Note: This article is the first in an ongoing series on Board Directors. To learn more about their roles and responsibilities, download this free eBook today Director's Guidebook: How to be an Effective Board Director in Early Stage Companies or purchase our books at Amazon.com.
How can a small group of people, who get together 4 to 12 times a year, have such a big impact on the future success of an early stage company? Ham and I will consider this series of articles a great success if we answer this question in a way that helps you build great boards for the companies you are involved with. We believe we can convince you of the incredible value a board delivers for a startup company, so let’s get started.
A few years ago, as Managing Directors of Launchpad Venture Group, Ham and I worked with a small group of our investors to study the results from all of our successful and failed investments. After reviewing a few dozen exits, a number of key driving factors continually reappeared. Most of the factors related to issues around market timing, customer demand, and quality of the management team. But they were not the the most objective, the strongest or the most consistent. One factor correlated more strongly with exit success than any other - whether we had a seat on a strong and value-added board.
So what, specifically, did we learn during our research? No big surprise here… having an engaged director take a seat on a well-designed and active board resulted in the strongest correlation to a successful exit. By no means does a board seat guarantee success, but our data revealed that it does markedly improve the odds of success. And when you are making high risk investments, you want to do everything in your power to reduce risk!
This article will focus on the key ingredients you need to build a strong board. Ham has spent close to 20 years on a wide variety of early stage company boards. I’ve heard many stories from him over the years (fear not, he never divulges company confidences.) One thing I can tell you for certain is he really enjoys board meetings when there is a strong board. Even after spending 3 to 4 hours in a small conference room, he comes out energized by the discussion. The contrast with weak boards is marked - frustrating, soul-sucking, time-wasting meetings are the norm in those situations. I can’t tell you the number of times he has emphasized to me that he is always looking to create a great board, because bad boards lead to bad outcomes.
Q: Ham, if you could build a model board for an early stage company, what would it look like?
Whether you are talking about a board for an early stage startup or a large public company, there are three key attributes that I look for when building a model board:
Diverse - Great boards are comprised of individuals with diverse talents, backgrounds, instincts and expertise.
Relevant - Diverse backgrounds and experiences are only useful to the company if they are relevant to where the company is going.
Aligned - Great boards are focused on a common long term goal and ensure that senior management buys into that future.
Q: Let’s start with the word “diverse”. Will you explain what skills you expect to find in a diverse early stage company board?
For an early stage company, a diverse board should have several of the following key skill sets:
Market Expert - This director understands the target market and has a great network of potential customers and partners to connect the company to.
Financial Expert - This director understands how finances work with early stage companies. They are well connected to sources of future funding and provide important oversight on the company’s financial plan.
Mentor / Advisor - This director is most likely a former CEO who successfully guided a company from the early stage through the growth stage. This skill helps the CEO navigate the minefields that all CEOs face.
Exits Expert - Ultimately, all successful startups must exit at some point, whether by IPO or M&A. This director understands that exits don’t just happen. They need long term planning and constant oversight from the board.
The Missing Piece - I use this descriptive term to highlight a potential missing skill set on a board. You want to make sure you have all major departments in a company covered. So, for example, the board of a software company would ideally have members with experience in each of the following areas: Product Development, Sales, Marketing, Customer Success and Finance.
Q: How do “relevant” and “aligned” relate to a highly functioning board?
Relevant is pretty easy to understand. If your startup company is selling software to large companies, you want board members who’ve either sold or purchased software for corporate purposes. If you are dealing with a medical device company, you want board members with regulatory, reimbursement and healthcare experience. So relevance is as simple as making sure your board has significant experience with the landscape of your target market.
Aligned is a bit more complex to describe. At a high level, think of it this way. Building a successful company is hard enough without having the board and management pulling in opposite directions on fundamental topics. You want to make sure management and the rest of the board are in sync with the short and long term business plan, as well as the key milestones along the way. And, make sure you revisit the plan at least annually. That’s a very quick summary. For more on alignment, we dig in at a deeper level here - In the Foxhole: The Importance of Board Relationships.
Q: What process do you recommend to ensure you have a board that is Diverse, Relevant and Aligned?
When you are considering whom to appoint to your board, think about any gaps you might have on your board. An approach that I’ve seen work on a number of boards is the following: put together a spreadsheet with each of the key skills you need in the first column. By skills, I mean areas such as market expertise, finance expertise, fundraising, exit planning, etc. This list should contain somewhere between 6 and 10 skills. Across the top row of the spreadsheet list all of your current board members. Finally, whenever a board member has a particular skill listed in the right column, mark an “X” in that cell. See Seraf Toolbox: Recruiting Guide for Early Stage Company Boards for a sample spreadsheet.
