as the company’s main Board. Ad hoc committees come and go. However, a few standing committees have become the norm: the Finance and Audit Committee, the Compensation Committee, the Nomination and Governance Committee.
Early startups would consider the formation and deliberations of committees an overkill. In startup Boards, up to a certain stage when it starts making sense delegating power to a few members on topics, Board members are very much keen to debate all issues together. This does not prevent the Board to assign two members to prepare the main points of a discussion and share their findings, without the formality of a committee, with its scheduled meetings, its chairman and its minutes.
The first committee that startups form is the Compensation Committee, as it is a complex issue that requires mature Board members to convene and analyze market data, put the policy in perspective over the long range. For instance the preparation of an incentive stock option is a sensitive issue taking into account the expectations from future talented executives, the culture of the company, the position of the competition, the growth of the company, the assessment of the maximum dilution accepted by investors when determining the total pool of options, etc.
Following the Compensation Committee, the Finance and Audit Committee quickly becomes necessary to deal with matters that experts are suited to analyze in-depth, in liaison with the CFO. Their conclusions are presented to the Board.
4. How to Optimize the Board Effectiveness
The Board is not an organ set up to ratify blindly all the decisions the CEO wants to take to move forward. While the management team is bound to focus on operations, the Board guides the team to keep the strategic direction. The Board must work as a cohesive group to give the best value to the company. As a founder, you cannot afford to put together a poor Board for the sake of complying with the bylaws of the Company. As mentioned in section 2, the selection of the members is paramount. But it is not sufficient. A Board must be managed. The fundamental element is the capacity to blend diverse personalities with different backgrounds, all driven to serve the long-term vision of the company, to come together as a group making strategic decisions with unanimous consent, each time following an open discussion where all perspectives are exposed.
a. Transparent Communications
The role of the CEO as well as the founder(s) is important to foster total transparency in communications with Board members. Retention of information leads to failure. The Board is not nominated to shower management with praise or blame but to help management execute upon its vision as quickly as possible, with as little resources as possible. If something is going wrong, communicate right away with each member and set up an unscheduled conference Board meeting as soon as possible. Lots of innovative ideas are born in Board meetings. Trust must be built between Board members and between the CEO and its Board. Startups always encounter rough times. This is when the Board can be most helpful.
b. Number of Board members
Startup companies are better off with a small Board. Early stage startups generally have 3 or 5 Board members. An odd number makes votes easier when some decisions cannot carry unanimity. Board member should not serve too long, first because they were chosen at a stage when their skills were sought after, second because new blood regenerates strategic debates. Five years seems a maximum.
c. Alignment stage by stage
As mentioned earlier, the composition of the Board evolves, as the expertise required in an early-stage startup is different than the one in a growth-stage or in a late-stage venture. For that very reason, very few Board members contribute their value for a long period. A good plan must be in place to smoothly effect the progressive changes, making expectations for the tenure of Board members clear.
d. Tips
Keep your Board abreast between meetings. This allows for better time spent during meetings when discussions take precedence over the transmission of information.
Schedule an annual, full-day meeting, where Board members attend executives’ presentations and interact with them. When your company becomes more stable, if ever, organize a retreat in a casual setting. Strategic issues are better discussed when the information related to the issues are known ahead of time. Give your Board members a week to be prepared. Do not shy away from exposing problems as you see them and introduce the potential solution you envisage. Board members expect you to be proactive and not wait from a solution to come out from them. You will find them stimulated.
e. Meeting frequency
As a rule of thumb, the earlier the stage, the higher the frequency of meetings. It is not uncommon for a seed-stage startup to hold 7 or 8 Board meetings in a year. It benefits the company as both Board members are eager to help maintain the momentum, and founders are hungry for advice. In a growth-stage company the number of meetings is closer to 5 or 6. In exceptional times, when the startup faces a crisis, frequent meetings are necessary, generally on conference calls as not all members are available to be physically present to attend an emergency meeting.
f. Selection criteria for independent Board member
“Boards must be pragmatic enough to adapt to the individuals involved rather than put a rigid structure in place” ( "Board Governance Depends on Where You Sit", Bill George, former CEO of Medtronic, 2013) The selection for an independent Board member is a process that should make a difference in taking your vision to high levels. That person must be familiar with the path from early to growth stages. Her experience ideally would complement other members’.
5. Pitfalls to Avoid
- Never seek a CEO of a large company to become the Chairperson of your startup, or a Board member. It is a recipe for disaster. There is too much of a culture gap between a fast-paced scarce-resources innovative startup and a large organization. The expertise of the CEO, as impressive of her achievement is, is irrelevant to take your startup on the success path.
- Keep in mind that the CEO reports to the Board. From the day your startup received “smart” money, there is no free ride.
- Prevent the Board to micromanage the company. When it happens, the Board becomes ineffective, and the CEO wastes a lot of time. Ultimately, it is a costly mistake. Defining upfront the role of the Board when hiring Board members is a way to avoid this issue.
- Do not send a heavy load of documents to Board members prior to meetings. Apart from financials which you should not reduce to a 5-line statement, they need synthetic, clear documents that go to the essential. If you must give them a long document full of relevant data, make sure that you give them time to analyze the data so that they may be prepared when the document is discussed in meeting.
- Last, never, ever, hide bad news in the hope that circumstances will change, or you will be good -or lucky- enough to correct them soon. Board members respect candor.