When should a Board of Directors be formed?
Board of Directors
In the section entitled Incorporation Options, it was established that the C Corp is the form of incorporation favored by professional investors. As such, C Corp regulations require the formation of a Board of Directors simultaneous with incorporation, but place no limitation on the number of Directors (i.e., one Director meets legal sufficiency). The Board’s role is to ensure that the company is running in the best interests of its shareholders. Prior to external investment the founder(s) might be the only shareholders, so it would be appropriate for these individuals, or a subset of them, to constitute the initial Board. Most states also require a corporation to have a minimum of two Officers (typically a President and a Secretary), but Directors can also fill these roles.
When, and under what circumstances should the Board be expanded?
Although recommendations to founders regarding Board expansion are all over the map …
Many experienced advisors suggest you keep it simple for as long as possible − don’t give up Board seats too easily!
The recommendation above relates mostly to the period from incorporation through friends & family fundraising, prior to seeking capital from professional investors. Some advisors will actually encourage founders to seek a highly-qualified outside Director, such as an ex-CEO from your industry domain (who would also make some level of investment) to help you raise the Angel or Series A round of financing.
Whether or not such expansion has occurred, in a pre-seed financing round prospective angel investors will often seek a Board seat.
The decision to accept such a request (demand?) should be based on several criteria:
- Most importantly, how badly do you need the proposed investment?
- Does the proposed Director have the requisite industry background and experience to assist the company moving forward?
- Does he/she represent a group of angels making a significant collective investment?
- Would the addition of the Director bring the Board to an undesired (even) number of Directors?
The answers to the above questions may lead you to grant acceptance and bring on the new Board member. However, if a compromise is required, an angel may accept Board Observation privileges, since they are quite aware that their membership could be short-lived anyway (end with the next round of financing). You should actually be open to offering such observation privileges to several smaller investors along the way.
At the completion of the Series A round of financing...
Venture investors most often want to have a five-person BOD, comprised of up to two founders, two VC investors, and one independent member who is acceptable to all.
The odd-numbered Board avoids voting ties. A great outcome for founders would be the VC acceptance of your originally-selected, outside Director to remain as the independent member.
What is the role of the BOD, and at what level are they involved in running the company?
Typical duties of the BOD include:
- Governing the organization and establishing broad policies and objectives
- Selecting, appointing, supporting and reviewing the performance of the chief executive (CEO)
- Ensuring the availability of adequate financial resources
- Approving annual budgets
- Accounting to the shareholders for the organization’s performance
- Setting the salaries and compensation of company management
Typically the board chooses one of its members to be chairman, who is responsible for setting the agenda for its meetings and either runs the meetings or appoints another, usually the CEO, to run the meetings.
The BOD may create committees composed of a subset of the Directors.
Typical committees include the Executive Committee, which assists the CEO with urgent matters not requiring approvals of the entire board; the Audit Committee, which oversees and resolves financial information between the company and its outside accounting firm; and the Compensation Committee, which sets the salary and other compensation of the company’s senior management team.
Key matters that require BOD approval include:
- The annual strategic and operating plan with budgets
- Selection of company senior executives, including the CEO
- Major purchases and leases requiring capital
- Equity financing and acquisition plans
- Appointment of accountants, attorneys, insurance agents, etc.
- Loans to officers or employees
- Contracts and retainers over a specified amount
- Company investments
BOD meetings occur as often as monthly, but typically quarterly. Sometimes an “emergency” board meeting is called by the chairman for matters that must be addressed before the next scheduled board meeting.
For more detailed guidance on the conduct of BOD meetings once professional investors and Directors join your Board, visit Post-Funding.
NOTE: The BOD has a fiduciary responsibility to its shareholders, and can be sued by the shareholders if Board decisions are not made in the shareholders’ best interests.
What is the role of a Board of Advisors, and when should it be formed?
Unlike a BOD, members of the BOA have absolutely no fiduciary responsibility to the company and are there solely to advise the company on technical or business matters...
While a BOD is required to be in place from the start of your company, you can slowly develop your BOA, possibly starting out with just one or two advisors and not even refer to it as a board.
Board of Advisors
The purpose of the Board of Advisors (BOA) is to complement the company’s senior management team with industry experts, who are sought for their in-depth domain knowledge. You can think of them as a team of “coaches” that draw on their vast knowledge in a particular domain to help the company. These individuals are too expensive or otherwise unavailable to become employees of the company, or perhaps they simply aren’t needed on a full-time basis.
It is common to have someone with a very deep and relevant product background, someone with deep marketing experience, and a very strong technologist on the BOA. If there is a weakness in the current senior management (e.g., an inexperienced CFO), one can fill in this weakness with an appropriate person on the BOA.
Oftentimes, companies will retain a known or “marquee” name in the industry, such as a well-known scientist or physician, to be on its BOA to add credibility to the company. This is encouraged, especially if this person actually contributes his/her expertise for the benefit of the company.
Experience in working with such individuals over a period of time sometimes leads to an invitation to join the BOD as an outside Director.
How are Directors and Advisors typically compensated?
Board compensation varies but, in general, startups don’t have the cash to pay Directors or Advisors. Instead, independent Board members and Advisors are compensated with equity incentives, primarily stock options. Directors who are company employees, or who represent Angel or VC investors in the company, will not typically be compensated for their service on the BOD.
You will want to avoid as much as possible having individual negotiations with each prospective addition to your Board(s). Some experienced advisors suggest the development of a table that defines a range of stock options that would be associated with an individuals’ “celebrity” class, as well as their expected level of engagement. It should also take into consideration the stage of company development — lower % of stock allocation as the company matures.
As an overview, the average range of stock options that are suggested (by various professional bloggers in this space) as appropriate for early-stage startups to offer BOA and BOD members, is from .5% to 1.5% of the fully-diluted share base.
To review an excellent source of detailed guidance on this subject, visit this particular blog contribution published by a group of Silicon Valley attorneys and tech entrepreneurs representing Startupsmack.com.