The Board of Directors will evolve in size and composition from the start-up stage until the Company is fully operational. Directors must recognize that the composition of the Board must change over time. New directors may be appointed, and those that have completed their contribution may need to step aside. Typically, this is done on an annual basis leading up to the Annual General Meeting of the Company. Please see related documents Board Review and Governance Practices by Stage of Growth for Early Stage Technology Companies.
Start-up. At start-up, the Board is usually comprised of the founders. As the Board’s job is to protect the interest of the shareholders, which are the founders, this is appropriate. A typical Board size is three, although that may vary depending upon the number of founders. The Board often functions as a senior management meeting combined with a Board meeting. Decisions specific to Boards, such as share and options issuances, financings, etc. (see related document Terms of Reference of a Board of Directors) are decided at these meetings.
A start-up often raises funds from the founders, friends and family (and fools). Most of these early investors trust (and pray) that the founders know what they are doing, and are passive investors. They do not take a Board seat.
Occasionally, an experienced friend or family member will ask to sit on the Board to provide advice. This may or may not be a positive event. Typically, the new Board member is not sufficiently independent to provide objective advice and oversight for the founders. Also, their business expertise may not be applicable for the challenges of an early-stage technology company. The founders need to consider whether this new director is willing to step aside if new investors want a candidate with different strengths and experiences.
Again, the Board has typically three directors at this stage, but may expand to five, depending on the number of founders and active investors.
Fiduciary Duty. With external financing in place, the founders now have a fiduciary duty to investors other than themselves. This is a good time to begin to bring independence and oversight to the Board. The founders should begin to look for two or three independent directors who are experienced in one or more aspects of building start-up technology companies. The goal is to have a majority of independent directors on the Board. One or more of the founders may need to step off the Board. See section 6 below for guidelines on director appointments.
Development phase. As the company develops its product, it begins to take planning, goal setting, and accountability more seriously. At this time, adding experienced directors to the Board becomes increasingly important.
Often at this time, the company raises capital from outside investors, who are often angels.
Angels are typically experienced technology executives who have been previously been CEOs or senior executives of technology companies. They invest in technologies and management teams that appeal to them. Some are passive investors, and some look for active involvement, usually with a Board seat. In any event, once an angel has committed to making an investment, he will look to see the Board become more independent and exercise objective oversight. More often, this is becoming a pre-condition for the angel to invest. If the angel is not taking a Board seat, he will often request that the Board and founders adopt a Board development plan that sees the Board comprised of a majority of independent directors, each recruited for specific talents or experiences which can assist the company. Please see related document Board Review.
It is at this point that a properly constituted Board with clear terms of reference can begin to be effective, as described in all of the accompanying documents.
Rapid Growth. If the company develops a product which satisfies a need, it should experience rapid growth when it begins selling. In previous years, this was often the time for the company to raise venture capital funding. Currently, many software and web companies can scale quickly without the need for venture financing.
If VCs do invest, as a requirement for financing, they will formally restructure the Board. At this point, it is no longer a start-up. The entrepreneurial drive of the founders and senior management are now focused formally by the oversight of a professional Board. The VCs will typically take one or two seats on a Board of five directors and look to have additional independent directors appointed. The founders will be limited to one seat, that reserved for the President and CEO.
If the company is able to scale without VC backing, the founders nonetheless should look to restructure the Board to bring additional experience and governance. They will have considerably more freedom and time to do so, as the restructuring is not a condition of imminent financing. They will have a deeper pool of talent to draw from than the candidates the VC will propose.
Far too frequently, Boards of venture-backed companies do not perform well, even though the directors are usually experienced. There may be confusion about roles and responsibilities.
Much of the material in this set of best practices is intended to influence the behaviour of Directors to improve the performance of the Board and the company.
Recruiting Professional Directors. The Board and management should develop a matrix of required skill sets and potential available candidates for director. Candidates can be evaluated based on their skills and experience and recruited to cover the important areas, particularly those in which the management team may be weak. See related document Board Skills Matrix.
