Every company has a board of directors – but few founders and entrepreneurs give the matter of board composition much thought.
We’d like to offer some advice to founders and CEOs seeking to learn more about their boards, as well as to people who have been invited to sit on a board. This piece is aimed at U.S.-based startups who are, or are intending to incorporate, as C-Corp companies.
Do I Have to Have a Board of Directors?
Yes. Every company (that is, a C corporation) 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 needs to have a board in place.
When Do I Need to Start a Board?
When you first start a company, a board must be put in place. This doesn’t have to be complicated. A board consisting of one person (even if it’s just the founder) is legal, and also has the advantage of making board meetings much shorter.
Why Do I Need a Board (Aside from Legal Matters)?
You must have a board to handle corporate matters like issuing stock, setting up a stock option plan, authorizing a fundraising, or getting loans. Boards make the important decisions for companies. Under Delaware law, these decisions must be approved by the board for the action to be valid.
What Should I Do When Starting a Board?
To create a board, you should hire a lawyer experienced in board setup. There are many other factors to consider, so we’ve included other resources at the end of this article.
Who Else Is on the Board and Why Does It Matter?
In most startups, the founder will typically appoint himself or herself to the board. From there, others get added to the board as the company grows.
The board will ultimately be responsible for making the critical decisions for the company, like whether to raise money, whether to be acquired, whether to enter into important strategic transactions and whether to hire or fire senior management. So make no mistake – who sits on the board is critical. It’s important to ensure these major decisions are made by smart people who are knowledgeable about the company and the industry in which it operates.
While the composition of the board can and likely will evolve over time, and certainly will vary from company to company, standard approaches for startups do exist, depending on the stage of the company.
While it isn’t necessary, many companies choose to have an odd number of directors. This number reduces the risk of a tie vote, which equals a “no” vote in the boardroom
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. 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, say hi to 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.
While each “series” of investors typically gets to appoint a board member, it’s important to know that the representative of that series represents all investors – not just that series.
At some point, if the board is getting too big or if the investment size doesn’t merit a board seat, instead of giving out more board seats, the company might allow investors to act as “observers.” That is, they can come to and participate in the board meetings, but they do not get a formal vote. Sometimes the later investors become the observers, and sometimes earlier investors will become observers.
You won’t get to choose all your board members, but for those you do, consider the value of diversity. A McKinsey study found that diverse companies were up to 35% more productive than less diverse companies. But startup boards haven’t kept up – for example, 70% of U.S. startups in 2017 had all-male boards. As leadership often reflects the opportunities available for employees, keep your eyes open for opportunities to increase the diversity of your board. TheBoardlist is one useful resource.
What Does a Board Do?
The board 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.
Finally, board members provide connections with other helpful companies, individuals, and resources, as well as offer overall advice and guidance.
I Don’t Understand Where the Loyalties of Board Members Lie
Board members are “fiduciaries” because they are entrusted with managing the business that is owned by different people – stockholders. Hence, they have what are called “fiduciary duties” to the company’s stockholders. In short, fiduciary duties are the obligations the board has to act responsibly and in the best interests of stockholders. It’s a common misconception that the official role of board members is to protect the value of their own or their firm’s investment. In fact, the fiduciary duty of board members is to maximize value for ALL stockholders.
The board can get sued by stockholders if board members do not satisfy their fiduciary duties, resulting in time-consuming and expensive litigation, potentially major damages, and otherwise disturbing the business. To comply with fiduciary obligations, directors must satisfy what is called the duty of care and the duty of loyalty.
The duty of care says that directors must be informed about what is going on and make decisions armed with the relevant facts. In other words, pay attention and don’t just show up for the quarterly meetings and do the crossword puzzle. Keep involved between meetings and stay abreast of what is going on with the company.
The duty of loyalty states that the director must act in the best interests of the company and stockholders and not in his or her own self-interests. If the director has a conflict of interest – for example, the company wants to sign a major contract with another company owned by one of its directors – the conflict must be disclosed to the other board members and the conflicted board member should recuse him/herself from the discussion and approval process.
How Often Do Boards Meet?
How often a board meets depends on the stage of the company, the needs of management and other factors. It is fairly typical for startup boards to meet in person once a quarter, towards the beginning of the quarter to review the prior quarter’s results. Early-stage companies might also hold more frequent informal board meetings, either in person or by phone. The more frequent, informal board meeting can be beneficial because the strategy at early-stage startups changes more often (such as the pivot Zeel undertook in fall 2012, culminating in a new launch in April 2013).
During particularly intense times, such as crisis situations or when the company is being acquired or is acquiring another company, the board can meet much more frequently, possibly every day or multiple times per day.
A typical, regular quarterly board meeting lasts about 3 hours, but some go much longer.
It’s also becoming more common to hold a board meeting telephonically or by video, although meeting in person from time to time helps cultivate a healthy board dynamic.
Do I Pay Board Members?
Compensation for board members varies by stage and by the identity of the board member (eg, a renowned chairman); it also varies between companies. 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% and 2.0% equity. This percentage should drop as the company grows. In some cases, cash compensation is included.
Companies will almost always reimburse the directors for out of pocket expenses, like travel expenses. Also, the company will usually indemnify directors from any liabilities they incur in their capacity as a director, like if they get sued by stockholders. Directors should also require the company to maintain a minimum of $1 million of directors and officers (D&O) insurance, and more as the company grows.
If you’d like to explore more resources, here are a few suggestions:
Advice from Cooley on managing board meetings and members – https://www.cooleygo.com/topic/board-and-advisors/
First Round Capital’s guide to running board meetings – http://firstround.com/review/The-Secret-to-Making-Board-Meetings-Suck-Less/
Sequoia Capital on preparing your first formal board deck – https://www.sequoiacap.com/article/preparing-a-board-deck/
Parts of this article originally appeared on TechCrunch.
Disclaimer: This article is not intended as legal advice and cannot replace legal consulting on a case-by-case basis. It is merely a brief and simplified summary of a very complex matter. The information contained in this article is for general information purposes only and will not be checked for currency regularly. German Accelerator will not be liable for any false, inaccurate or incomplete information presented on this website and for any loss or damage of any kind incurred as a result of the use of this information.
About the Authors
Samer Hamadeh is founder & CEO of Zeel, the Massage On Demand(R) company. An experienced entrepreneur, Samer has created, led and advised successful tech startups for nearly 20 years. He has been on five startup boards and has founded and served on the boards of two of his own companies. Samer has been mentoring numerous German Accelerator companies since 2014.
Adam Dinow is a partner in the New York office of Cooley LLP, one of the world’s preeminent technology and startup law firms. Adam represents clients at all stages of their life cycle, from incorporation to exit, with an emphasis on working with entrepreneurs and fast-paced, rapid-growth enterprises.