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28 October 2019Lisbon 2020 Corporate Governance conference: Editorial committee
The ultimate guide to building a board of directors
Building the Board of Directors for your startup is tough as they will help shape the future of your company. Early mistakes with the board can be devastating.
The board of directors at your startup exists to guide your company. They aren‘t the scotch-and-cigar-filled rooms where the rich divide assets up among themselves, especially not in a startup.
The board of directors should be the most experienced people in the company, elected by stockholders. The board determines the company’s direction and drafts the company’s bylaws. Also, when it comes to who is responsible for the success and the failure of the company, the board is where all eyes fall.
The board is responsible for things like setting high-level goals for the company, hiring the CEO, issuing stock, and clearing dividends. Keep in mind, your management team oversees all day-to-day operations, while the board supervises only the executives and the CEO.
Companies incorporating as C Corporations or S Corporations must have a board (for example technology startups looking for funding in Delaware typically incorporate as a C Corporation). But, a sole proprietorship, LLC, or general partnership does not need a board.
Remember, your financial investors do not have to join your board. Also, board members can fill four roles: board member, advisory board member, a board observer (a non-voting member who attends meetings), or non-active board member.
1. Common Directors – Directors represent the common stock and shareholders. Common Stock Directors are often one or more of the company founders and sometimes seed investors. Before raising venture capital, your board usually only have Common Directors.
2. Preferred Directors – Preferred Directors represent preferred stockholders. These Preferred Directors are typically lead investors who make company decisions based on how they affect the interest of all investors.
3. Independent Directors – These are third-party directors appointed to represent only the company’s interest. Independent Directors are market experts that make decisions without being bogged down by stockholder allegiances. These directors have no stock in the business.
Having a board of directors that has a clear agenda and a way forward is essential to ensuring the success of your startup. The following is a step-by-step method to building a board of directors that can guide your company into the future.
Consider Having an Advisory Board
Startups often choose to skip having a typical board until they get outside investors.
Remember, boards focus on what is best for the shareholders and are not devoted to the founders. Essentially the board oversees the founders.
Alternatively, advisory boards offer advice, investments, and introductions to important people, but they have no control over the founders. In some startups, this advisory council meets quarterly, while others come together when they need individual investors. Also, these advisors receive compensation in the form of stock in the company.
For startups, board strategy is essential, and many don’t put outsiders on the board until they receive Series A funding. Before this point, they pick reliable advisors along with any seed investors for the board. When they receive Series A funding, they might bring on one or two professional VCs with a dependable advisor as an outside member.
Have the Right Number of Members
When filing articles of incorporation you usually must pick an initial director or directors for your startup. Several states only require a single director, often the CEO or President.
One mistake that a lot of firms make is not having a board of directors with the right number of members for their purpose. A good place to start for a startup is three to five directors at the beginning. This gives you room to expand, and it will also help you avoid any chance of a tie when votes come up. More members than this at the beginning can make scheduling an issue and be a drain on your funds, and any fewer members is not a board. Compensation is essential, so keep that in mind and consider giving them access to a percentage of stock instead of money. A common amount given is 1% of stock or expenses per quarter plus a meager retainer.
Typically VCs will try to create additional board seats, but you should limit their number to no more than seven (the two founders, one to three VCs, and two additional professionals in the industry).
Hire Independent Directors
When a company raises money through investors and gains venture capital, their investors ask for seats on the board in order to keep an eye on their investment. But startups must be cautious as some board members can put the interest of investors or founders above the well-being of the company.
Outside directors can provide professional advice and perspective to the board that you might not get from a member who is too close to the company. Outside directors are typically experienced in making objective corporate decisions and are not encumbered by a personal or emotional connection to the company. They can also bring in skills that might not exist in your startup.
Don’t Demand Management Support
Expecting your board of directors to fall in line behind management is a recipe for disaster, as the benefit of a board is the ability to make decisions based on divergent opinions. Forcing the minds that you are compensating and providing with seats at the table to simply agree with management is a waste of resources and will likely result in poor business decisions.
Avoid Misalignment Regarding the Board’s Role
Boards of directors have many fiduciary and legal responsibilities. Still, boards often have additional roles correlated with the venture’s stage.
At early-stage startups, members should support the management (without micromanaging it). For example, they may help guide product decisions or provide access to recruits, customers and investors. Ideally, board members could also mentor founders. More established startups, however, may need a different type of assistance related to scaling sales, engineering, logistics and other functions that no longer fit into a garage.
Establish Structure for the Board
Think about putting four-year term limits on board membership and other rules. Plan how people can join the board. Will management vote? Will members select their successors?
Your board needs a playbook and defined roles and responsibilities. Written governance policies should be created through voting. At a minimum, the board should be required to meet four times annually in the presence of a quorum, or if there are any pressing issues to be addressed.
Find the Right People for Your Board
Even though board members are key resources who provide support, insight and professional networks not all members are created equal.
Consider the future: When selecting board members, consider how they will function in the long term. Select directors who are ambitious, want to see the company grow and have a vision for taking your company from a startup to a powerful business.
Develop a clear job outline: Make the title and description of each board member explicit from the beginning. This includes both non-executive and executive positions. Define the goal of each role, including the role the board will play in risk management and strategy.
Choose your workhorse: Find at least one person on the board who understands your vision of the company and who can handle directing the board. Look beyond those who are simply accountants and lawyers and actively seek out leaders.
Infrastructure is everything: Try to create a reliable structure to build upon from your team. Keep in mind that as the CEO you report to the board, so gather a team of people you respect with the know-how to get things done.
Be impartial: Look to the duty and leave your emotions behind. Make sure each member knows their role clearly and the roles of the board. Make sure that they understand that they are there to protect the company and not their own best interest.
Avoid all yes-men/women: Avoid those who are prone to sucking up. Go for those who are smart and brave enough to know when to disagree with you.
Choose a mixed-bag approach: Try to create a sense of diversity among the group. This diversity should be in reference to ideas, identity and skill set. A group is often as strong as they are different.
Develop a unified concept of the future: Try and make sure that these different people are capable of coming together when it counts. Make sure that they have a shared goal and are looking to reach the same destination.
Hone the idea of the imaginary line: Make sure to be very explicit about the jobs on the board. Keep jobs like CEO and board chairman distinct and separate.
Pay fair and consider the past: Look for those with substantial and valuable experience. Consider their skills and be sure to pay them accordingly.
Written by Alejandro Maher