Recruiting independent professional directors can start any time. As noted above, if the company is raising angel funds, it will become a priority. If the company raises venture capital, the VCs will insist on restructuring the Board. The earlier the company recruits Directors, the more likely they are to have ones which provide the skill sets and experience they need, rather than being subject to the appointees of investors, who may not have the same priorities.
Since the number of directors to be appointed is limited, the range of skills and experiences can be grouped into the following three categories, each of which should be represented on the Board:
- Reputation Director: A reputation director is an independent which provides “name” recognition. This is someone with relevant industry experience according to the Board Skills Matrix developed for your company, and is well known in the community. He needs to be active in sourcing opportunities and opening doors. His presence provides Board validation and thus validation for the company. He often plays an instrumental role in introducing potential investors to the company.
- Active Director: The Active Director is usually the Chairman of the Board. He drives the Board to ensure that it is functional and accountable. One of the huge failings of early-stage company Boards is that no one has the responsibility for ensuring that the Board executes its fiduciary duty. If the Directors are too busy, not close enough, and not engaged, then they are not sufficiently informed or motivated to hold management accountable. Often, the Boards are then driven by the management and founders, particularly if they hold the majority of the equity. In this case, the Board may “look good” but is ineffective at its primary task.
It may well be the case that the engagement of the Active Director or Chairman is crucial for ensuring that the Board stays focused and provides the mentorship and oversight to management which might make the difference between success and failure. This is one of the pivotal reasons for assembling these Board documents and philosophies.
- Supplemental Director: All of the Directors bring their experience in one or more of the functional areas in which the company needs mentorship. As the Supplemental Director is usually the last one selected, the primary selection criterion should be in filling the most significant hole in the management team not covered by the other directors. Specifically, if there is a choice to be made between reputation and expertise, for this appointment, the expertise should predominate.
Experience and Qualities of Directors. In addition to their qualification to serve specific roles, independent directors should have some or all of the following attributes:
- Be a mentor, advisor and confidant of the CEO. As noted throughout this blog, this is the significant difference in the profile of the director of an early stage tech company as compared to a more mature company.
- Have C-level executive experience in building a management team which has developed a product and gained customer traction; and preferably has achieved operating break-even. In this previous experience, s/he will have encountered and solved many of the early stage challenges that the CEO may be encountering for the first time.
- Has raised external financing. If there is one attribute that distinguishes successful start-up CEOs, it is the ability to craft and deliver a compelling value proposition that will convince a sophisticated angel to invest in the company. The others run out of money or never get off the ground.
- Has domain experience in your industry. Industries have their own unique characteristics; aggressive or conservative, length of sales cycle, concentrated or dispersed, culture, etc. Much time and money can be saved by a knowledgeable director guiding inexperienced executives away from unknown dangers.
The personal characteristics of the Director are more important than the experience and qualifications they bring. A Director must have integrity: honest, transparent, and fair, with no hidden agendas, and no information withheld. She must also be smart: understand the conflicting considerations in an issue challenge the CEO`s thinking and be able to advise the CEO on the best course of action, which is much different than quick responses based on limited thinking. He must also be a mentor, as mentioned throughout this document: offer constructive criticism, but always in an attitude of support; someone the CEO can trust not to use confidential information against them.
There is a debate in the tech start-up industry as to whether it is better to have Board members with start-up experience or industry domain experience. Many would argue that rapid change and need to make quick decisions in the absence of complete information transcend all domains and is the better experience to have. Others may counter that understanding the industry better would avoid many of those problems altogether.
Geographic Considerations. Not all of the best directors live in town. Until recently, geography was a major consideration in the choice of directors because Boards are much more effective when the Directors are physically present. Now the proliferation of high-speed internet and the development of significantly better teleconferencing applications, such as Zoom, Skype and Google Hangouts, has greatly improved the quality of online communications. A video conference is now almost as good as being there in person.
Consequently, companies now can recruit the best Directors from a worldwide pool of experienced executives who will bring a more diverse set of experiences to the Board’s deliberations. Boards should now not suffer from a lack of talent in their immediate vicinity.