Boards

What

An overview of the oversight/governance function your startup is legally required to have once you create a formal organization.

Learning Objectives

After completing this module you should be able to:

• describe the functions the board of directors serves in a startup venture (e.g., responsibilities, potential sources of resources, types of value they should provide to your startup)
• describe the different types of board member roles (e.g., investor seat, independent seat, advisory board members) and differentiate between them
• determine who should be on your startup board of directors at different stages in your venture's growth and how to negotiate the terms of board memberships (e.g., contingency-based duration of service, number of investor seats you have to allow)

Instructions

• Watch the assigned videos and presentations;
• Read the assigned readings;
• Complete the practice quiz or other assigned practice activity
• Complete the assessment;
• Complete the "Mark as Complete" checklist.

Context

The context of this topic is new ventures. Start here if you want an overview of this topic more generally, along with a great pic of the Liepzig-Dresden Railway board of director's social media page from 1852. But I digress.

View

Watch the first two of a series of 15 videos created by the Kauffman Founders School to help entrepreneurs understand Boards of Directors. Obviously you're invited to watch all 15 videos, and I encourage you to subscribe to the Kauffman Founders School feed on YouTube.

Read

Required for This Module

Hamadeh, S., and Dinow, A. 2016. What you need to know about startup boards. TechCrunch.com, November 5, 2016. accessed August 5, 2020.

Suster, M. 2009. Should Your Startup Have an Advisory Board? BothSidesoftheTable.com, October 12, 2009, accessed August 4, 2020.

Suster, M. 2019. Who should be on you startup board? BothSidesoftheTable.com, February 20, 2019, accessed August 4, 2020.

Wilson, F. 2012. The Board Of Directors: Role and Responsibilities. AVC.com, March 3, 2012, accessed August 7, 2020. (The comments section alone contains priceless insights)

Wilson, F. 2020. Board Diversity. AVC.com, June 25, 2020, accessed June 25, 2020.

Wilson, F. 2020. Independent Board Compensation, AVC.com, August, 5, 2020. accessed August 5, 2020.

...and read the overview I've provided on Boards of Directors below

Boards of Directors

Overview

The board of directors (BoD) is responsible for the overall direction of the company and for making major decisions, such as hiring and firing senior management, approving a budget and keeping the company financed through equity investments and debt financing. Key hires will need to be approved by the board, along with salary and other compensation, like stock. This last one includes your salary as CEO. Board members provide connections with other helpful companies, individuals and resources, as well as offer overall advice and guidance (Hamadeh & Dinow, 2016).

Every company is required by law to have a board of directors. The board doesn’t need to be elaborate, or even more than one person, but every company must have a board in place. It is ok for the company to have only one board member, and it may be you. You must have a board to handle corporate matters like issuing stock, setting up a stock option plan, authorizing a fundraising or getting loans. In most startups, the founder will typically appoint herself to the board. From there, others get added to the board as the company grows. (What you need to know about startup boards, Hamadeh & Dinow, 11/5/2016). As you consider adding new members to the board, you need to think strategically about their value to the stage and needs of your company and ability to contribute to the company's goals.

What a Board Should Do and What it Should Not Do

From Fred Wilson (emphases added by CA): "The Board of Directors is the governing body for a company. All major decisions will need to be ratified by the Board. You will need the Board's approval to sell your company. You will need the Board's approval to hire or fire a CEO. You will need the Board's approval to do a major acquisition. You will need the Board's approval to do a major financing, including an IPO. On all matters of major strategic importance, the Board will need to be engaged, involved, and supportive.

"However, the Board should not run a company. That is the role of the CEO and his/her senior management team. The Board's job is to make sure the right team is at the helm, not to be at the helm themselves. Boards that meddle, that get too involved, that undermine the management team are hurting the company, not helping the company.

