By Mark Juliano
One of the most important decisions for all startups is the composition of the Board of Directors, and the powers of those Board members — trust me, they have more power than you think!
The typical Board of Directors is comprised of individuals from four areas:
- Founders and Company Executives (insiders)
- Investors and Venture Capitalists
- Trusted business associates
- Industry professionals (consultants, customers, etc.)
Sometimes lawyers are also on Boards, but often they prefer to serve as corporate counsel to remain somewhat independent of the actual Board decision making. I agree with this assessment.
Boards are generally odd numbers, so that there are no voting ties — however, most Board level decisions are unanimous because, 1) startup companies strive to reach a consensus, and 2) it is considered “bad” to have dissenting opinions in small companies. Usually the company has 2-3 insiders (founder and executives) on the board, along with 1-2 outsiders. Board control is a VERY important issues — especially when outsiders outnumber insiders. When this happen — and TRUST me on this one — the outsiders, even if they don’t own a majority (>50%) of the stock, can overrule insiders, and even force the firing of a CEO, Vice President, etc. even if these individual own a significant percentage of the company.
What does a Board of Directors Do?
The company’s Board has a great deal of power, and the powers of the Board should be spelled out in the Shareholders Agreement and other corporate documents. The basic powers include ability to authorize and allocate stock, and stock options. This of course is critical for paying employees with stock options, raising capital (including venture capital), etc. They are naturally also involved in buying companies, and selling the company itself. The Board also authorizes annual and quarterly expenditures, especially any large or new expenses.
While all of this seems “standard” the mistake companies also make is what I’ll refer to as “VETO POWERS“. Even if the founders and employees own more than 50% of the company stock, the Board’s power can often “trump” those voting rights. Venture Capitalists are notorious for adding all sorts of clauses that both the Board, AND the Venture Capitalists must approve. No, the clauses don’t say Veto power, they simply say the Board (or Investors) must approve the following …
An example illustrates the potential problems associated with these Veto Powers. Let’s say a company wants to raise additional funds from a private or venture capital investor, and insiders own more than 50% of the stock. Let’s also assume the board is comprised of 3 outsiders and 2 insiders, and the Board has the WRITTEN ability to approve all new fund raising — and YES, I have been in this position as a CEO. Very quickly you, as the CEO, will find that the new investors, say venture capitalists, are negotiating with the OUTSIDERS, because they do have the power to Veto any deal.
These Veto powers can extend to major capital expenditures, sales of insiders’ stock, etc. etc. etc. I was in one situation where my company — MediaSite — licensed technology from Carnegie Mellon University. They had a Board seat (required to license their technology from the Tech Transfer Office), but only 10% equity in the company. Frankly, they were worthless Board members, and were ONLY concerned with how any business deal affected Carnegie Mellon. I actually told the CMU Board member that he had a “fiduciary responsibility” to act in the COMPANY’s best interest. He couldn’t have cared less.
So what happened … I found future investors negotiating with CMU, instead of the CEO and other board members knowing that the CMU Board had veto power. There was no way to get rid of the CMU Board member, and he created untold conflict on the Board — not to mention he has ZERO business experience … lesson learned…
I have heard this absurd concept of a “balance” whereby Insiders own the majority of stock, and Outsiders have Board control — sorry Investors and Venture Capitalists (and those on Shark Tank :) This is totally Absurd!!! Investors should not give up Board control until they have no choice. These investors are wonderful in good times, and absolutely SHARKS in bad times. trust me…
- DO keep more insiders than outsiders on the Board at all costs
- DO add investors to the Board when required, and be sure they have solid industry, market, and company knowledge
- DO find outsiders who you TRUST with your company
- DO add outsiders to your Advisory Board, who are advisers, but don’t have the power to make
- DON’T put outsiders on your board who have little or no industry and market experience
- DON’T give up Board control when you still have stock ownership control
- DON’T put friends on your Board unless they have solid business experience, and you trust them
- DON’T sign too many Veto powers — remember, they don’t say VETO on the investing document. They say, “the investors have to approve the following things:” and they all sound innocuous until …