Startup Board of Directors Composition

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!

Board Composition

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.

VETO Powers

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…

Conclusions:

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…

DOs

• 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’Ts

• 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 …

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Forming an Advisory Board – and What to Expect

By Mark Juliano

Many companies form Advisory Boards as part of their overall corporate structure. Advisory boards are DIFFERENT from the Board of Directors, which have control and power in the form of voting, regular contact, full company financial disclosure and generally equity ownership. Advisory boards CAN be extremely effective for company executives if they communicate with them frequently, and respect and heed their advice.

An Advisory Board is generally made up of people who can offer unique advice on a number of areas of expertise for the company such as: marketing, sales, customers, legal, financial, etc. These are people who the founders and executives trust to give good, unbiased advice to the company. As such, they should be experienced members of the industry with significant experience in similar companies, products, industries and disciplines.

Personally, I have served on Advisory Boards to a half dozen companies over the years. My expertise is broad, having been a founder (or CEO/senior executive) of ten organizations, as well as taught entrepreneurship and business planning at the University level (both graduate and undergraduate).

Advisory Board Compensation

The basic rule of thumb is that Advisory Board members should be compensated in some way. These are generally very busy people, whose advice and counsel is sought by many companies and individuals, in addition to their regular vocations. While some advisers will give great advice and spend considerable time with company management — ask yourself which company you’d help if you were an adviser to 6 companies, and 2 were compensating you …

Generally minimal equity (1-3%) is fair (or possibly a small percent of revenues or profits), and/or a small amount of cash (less than $10,000 per year) plus reimbursement of any direct expenses. Remember that hiring a consultant can easily cost $100 – $500 per HOUR, and Advisory board members tend to always have the company’s best interests in mind — not that consultants don’t, but they are more arms-length advisers.

In some cases, Advisory Board members WON’T or CAN’T take compensation — such as if they are a customer, members of the government, etc. Separately — be VERY WARY of potential board members seeking a high level of compensation without any firm commitment of time.

What to Expect from Advisory Board Members

DO expect:

• Regular consultation
• Them to return your phone calls and emails promptly
• Unbiased advice and help
• Focus on their specific area of expertise
• Contacts in the industry, customer base, etc. (i.e. their Rolodex)

DON’T expect:

• Them to do your job for you or run your company
• Them to come to regular meetings and travel extensively. In fact, most times advisory board members meet with company executives separately (or via telephone) versus the board of directors which tends to have a regular meeting schedule.
• Them to be as involved as Board of Directors who generally have a large equity stake, voting rights and a vested interest in the success of the company.

What Makes a Great Advisory Board Member?

Any adviser or consultant should remember ONE most important thing — they are being asked for their ADVICE but NOT decision making. If any adviser (or consultant) finds themselves playing corporate politics, or trying to make decisions against the existing corporate executives — personally I believe these are NOT good advisers. Using the excuse, “well I’m only looking out for the company,” is often untrue — when they are actually trying to improperly assert themselves into the company decision-making structure.

Where to Find Advisory Board Members?

• Experienced, semi-retired, and retired executives
• University professors
• Customer base (yes, they are interested and do have a vested interest in the company)
• Legal community
• Business associates (and friends who have business expertise)

CONCLUSION:

An Advisory Board can be an extremely valuable part of any company’s structure and decision making process. Members can, and should, have solid expertise and experience in the company’s industry and/or a specific business focus (such as sales, marketing, strategy, planning, finance, etc.). As with any advisers and board members, the CEO and senior executives must manage these people, and be sure to give them praise and appreciation. After all, Advisory Board members are people too and in particular are generally giving much more advice than the compensation they are receiving.

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