Creating and Managing Your Board of Directors: Best Practices & More
Written by Thomas Rush, 08/03/2022
I. WHAT IS A BOARD?
The day-to-day business of a corporation is run by the company’s officers, such as the CEO and CFO. Ultimately however, it is the board of directors who is responsible for the management and oversight of the company and their formal approval is required before the company can take certain actions (such as altering the governing documents, issuing shares and taking up loans). Legally speaking, the board of directors is a group of individuals elected to represent the owners of the company, that is, its shareholders. As part of this structure, the directors are said to owe fiduciary duties to the company’s stockholders. These duties are an important part of corporate governance. These duties include legal concepts such as duty of care and duty of loyalty, as well as serving on committees and other responsibilities. Each of these duties are derived from the specific corporate laws of the jurisdiction in which your company is incorporated. The duties described specifically below are applicable to the state of Delaware.
Board members are bound by two formal legal obligations, defined as follows:
- Duty of care: A board member is to conduct all actions in a manner where they see no foreseeable harm. A board member needs to be attentive and prudent in making board-level decisions, act in good faith, and conduct sufficient investigations to provide a logical basis for decisions. A board member breaches his duty of care when he acts in a negligent manner or knows that the consequences of an action could be harmful to the company.
- Duty of loyalty: A board member should ensure that interests of the shareholders of the company are always first and foremost in his mind and that loyalty to the shareholders supersedes any other vested interests he might have. Duty of loyalty is breached when a board member puts his personal interest ahead of the company, conducts inappropriate transactions that benefit the board member (known as self-dealing), or benefits personally from confidential information shared in the boardroom.
These legal obligations in turn have subsets that are just as important. Included among these are the duty of confidentiality and duty of disclosure, which are defined as follows:
- Duty of confidentiality: A subset of the duty of loyalty, this requires a director to maintain the confidentiality of nonpublic information about the company.
- Duty of disclosure: A director, pursuant to the duties of care and loyalty, is required to take reasonable steps to ensure that a company provides its stockholders with all material information relating to a matter for which stockholder action is sought.
As Mark Suster writes on his blog Both Sides of the Table: “It is worth pointing out that there are actually three levels of governance in venture-backed startups” as shown below:
II. CREATING YOUR BOARD
The most important functions of a board:
- Ensuring success and sustainability
- Establishing financial controls
- Developing reporting guidelines
As a general guideline (i.e. not a hard and fast rule) your board will be composed of three different types of board members:
- Executive Board Members: Members of the management team, or “Founding Board Members”
- Independent board members
Investor Board Members
As a point of information on investor board members, it’s important to understand that different investors could own different types of shares (common, preferred, etc.) which grant different rights. Best practice is to ensure that there is someone on the board to look out for the beneficiaries of each particular set of rights associated with each type of share.
Executive Board Members
An executive board member is often the Founder or CEO who also serves on the company’s board of directors. This person typically runs the day-to-day business and makes key decisions within the framework agreed upon between management and the board.
Independent Board Members
Most board members in a startup represent either the investors or the founders. An independent board member represents neither group. Independent board members will likely be less intimidating for the CEO to talk to in an open way, since the CEO doesn’t have to worry about jeopardizing the funding of the company in any conversations with that particular board member.
Before searching for a board member, define the characteristics (i.e. skills / capacities) you are looking for, such as:
- Customer development (early stage companies)
- Product development
- Business model development
- Team building
Former Andreesen Horowitz partner Scott Weiss believes that the following represents “table stakes” for the best board members:
- Sharp opinion (not a quiet person who doesn’t contribute)
- Does real sh*t. Doesn’t just show up for the meetings, but materially contributes to the success of the business.
Use the characteristics defined above to create a list of ideal candidates — including aspirational ones. Then ask yourself these questions:
- What skills does this potential board member have? What would be the single most important contribution this board member could make for my startup over the next year? (This may evolve over time.)
- Will I have the ability to learn and grow under the guidance of this board member?
- Do I see any conflicts, now or in the near future, that need to be addressed?
- Will my other board members engage effectively with this person? Are there any known historical conflicts?
In Matt Blumberg’s book Startup CEO: A Field Guide to Scaling Up Your Business he suggests the below rigorous recruiting process for board members:
- Take the process seriously: devote as much time to this as you would to the process of building your executive team.
- Source broadly
- Interview many people
- Check references
- Have finalists attend a board meeting
- Have no fear of rejecting potential board members.
Formal Structure of Your Board
When a company is first incorporated, the board of directors usually consists only of the founder(s). As the company grows and brings in outside investors, the number of board members usually increases and eventually it will be prudent to form committees to perform certain specific duties. Below we have outlined the duties of the most common committees: the audit, compensation, and nominating committees.
- Audit committee: Oversees the company’s accounting and financial reporting processes and financial audits. The responsibilities include ensuring the timeliness and independence of audits and communicating with the independent auditors about any relationships or services that could affect the auditor’s objectivity and independence.
- Compensation committee: Establishes CEO and executive officer compensation, oversees equity compensation grant policy, and hires outside experts to provide opinions as needed on market-based compensation ranges.
