Note: This article is part of 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.
Many years ago, during the early days of my entrepreneurial career, I walked by the main conference room in our office. Seated around a big, oblong table was a group of serious looking people engaged in a heated debate with my CEO. It was the first time I had seen him on the defensive. I couldn’t understand why such a confident, forceful individual would look like a deer caught in the headlights.
Later that day, I ran into the CEO and asked him what that meeting was all about. He told me it was a board meeting, and went on to say he had to report some difficult news. I knew we were struggling to get our second product released, and the CEO had to describe another schedule slip. Needless to say, the board wasn’t pleased and pressed him on how he was going to fix the situation before the company ran out of funds.
Being relatively young and naive, I asked a simple question. “Why do we have a board?” One of my CEO’s greatest gifts to me was a willingness to answer any question I had, no matter how simple or how complex. He was a great mentor to me in my early career. He asked me to join him in his office. We chatted for over an hour about the role of a board, how often he meets with them, and some basic mechanics behind the operations of a board. It was an eye opening conversation for me, and was the first of many discussions we had about our company’s board.
Christopher learned all about board theory during his years as a corporate and securities lawyer and put that learning to work as the general counsel, and later, the CFO of IONA Technologies. Over 14 years he watched that board change from the pre-IPO revenue stage of a couple million dollars a year to a public global company with hundreds of millions of dollars in annual revenue. Since leaving the enterprise world he has also served on or chaired many startup and non-profit boards. Given his experience, including a decade of responsibility for the organizational aspects of operating a board, let’s ask him a few key questions to help understand some important board basics.
Q: Christopher, let’s start with a variation on the question I asked my CEO many years ago. What is the main role of the board?
The management team works for the board and the board works for the shareholders. As we have outlined, in addition to overarching fiduciary duties like the duty of loyalty, the duty of care and the duty of good faith, boards are responsible for five primary things:
Policy setting and enforcement
Evaluation (and replacement) of the CEO
Determining the adequacy of financial resources
Approving annual budgets
Making account to stakeholders for company performance
What this really boils down to is that a board’s job is: firing the CEO if he/she is not going to be able to drive the company adequately, making sure the company does not run out of money, and delivering good returns for shareholders (i.e. with start-ups, driving a good exit which will deliver liquidity for investors).
Q: What should the annual board calendar look like for an early stage company?
We’ve long taken the position that startup boards should meet relatively frequently, and that a healthy number of those meetings should be in person. You are trying to balance good oversight and timely involvement against creating too much work for the CEO.
What we recommend in practice is one in-person board meeting every financial quarter, and one meeting by video conference in between, for a total of 8 meetings a year.
We specifically recommend video for the virtual meetings because video requires more attention and engagement than a phone call. We have all been on conference calls where in the background you can hear the keyboard clack or the store checkout person say “paper or plastic?” Meetings where everyone is tuned out are worse than nothing - they waste precious time that could be spent productively. Video requires sitting at a desk and being mentally present.
While 8 meetings a year is usually plenty, companies going through very difficult periods might consider adding interim check-in video or telephone calls or even adopting a monthly board meeting schedule for a short period of time. These should be thought of as temporary measures, but with board meetings, as a general matter, more is not always better. If board meetings are too frequent, fatigue and repetition can set in. People stop preparing and the meetings become too informal. 8 meetings is the perfect balance of formality and frequency.
Q: Public companies typically have a number of board committees such as Audit, Compensation and Governance. For an early stage company are these committees necessary?
Not at the earliest stages, but they quickly become a good and necessary practice. The two most important committees are audit and compensation, and an independent director should chair each one. As soon as a company has some revenue growth and is starting to hire regularly, it should establish these committees. For a company that is merely burning equity and still finishing the product and trying to find product market fit, these committees can be too much. But, once a company starts to achieve steady revenue, it is time to observe the discipline.
The audit committee is important because of the above-mentioned director duties around adequacy of financial resources and approval of annual budgets. But that is not the only value an audit committee provides. Having an audit committee ensures that there are some people on the board who are getting down into the details of the financials and not just taking management’s word for it.
Additionally, an audit committee’s job is to set the policy around review of financials. In the earliest days when there are expenditures but no revenue, this may be nothing more than an agreed-upon set of procedures. However, as companies grow their revenue and approach the point of an exit, they want to regularly ramp up the level of financial controls and the formality and thoroughness of the annual financial review, ultimately culminating in a full financial audit.
An audit committee also ensures the company has basic financial and non-financial controls in place. Having the financial person (whether internal or external) interface with the board ensures there is some discussion of key accounting practices and controls as well as a formal review of the numbers. For example, it ensures that there is a basic revenue recognition policy which requires an appropriate level of documentation prior to putting revenue on the books. For more detail on audits you can also see our ultimate guide to audits.
A compensation committee is important because it serves to remind everyone of and bind everyone to two important principles:
The board has a responsibility to spend the shareholders’ money wisely, and
Pay should be tied to performance and to market norms.
