With the myriad of tasks faced by the founders of a start-up, the composition of the company’s board of directors often gets put on the back burner, at least until the time when the company seeks outside capital, at which time it often becomes a significant issue. Putting aside some time to thoughtfully consider who should comprise your board can reap benefits in the long-term, even if the role played by your board seems minimal in the near term.
At its most basic, a board of directors makes non-ordinary course decisions for the advancement and benefit of the company, on behalf of its stockholders. A board of directors is required by law if you are a corporation and potential investors expect that there will be a body that acts like a board of directors whether required by law or not. The primary issues faced by start-ups in connection with their boards are determining whom to put onto the board, figuring out the right size for current operations and future growth, and deciding what compensation (if any) to pay to board members for their service. Each of these issues is briefly discussed below.
Ideally, each member of your board will provide support, knowledge, strategic vision and access to networks that may benefit the company operationally or with respect to financing. Ascertaining whether a person possesses these criteria may be difficult, which is why it is important for founders to complete the necessary due diligence at the outset- this means looking at each board member’s prior experience on boards- were they active and engaged, did they help the company to successfully grow, or were they focused on a personal agenda of some sort, or overly focused on details and operations, which is the purview of management? Make sure you get enough feedback from people who have worked with them in a board context before extending an offer. Also, even though it is tempting to choose board members with backgrounds similar to your own, try instead to find members that offset potential weaknesses of your current team, and bring strength in areas where you are lacking.
Assuming that your potential board member has prior board experience, it is helpful to also understand what type of board he or she served on, as the role of a public company board is often very different than that of a start-up. And although it is natural to focus solely on potential board members who have access to financing and other similar networks, try not to overlook the importance of board members who have experience in particular areas (marketing, sales, customer development, etc.) that your company will, at some point, need to focus on. A diverse board, in terms of profiles and areas of expertise, will inure to your benefit as your company grows.
When establishing your board, try to anticipate what your growth needs may be down the line- in 6 months, a year, two years, and in your mind “reserve” positions for those that may need to be added down the line- whether to meet a strategic development need, or those who will join your company in connection with a strategic partnership or financing. Typically, each round of financing may lead to one or more board seats for the lead investors. Keep this in mind- what you want to avoid is finding your company with a ten-person board four years’ into existence. Large boards (in excess of seven) are usually not as engaged as a smaller board, and the logistics involved with having periodic board meetings and calls become very challenging. You will also want to be sure to allocate board positions at the outset to certain constituencies- including the founders, management or common stockholders, and try to make sure that there is at least one “independent” director, who is beholden to no one but the company (as opposed to preferred directors, who typically represent one or more classes of preferred stockholders, and are often affiliated with the lead VC of a round).
Given that almost all material decisions affecting a company are decided (or at least discussed) at the board level, being an engaged and informed member of a company’s board takes considerable time and effort; as a result, it is more typical than not that a board member expects to receive some level of compensation for his or her efforts. There are two categories of exception here- one exception is management or employee directors- they are already being compensated by the Company, and should not receive any extra remuneration in connection with their service on the board. The other is a preferred director (or professional director) who is affiliated with or employed by a VC fund or other funding source- being on the board of a company which his or her employer has already invested is typically part of the job description. As such, they often times don’t need to receive additional compensation.
Otherwise, since most start-ups are cash-starved, companies typically rely on equity to compensate board members. There are multiple forms that such equity can take, with stock options and restricted stock being the most recognizable. To save on costs and administration, at the outset a company can utilize the omnibus equity incentive plan that they have in place for their employees to use in the board context as well. As the company grows and evolves, it can then assess whether a separate plan for directors only makes sense in their particular situation. As far as the amount of equity is concerned, again this varies widely given particular facts and circumstances- a good approach is to work backward- you’ve already determined the percentage dilution of your equity plan- determine what your needs will be for employees, what remains for your board, and then allocate further from there. Unless a director has an absolutely crucial set of skills that you cannot live without, providing him or her equity in excess of two or three percent isn’t advised. Another approach- model what your ideal exit value multiple would be, and determine what the director’s return would be under that scenario- have they added value to your company in an amount that justifies that price tag?
Keep in mind that your board of directors will evolve in size and composition from your initial stage through the life of your company- you will need to maintain flexibility to allow this evolution to occur. The skill set that a director brings to the table in years one and two might no longer be needed when you get to year four. Although there is nothing written in stone, a good size for a start-up board of Directors ranges from three to five, which will typically include one or two founders (depending on whether they also serve as CEO), one or two independent members, and one or two angel or VC investor representatives (depending on where a company is in its financing efforts). As a final note, management should make sure that all board members understand (and appreciate) their fiduciary and legal duties in connection with the role they will be playing.