In short order, you will see the areas where you need additional talent on your board. Understanding the board’s shortcomings will help define the key skills you are looking for in new board members. For more on recruiting a new director, check out Chemistry Experiment: Recruiting A New Director.
Ultimately, this self evaluation of the board’s skills is the first step to build a high performing board. But remember, when you start this process, make sure you focus on both current and future needs of the board. For example, selling your company might not happen for many years, but having a board member with exit experience can be very helpful years in advance of the actual exit. Similarly, sales management is not critical on day one when a company is seeking product market fit, but once a repeatable sales model comes into focus, sales leadership will quickly become essential.
Q: Both of us have been on boards that did not perform well. Give us some examples of situations that cause boards to struggle and negatively impact a company?
There are a hundred different ways to mess up a board, but I will try to keep my answer to this question relatively brief. There are four examples that I see on a fairly regular basis, so I will lead with them:
Too Many Investors / Limited Market Expertise: I am a board observer for a company with six different investor groups represented by either a board member or a board observer. Here’s what the board looks like:
3 board members who are partners at 3 different VC firms, each at different fund stages
1 board member from a Corporate VC
1 board member who is the company CEO
1 board observer from a quasi-government backed VC fund
1 board observer from an Angel Group
I will say all of the investors are very smart and capable individuals. But, if you run through the exercise of determining if the board is Diverse, Relevant and Aligned, the results won’t be what you want in a great board. Alignment is one of the biggest failings here. Also, you will notice that this board doesn’t have any independent directors. It’s very rare for a board that’s full of investors to have the diversity you need to cover all the important skills for operating a board.
Like-Minded and Like-Qualified Directors: In this situation, you frequently find a board that is composed of individuals who worked with the CEO at a past company. The board is cohesive because they know each other well. But, they don’t have a broad enough base of experience and they think too much alike. When things go wrong at a company (and they will!), it’s important to have a diversity of experience to help guide the company through tough times. In times of trouble and uncertainty, the value of a different perspective from out in left field cannot be overstated. And, it’s important to have board members who will do the tough work and hold the CEO and her management team accountable.
Too Many Management Team Members: Oftentimes, a startup company with multiple co-founders will want all the co-founders on the board. It’s not surprising to see this happen, because the CEO wants her co-founders to have a big say in the company’s future. Also, by stacking the board with co-founders, the CEO hopes to ensure that she will get her way on all important decisions. There are multiple reasons why this board situation is sub-optimal and working through it is often the first real leadership test a young CEO faces.
The problems with this approach are two-fold. First, you are probably not getting the diversity you need on a board. Second, if one of the co-founders isn’t doing a good job or his/her functional area is holding the company back, it’s impossible to have that discussion during a board meeting. Ultimately, I believe the best board structure has only one management team member on the board, the CEO.
Friends and Family of the CEO: This is one of the most uncomfortable situations to be in. Typically a friend or family member will have a close allegiance to the CEO. A board member’s duty is to the company first, not the CEO! Family, marital or personal relationships, in most situations, cause board members to break this rule - companies come and go, but families, marriages and special friendships are for lifetimes. Think twice before you invest in any company with this type of board dynamic. I’ve witnessed these types of boards a number of times during my investing career. They are textbook examples of dysfunction in action. In every case I was underwhelmed by the end results of these companies.
Q: What is the optimal size of a board for an early stage company?
As you might imagine from reading the skills observations above, there is an inherent trade-off involved in this calculus. More people means more skills. But it also means longer, more cumbersome meetings, more difficulty scheduling, more politics, and the potential for more interpersonal conflicts.
My personal recommendation for early stage companies is to have a board with five individuals. There are times, especially in the earliest days, when three is sufficient. To make it clearer, let’s break it down into the different components of the board, and I will explain why I recommend five. Here’s a typical structure for an early stage board:
1 or 2 from the Management Team: CEO and a co-founder
1 or 2 Investor(s)
1 or 2 Independent Director(s)
As mentioned above, I prefer to have only the CEO on the board. But there is a stage, such as immediately after a small seed round of investment, where the management team can very appropriately have two board seats.
If you have a three person board, you should structure it with the CEO, one investor and one independent director. At five people, how you ultimately divvy up board seats will depend on many factors. Net/net, you want to make sure you have at least one from each category.