Boards work for the company. The company is their responsibility. They must always act in the best interests of the company and its major stakeholders; the employees, the customers, the shareholders, the debtholders, and everyone else that is relying on the company to deliver on its promises" (Wilson, 2012; Note the converse of Fred's "who for whom" statement: Companies do not work for the Board.)

Allocating Board Seats - from TechCrunch:

"After your initial seed round, you’ll usually have to allocate a board seat to the firm or person who led that seed round. To ensure that the founding team still remains in control of the board, a fairly typical setup at this stage would be for the common stockholders (i.e. the founders) to retain two board seats and your new investor to have one seat.

"It is common to allocate a new board seat for the lead investor for each new round of investment (i.e., starting with Series A). Keep in mind that when you accept an investor, you also typically will be bringing on a new board member. Some investors will attach a board seat to their terms of investment. If you do not want a certain person on your board, you may have to turn down that person’s investment. If you need the money, welcome your new board member.

"After the second round of financing, it is fairly common to also designate one seat as an “independent” seat. This person is typically not an investor or a founder or an employee of the company, but should have industry knowledge and valuable contacts. By appointing an independent after the second round, the composition of the board would be the two founders, the two investors and the independent. Hence, the independent potentially serves another important role — tiebreaker" (Hamadeh & Dinow, 2016).

Start Early But Keep Them Small (See "Seed" stage in banner graphic above)

Zuck, Peter T., and the Napster guy...Zuck turns down $1B offer from Yahoo! for Facebook, says he'd use the money to start a social network company and that he already has one he likes. -- Zero to One. (Thiel & Masters, 2014).

Peter Thiel's advice for startups on boards: "Keep them small."

Meanwhile... read "Who should be on your startup board?" by Mark Suster, posted 2/20/19 (Suster, 2019). "...amazing board members can be transformative with important advice and access and can also help attract other great board members (and team members). Bad board members can make business very unpleasant."

How to avoid the potential "bad board member" problem (at least in the early stages)? "If angel investors are pressuring you to set up a board and if you don’t have the leverage to push back a little then I might suggest a 3-person board in which all 3 seats are appointed by the common stock and you agree to appoint one of these seats to the angel investor but perhaps make it either time based or event based. Time based as in 'a guaranteed right for 12 months, which can be renewed by mutual board consent” and event based “a guaranteed right until the company has raised $x million from new investors.'”

Know this (also from Mark S.):

• The role of management is to run the day-to-day business and make key decisions within the framework agreed between management and the board
• The role of a board is to agree an annual operating plan (budget) and strategy and to periodically (usually quarterly) review progress and make adjustments when necessary. The board’s job is also to confirm the financial results (audit), to manage the compensation of key executives including the CEO. Finally, the board's job is to vote on key considerations including budgets, financings, legal issues and on rare occasion — hiring & firing the CEO.

The figure below shows the "separation of powers" and overlap between the startup CEO and the Board Members.

Advisory Boards

What

An advisory board is a body that provides non-binding strategic advice to the management of a corporation, organization, or foundation. The informal nature of an advisory board gives greater flexibility in structure and management compared to the board of directors (Wikipedia.org). Advisory boards do not have the authority to vote on corporate matters or to assume legal fiduciary responsibilities like members of boards of directors. Advisory boards can look appealing to early-stage startups because the advisers can provide advice (duh), expertise, and valuable network contacts without the expense or formality of the board of directors.

Advice on Advisory Boards

This advice from Mark Suster from the wayback machine (Suster, 2009)*:

"...do advisory boards really add value? And if you decide to have one how do you best implement it?

"In my experience most advisory boards under deliver relative to expectations. The CEO picks prominent people who are busy in their own right with their own companies. They are usually offered around 0.25% of the companies equity in exchange for their role and I’ve seen many companies hand out a total of 2% to advisers.

"If you plan to set one up — no problem. But know what your expectations are and make them realistic. My main advice to you if you’re considering it is don’t waste much equity on it."

