An iconic venture capitalist (who asked to remain nameless) told me early in my career that bad boards destroy more companies than bad management or bad tech. At the time, this sounded melodramatic and maybe a tad self-serving, but over 20 years and a few bad boards later, I couldn’t agree more. Founders will conduct an exhaustive search for a key employee to ensure just the right fit. Yet that same founder will happily hand over a board seat to almost anyone writing a large check.
Keep in mind, a bad employee can usually be fired without notice (depending on the state). Removing a board member involves a process that can be cumbersome, time-consuming, emotionally draining, and publicly embarrassing. If the person refuses to voluntarily resign and has to be “voted off the island,” this becomes a diligence item for future investors and you will have some serious ex‘splaining’ to do.
The board’s role
First, one should understand the board’s role is both strategic guidance and governance. For the purposes of this article, we are generally referring to a board that includes outsiders as opposed to just founders. The legal requirement to have an actual board is determined by the form of the entity and the associated bylaws. A traditional C-Corp requires a board of directors while a limited liability company (LLC) does not, though LLC operating agreements often provide for one. While responsibilities and board constitution are established upon formation of the entity, they can later be changed.
Since large investors typically require one or more board seats concurrent with their investment, one might assume their objective is to oversee their investment and provide guidance, which is true. However, many founders don’t realize that governance is a legal requirement of the board. Board members have a “fiduciary responsibility” to exercise their powers for the benefit of the corporation and its stockholders collectively. Some states allow directors to take into account the interests of constituencies other than shareholders, while others (such as Delaware) are more shareholder-focused.
Board members have a “duty of loyalty” and a “duty of care” that supersedes their own self-interest. Their duty of loyalty is first to the company and its shareholders. Board members who act in a manner that appears to benefit their own self-interest at the expense of the company or other investors may be accused of “self-dealing” and thus be exposed to a shareholder lawsuit. A classic example of self-dealing would be a board member representing a venture fund that puts forth an “unfavorable” term sheet who then discourages or impedes the company from pursuing competitive offers.
The duty of care issue arises more frequently and tends to be more subtle and subjective. An example would be board members who knew or should have known the company was running out of cash and who did not suggest actions to extend the runway or secure additional funding.
In assuming fiduciary responsibilities, board members are thus potentially exposed to shareholder lawsuits. Lawsuits brought by disgruntled shareholders, typically after a company has failed, may be without merit but are nevertheless highly unpleasant. Hence, many executives will insist that the company secures Director and Officer insurance before joining a board.
Now that we understand the legal side, we can move on to the more interesting question.
Do you need a board?
A board should be a major asset. As such, one may want to form a board even before it is a legal or funding requirement. Like any major investment, the cost-benefit should be well understood. There are many factors to consider. If you are an early stage startup, you are likely heads down building out your platform. You are working nights and weekends to simply build the product and may be racing against the clock to hit development milestones before the ramen noodle supply runs out. Managing board interaction and preparing for board meetings is a major time commitment that may distract from immediate mission-critical tasks.
Instead of being encumbered with the formality and documentation requirements of a board, which include holding regular meetings (typically once per quarter) and documenting them (board minutes), you may be better served by creating an informal advisory board. Typically, such advisers are offered stock options as compensation.
As your company evolves and has a line of sight to commercialization and institutional funding, a board of directors can add immeasurable value. Many founders have never experienced the benefits of an engaged and supportive board; hence, the value and importance are underappreciated. A great board is like a great spouse — there are countless tangible and intangible benefits.
When the time comes to recruit outside board members, your team should put significant forethought into the process — with an emphasis on creating an actual process. That includes carefully crafting the profiles of your ideal BoD members and identifying your prospects.
To the uninitiated, board creation before it is required may seem like a major time suck, but is the juice worth the squeeze? Yes! Resurrection is harder than birth — creating a great board via a controlled, thoughtful process is far easier than fixing a broken one that was foisted upon you.
Part 2 will focus on who should or shouldn’t be on your board and why, with an eye to non-healthcare company investors.
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