Without a compensation committee, management can get off track with a series of ad hoc compensation decisions. This can introduce the possibility of unfairness or discrimination, drift away from market norms, and routine raises that are not tied to performance.
A good practice is to put in place a requirement that the compensation committee approve all incoming salaries, all raises, and all equity grants. Depending on preference, you can set it up so the compensation committee either makes final decisions themselves, or makes recommendations to be approved by the board. The latter approach is generally better because it keeps everyone in the loop and it avoids the risk of a breach of by-laws, stock purchase or investor rights agreements, or charter provisions requiring full board approval of key decisions.
The final of the “big three” most common committees is the Nominating and Corporate Governance committee. These N&CG committees can be very valuable, which is why they are extremely common amongst larger companies, but they are generally overkill in the early days of a start up with its 5 member board.
Q: Over the years, about half the boards I was on had a Lead Director. What is the role of the Lead Director?
If good meetings are the board’s “product,” think of the Lead Director as the head of quality control for that product. Getting board meetings right is difficult. Good board meetings need to be efficiently focused, results oriented, actionable with assignments and accountability, and start and end on time.
These things don’t happen on their own. Without a lead director to serve in the role of a quasi-board chair it is all too easy for board meetings to become tactical, (i.e. getting into the weeds of company operations), tolerant of distraction (i.e. with people multi-tasking, emailing and texting), or sloppy (i.e. late, disorganized, poorly attended, rudderless).
If you are a lead director working with a new CEO, you will need to help guide the CEO in setting the right tone for board meetings. This is a very important coaching role. A new CEO will not have relevant experience in dealing with a board, raising additional capital, or scaling a company. Rather than allow the CEO to “curdle the milk” by floundering in front of the board, a lead director can help mentor the CEO and be a sounding board for strategic issues. Key areas will include:
Structuring Meetings - It can take time to achieve a well structured board meeting. You need to help facilitate this goal by communicating with everyone on the board.
Building Agendas - Make sure you have the right topics, right materials, right board book.
Lead directors will also take care of the following board functions:
Running the executive session at the end of the board meeting.
Making a follow-up call to the CEO to review the executive session and verify consensus on near term action items and strategic topics from the board meeting.
Discussing potential topics/agenda for the next board meeting.
Driving the process, whether formal or informal, of an annual review of the CEO.
Q: The Lead Director sounds a lot like a Board Chair. When might you choose to call the person in this role the Board or Executive Chair?
There are no hard and fast rules here, but it correlates somewhat to stage. Let’s take it from earliest to latest.
For a very young company with a very inexperienced CEO and a smaller board, the person in charge of the board might be called an Executive Chair, implying that he or she is acting in a somewhat executive capacity, working closely with the CEO to mentor and help guide the more important daily decisions. This is a very important coaching role that will encompass everything from business experience, to dealing with boards, to personal growth and effectiveness. Think of this as something between a very close mentor and a sounding board for key decisions. An Executive Chair will commonly spend at least one, if not two or three days a week in the company’s offices.
Next in line, for companies with a slightly more experienced CEO, would be the lead director who helps run the board and helps the CEO give structure to the board’s processes. As noted in the question above, this role encompasses some mentoring, particularly around the interface between the CEO and the board. A good lead director will help the CEO present well to the board and get value out of the board.
And finally, for a more mature company with an experienced CEO and a larger board, you will typically see a board formally elect a Board Chair. This director is responsible for setting agendas, running meetings, evaluating directors and committee chairs, and interfacing with the CEO around things like executive sessions and annual performance.
Q: Over the years a significant majority of the boards I was on had at least one board observer. What is the role of a board observer?
Board observers are typically in the room, not for the benefit of the company, but for the benefit of the investor entity reserving the right to appoint them. They generally don’t help out or contribute to discussions - their main role is to serve as the eyes and ears of a major investor and to gather information and stay on top of emerging issues.
As such, the role should be described primarily as a “silent observer” at board meetings. An observer should not direct or control board meetings. The observer does not have voting rights and does not have any fiduciary duty. However, the observer does have a strict duty of confidentiality and must not disclose confidential board information except to others with a similar duty.
There are multiple ways in which an observer can add value. When paired with a director from the same investing entity, they can serve as an understudy for the director, ensuring smooth continuity in the case the director can no longer serve. They can be asked to perform tasks for the company or the board, such as gathering data, doing analysis, helping with fund-raising or making introductions on behalf of the company. And in cases where trust has been built up over time, observers may be called upon to contribute their experience or opinions to a board discussion.
Board observers are not free to roam and interfere, however. An observer’s communications outside of board meetings should be limited to non-management directors. Observers should not contact members of senior management directly without board authorization, nor should they represent the company to investors or prospective investors without being specifically authorized to do so and based upon pre-agreed scripting.
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.