- Nominating committee: Recruit and orient new directors, manage CEO succession planning, and monitor governance processes.
One of the primary documents that describe your rights as an owner or shareholder is the shareholder rights agreement. However, the certificate of incorporation and the by-laws are also critical in defining the terms of a shareholders’ rights and obligations. These rights include:
- Voting rights
- Inspection of corporate books and records
- Initiating actions against directors for illegal or fraudulent activities.
Many boards have board observers who have the right to sit in, observe, and participate in portions of the board meeting, but do not have formal board roles or responsibilities. Observers do not get to vote on board matters, and do not have a right to be in the closed session of the board, often referred to as the executive session.
Below is a short list of objectives a board member should expect of counsel. Since many attorneys are involved in board or corporate governance matters, it is important to consider how your company’s counsel ought to be engaged.
- Represent the company’s interest
- Participate in board meetings, but don’t “hijack” the dialogue for legal issues.
- Engage with both management and the board collectively and independently
- Coach management on what should go to the board and how to help them make good decisions
- Keep the cap table clean
- Be open to criticism, don’t be defensive, and request constructive feedback
- Never, ever, bend the truth with the board, or be anything less than appropriately transparent.
Compensation for Board Members
Outside board members are an entirely different matter, as it is expected that they will be compensated in some way. An option grant of the company’s stock of up to .35% of the company that vests from two to four years is a normal / average compensation. The absolute amount varies, and grants are larger earlier in the life of the company.
Should you have an advisory board as well?
- Technical: Offers product development advice.
- Business: Offers business strategy guidance.
- Customer: Offers direction on product features/value proposition.
- Industry: Brings domain expertise.
- Sales: Counsels on sales tactics and demand creation.
III. THE BOARD MEETING
How to run a board meeting?
Before the Meeting
If possible, have a call with each board member prior to the meeting, after sending them all relevant materials. Raise issues with the director so that the operating team (yourself and/or others) can present potential solutions. This is especially true regarding new hire decisions which can be streamlined if board members have had a chance to speak to the candidates prior to the board meeting.
Most board meetings tend to be somewhere between two and four hours long, especially for early-stage companies. Take a 5-minute break every hour.
After the meeting, send out a note to the entire board, playing back the key things that they heard, so that the board as a whole is on the same page in terms of the context of what was talked about and outcomes of the board meeting. This sets a constructive tone for the continued interaction around the particular issues that were raised.
If you have a meeting that happens from 10–2, serve lunch. Do a little work and know if one of your board members is a vegetarian or if another board member keeps kosher.
Preparing your board package
Send out the board package to your company’s directors in advance, at a minimum 72 hours in advance but ideally one week ahead of time. Give your directors several days to absorb the information in advance, so that when they show up at the board meeting everyone is able to have a substantial and productive conversation.
Motions and Votes
A startup needs to determine what can be decided upon by the management team versus the Board of Directors. In later stage companies, this becomes increasingly complex. For example, which decisions require board approval or shareholder approval? There are often different thresholds for each, and something that could be approved by the board alone early on may need to get shareholder consent later on in the life of the company. Which decisions require approval of preferred shareholders? Which require the approval of all shareholders? In some cases, the preferred shareholders will need to approve a decision. In others, a subset or threshold such as a majority or a super-majority is all that is needed. There may be multiple classes of preferred stock, each with a separate vote. And finally, in some cases, a majority approval of common shareholders will also be needed. Can new directors be nominated or current directors be removed? If so, what is that process? In some cases, you will want to add a new director or remove an existing director from the board.
It’s important to know the rules around this well before the situation arises.
There are two common failure modes for early-stage boards:
- When directors believe they are best positioned to direct short-term operations
- When the company and board focus their discussions on non-core issues.
As explained in Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist, the two primary characteristics of every investment are:
V. RESOURCES / INSPIRATION
- Startup Boards, Getting the most out of your board of directors
- Role & Responsibilities
- Board Meetings
- 15 Tips For Successful Board Meetings
- Preparing a Board Deck
- Tren Griffin, blog post
- Thiel, Peter A. Zero to one: notes on startups, or how to build the future (“A board of 3 is ideal”)
- How to Build Your Board, Glenn Kelman — CEO of Redfin
Advisors: A set of individual advisors the startup works with on strategic matters, sometimes in exchange for compensation or equity with a vesting schedule.
Board Members: The most powerful group of individuals in a company, these individuals represent the company’s shareholders (and for a startup, they often are the shareholders). Board Members are typically involved in strategic decisions such as whether or not to raise funds, enter into talks concerning acquisitions or IPOs, and the hiring or firing of senior management.
Board Observer: The right to observe everything that happens at the Board level, which includes hiring people, equity grants, approving major deals, etc.
Common Directors: Directors that represent the common stock and its shareholders.
Independent Directors: Third-party directors that are appointed to solely represent the good of the company. Independent directors hold no stock in the company.
Information rights: The right to be provided information such as delivery of regular financials and notification of major transactions (like financings).
Preferred Directors: Directors that represent the preferred stockholders. These board seats are almost always filled by lead investors from a round of financing.
Originally published at mesh.xyz.