If you do decide to set up an advisory board, get them to invest a small amount in your company, e.g., $10,000 at a $2M valuation = 0.5% of the company...or go as high as 1% if you both know the adviser will be diluted by a VC. Now you've got some emotional commitment...

But Mark warns startup CEOs not to overplay their advisory board, especially during pitches to investors: "We all know advisers are mostly bullshit so it’s painful to hear you pretend like they’re really a big deal to the company. It’s OK to have the adviser slide where you glance quickly over the names. Just don’t lay it on thick." Avoid this trap so you can maintain credibility with your about-to-be new best friends.

*https://bothsidesofthetable.com/should-your-startup-have-an-advisory-board-c7cab4872838

CA insights

Related to the last point about overplaying your advisory board: if you're a student with little experience and the strongest element in your pitch in, say, a pitching competition is that you have an impressive advisory board, STOP. Go back to your idea and focus on the problem you're solving and the "why you?" argument before soliciting advisory board members...

HOWEVER, following Brad Feld's advice in the second video above, you can cultivate a team of advisors who constitute an informal advisory board to get their help AND pick from among these advisers whom you think would make great formal members of your Board of Directors.

Independent Directors

After the second round of financing, it is fairly common to designate one board seat as an “independent” director. This person is typically not an investor or a founder or an employee of the company, but should have industry knowledge and valuable contacts. You will compensate this person for her time and expenses, and you'd better cultivate a network of insanely strong candidates who share your vision for your company.

Diversity

Board Diversity (Fred Wilson, 6/25/2020). "The board diversity problem is a symptom of a much broader problem around lack of diversity in founders that get funded and lack of diversity in VC firms. Most startup boards are made up of a few founders and a few VCs. No wonder you have no diversity on the board." Fred argues for the creation of *two* independent board seats when the startup BoD is created, no more than *one* VC on the BoD, and term limits for members, among other points... *Two* independent board seats means you won't have control over the board, though, a situation you should deeply evaluate before making the move.

Compensation

Normally, board members who are representatives of funds that invest in the company do not get compensated to serve on the board. However, it is typical for independent board members to get compensated for their time and services. Usually, the independent board members get equity for their services. For early-stage companies, a typical director might get somewhere between 0.5 percent and 2.0 percent equity. This percentage should drop as the company grows (Samadeh & Dinow, 2016). If you want to avoid underpaying or overpaying talent you need to help your venture through the independent director position... "I believe the role of the independent directors is to represent “the Company” in all board discussions. Founders and investors can and do think about what is best for the Company, but they also think about what is best for them. An independent director can and should represent the Company in Board discussions. Also, an independent director should have experience operating a business and should actively share that experience with the leadership team." (Fred Wilson, AVC.com, 8/5/2020, Independent Director Compensation,)

Practice

Assessment - This is a Graded Activity

References

Feld, B., & Ramsinghani, M. (2013). Startup boards: Getting the most out of your board of directors. John Wiley & Sons. (sample on Google Books)

Hamadeh, S., and Dinow, A. 2016. What you need to know about startup boards. TechCrunch.com, November 5, 2016. accessed August 5, 2020.

Suster, M. 2009. Should Your Startup Have an Advisory Board? BothSidesoftheTable.com, October 12, 2009, accessed August 4, 2020.

Suster, M. 2019. Who should be on you startup board? BothSidesoftheTable.com, February 20, 2019, accessed August 4, 2020.

Thiel, P. A., & Masters, B. 2014. Zero to one: Notes on startups, or how to build the future. Currency.

Wilson, F. 2012. The Board Of Directors: Role and Responsibilities. AVC.com, March 3, 2012, accessed August 7, 2020.

Wilson, F. 2020. Board Diversity. AVC.com, June 25, 2020, accessed June 25, 2020.

Wilson, F. 2020. Independent Board Compensation, AVC.com, August, 5, 2020. accessed August 5, 2020.

Mark as Complete