Thoughts on boards (directors and advisors for early-stage companies)
This is part of a series I am doing called “Thoughts on… (particular subjects of interest to early-stage entrepreneurs).
- For an early stage company, a small Board of Directors (BoD) is better.
- An odd number is preferred (for obvious voting reasons); one is too small; so three is optimal.
- One insider from the founders, one industry expert and one who can add value through his/her experience with startups, or a particular domain expertise.
- BoDs for early stage companies need to be actively engaged. Hold monthly meetings; two-to three-hour duration with tightly defined agendas; task assignments and homework provided in-between. Monthlies can be via phone; quarterlies should be face-to-face.
- Annual term. Stand for reelection (or appointment by contract) each time. No staggered terms needed; those can mostly be reserved for very large boards in public companies.
- Given the primary responsibility/duty of a Board Director is as a fiduciary for the shareholders (and also of the creditors when the company is in the “zone of insolvency”), and a closely related second responsibility is to recruit/retain the CEO (and also to quickly recognize when a new CEO is needed to replace the current executive), it is critically important not to simply add directors who may possess great marketplace and business building skills and forget to determine their knowledge about governance. A company can overcome lack of board governance experience if it has a very strong and knowledgeable Chairperson who can ensure that the others directors act properly. The inexperienced board members are expected to quickly learn their duties and governance issues under the Chairperson’s guidance.
- Directors incur liability as fiduciaries for a company; thus they may require Directors and Officers Insurance (D&O). This is common and most insurance companies offer this type of policy ranging in annual premiums from $1750 to $4500, depending on what is needed.
- Obviously an early stage company may have difficulty attracting competent directors who can provide significant business opportunity and strategic skills, much less add the governance/CEO management piece. So if you need to augment the management team in areas of strategy, deep industry knowledge, or marketing/technology/partner expertise, then add those members to an Advisory Board. Further, there may be some candidates that are very good at the strategy piece, and/or be very useful filling gaps, but do not want the responsibility or potential risk of accepting a directorship. Again, a good Advisory Board fit.
- Whatever the mix of BoD and Advisory Board, the BoD cannot basically be ignorant of their duties or otherwise shareholders will not be well served.
- In addition to acting as a fiduciary for shareholders and recruiting and managing the CEO, directors for an early stage company should be involved in managing the affairs of the corporation. This does not mean that they run the company; rather their responsibilities might include: ensuring that the organization has an appropriate strategic planning process, reviewing outputs from the strategic planning process, understanding what is being developed and approving the strategic direction for the organization, learning the business and the industry well enough to have a well-formed perspective on the benefits and risks of the organization’s strategic direction, monitoring to ensure that strategies are being executed as planned and expected outputs are being achieved, and monitoring to ensure that the BoD is governing effectively.
- Directors are expected to work and provide significant value. Directors should be able to do whatever the company needs, from picking up the phone to make introductions, to facilitating strategic partnerships, fundraising, legal/accounting/banking relationships and the like.
- The corporation should adopt and enforce a “continual director improvement/replacement” policy or approach that says a director is elected/appointed for one year, but the director formally/absolutely agrees that, in the event a significantly better director is identified, the weaker director resigns their post to enable the better candidate the seat.
- Regarding director compensation, the company should expect to reserve approximately 20% of the option pool for directors. Therefore, in the case of a 20% company stock option pool, 4% is reserved for directors. Each director could be granted, for example, 1/2 of one percent of the fully-diluted shares in Non Qualified Stock Options (NQSOs) of the corporation to be vested over three to four years.
- Regarding expenses (a minor point but often over-looked), the company should reimburse each of the directors for all reasonable out-of-pocket expenses incurred while attending meetings of the BoD, meetings of committees of the BoD, and on company-approved business.
- Advisors should also be compensated but at an amount less than directors (since they take less risk and have no “formal” duties/responsibilities). For example, advisors could be compensated at half that of directors, or one quarter of one percent of the fully-diluted shares in NQSOs of the corporation, also vested over three to four years.