When I sit on a board, I like to have five board members for two key reasons. First, I know there will be at least one board member, who is not part of the management team, to discuss important challenges faced by the company. Second, the management team can’t be on either the corporate Audit Committee or the Compensation Committee. Asking one director to take on both of these responsibilities is a bit much.
Q: Should a board seat ever be for sale?
From a theoretical perspective, no. But in real life, it’s a complicated question. When a company raises a new round of financing, it’s typical for the new lead investor to ask for a board seat. After a few rounds of investing, you can end up with a board that is very investor-heavy (just look at the example I gave earlier in this article).
So, to a certain degree, board seats are for sale. But this is not necessarily the end of the world when you consider that, with investment, comes alignment with other shareholders and with the long-term success of the company. So major investors joining boards is not an issue, per se, but with the wrong types of individuals it can be a problem. And there is an important caveat. The lead investor should have a right to a board seat, but the board shouldn’t automatically expand by adding a director for every new investor. And if there is a strong case for adding more than one investor director in connection with a financing, you need to look at whether any of the current investor directors from earlier rounds should leave the board to accommodate the new blood.
A subtext to the original question relates to an issue that comes up during early stage angel investments. If I write the biggest check out of all the angel investors, do I deserve the board seat? Although not every round is as disciplined as it should be, or organized around a strong and value-added lead investor, we would clearly say the answer to that is “no.” At Launchpad, our best practice is to focus exclusively on merit and fit rather than check size. We work with the company founders to make sure there is a personality and skills match between the angel director and the rest of the board and that we are putting the best person into the job. Telling the biggest check writer that he doesn’t get the board seat can be a difficult conversation. But if you use some of the recommendations for building a great board to help support your case for the person who is ultimately selected to serve on the board, it can make it feel more objective and less personal.
Q: When should someone leave the board?
Early stage companies are very dynamic entities. One day they are trying to find their first customer, the next day they are growing rapidly and expanding sales overseas. When a company goes through rapid change, they outgrow both their founders and their early directors pretty quickly. To keep a company fit for the task at hand, you regularly have to evaluate both the management team and the board to make sure you have the right skills for the stage of the company. So, if you are you trying to find product-market fit, you might need one set of skills on the board. And if you are you trying to scale the business from $10M in revenue to $100M, you might need another set of skills.
Although I rarely see highly formalized annual board evaluations performed on early stage companies, there comes a time when you will need to undertake just such an evaluation. As a board, it can be very valuable to do a quick self assessment led by the CEO and board chair / lead director. It doesn’t have to take a lot of time (see Seraf Toolbox: Evaluating Board Performance - A Guide for Early Stage Companies). If you are missing key skills on your board, it will become obvious after this evaluation. And, if a current board member isn’t adding enough value to justify his seat, it’s time to ask that director to step down. This is NOT an easy conversation to have. The board chair / lead director will need to work closely with the CEO on this challenging duty.
Q: Any other advice or summary to add?
One thing I have not mentioned is that it is important to make sure all board seats get filled. Given the importance of skills, it can be tempting to shop around forever for that perfect independent. And some independents will hem and haw to drag it out and see how the company does before taking any reputational risk and getting involved.
But that tendency to drift into delay should be resisted with all your might because it will inevitably lead to crisis. During the honeymoon period it is easy to imagine that adding that person will be quick and painless. So you defer making that important decision and drift along with 4 directors until the company inevitably comes to a roadblock. At that point the board disagrees and splits down the middle. Ironically, the underlying issue might have been avoided in the first place with more skills on the board, but it’s too late now. You are stuck with critical decisions that need to be made and the board is deadlocked in a tie. Trying to agree on a 5th director in that situation, as the platform you are standing on burns, can be nearly impossible, and the deadlock can lead to the ultimate destruction of the company. Moral of the story: fill all board seats without delay!
3 Best Practices for Early Stage Boards
So, to summarize, here are three best practices that I think all boards should follow:
Think about the board in terms of skills. Draw a map and make sure you have the key skills covered. Make sure you fill all board seats. Having another pair of hands to guide a company to success is very helpful.
An annual board assessment can be quite valuable in your quest to build a great board.
You should have high expectations for you board, just like you do for the management team.
Want to learn more about the roles and responsibilities of Directors? Download this free eBook today Director's Guidebook: How to be an Effective Board Director in Early Stage Companies or purchase our books at Amazon.com.