The Imperfect Board

Big Red Car here. So The Boss is back in Steamboat for some skiing. It is cold and snowy in the ‘Boat which is apparently why The Boss goes there in the first place. Me and the housekeeper, well, we don’t like cold. We like top down Texas weather.

We just have to make it to Monday when it’s going to be 75F again. Please, God, move the sun faster, please.

Recently there were a couple of excellent discussions in regard to the creation of the “perfect board.” Of course, no such thing exists — not a criticism — as boards are a combination of folks undertaking a mission with more than a little of either real or imagined conflict.

Conflict — and its resolution — is why boards exist in the first place. Here are a couple of blog posts and discussion on the notions of the perfect board.

The Perfect Board

 Board Members

 Shareholders elect boards to retain management and then to oversee that management in accordance with plans created by that same management to advance the company which is owned by the shareholders who elected the board members in the first place.

Take a second and re-read that sentence. That is the foundation for the balance of this discussion. Bit confusing, no? It gets worse.

Board responsibilities

Do a little research as to what the State of Delaware requires of a board member and you will never agree to serve on the board of your daughter’s lemonade stand. It is a frightening set of duties and it is the essential responsibility for guiding the corporation.

Delaware is picked as it has a very highly evolved body of law pertaining to corporations and their care and feeding. Most public companies are chartered in Delaware for exactly that reason.

Management

The board is elected by the shareholders, They are not “appointed”, they are elected, a very important fact upon which to focus.

The board retains the management of the corporation hopefully subject to a written Employment Agreement which spells out every aspect of the relationship. It is malpractice not to have a written Employment Agreement and CEOs should demand a written agreement.

The complexity

Reality is a heartless handmaiden and just when you’ve got everything orderly and figured out in your mind, reality will raise its ugly head and complicate things.

Managers retained by the board — founders, CEOs, entrepreneurs — often are owners of considerable amounts of stock in their company. Thus, they are often a goodly portion of the shareholders electing the board members as well as board members themselves. They are also employees often subject to a lucrative arrangement — the Employment Agreement.

The totality of this arrangement creates a meaningful conflict.

Board members are often investors who have been promised a nomination to the board as an inducement to make their original investment. Board members must represent the interests of ALL shareholders not just their own shares. In this manner, they may be responsible to the founder/CEO/entrepreneur shares as well as other shareholders who preceded their investment.

The totality of this arrangement creates a meaningful conflict.

I would also say that the failure to represent the interest of ALL shareholders — required as a fundamental element of the fiduciary duty of a board member articulated very clearly in Delaware laws and its Chancery Court — is perhaps the greatest intellectual blind spot of investors who are board members.

What is a CEO to do?

Much of the discussion on the subject is lead by investors, typically venture capital investors. Understandably this discussion is colored with their interests paramount to all other interests. What they think is “perfect” may not be so perfect for a CEO.

The balance of this discussion is focused on the interest of the CEOs, founders, entrepreneurs and while there are many different legitimate roles at play here the conflicts between and among them are real and are the reasons why boards exist in the first place.

Bottom line — the CEO, founder, entrepreneur has to protect her interest at the board table as it is different than anyone else’s interest.

Rules of the road for a CEO?

Remember that board members are elected and that your agreement to take someone’s money may be predicated on nominating their hand picked individual to your board. Most times, it is the VC himself. Nothing unusual about that. This will also require you to vote in accordance with that nomination for some period of time.

1. Never give up control of your company. Never. Ever. Well, OK, unless YOU decide to and may have to. But given normal events never, ever give up control.

2. Use your control — shares and shareholding — to influence the makeup of the board, your board.

3. Never give an investor a disproportionate degree of control — they own 20% of the shares, they get 20% of the board seats. Don’t get talked into some “ideal” or “perfect” structure that gives a 20% investor two seats on a five person board. That’s 40% of the board seats for an investor who owns 20% of the stock. Should the discussion get started down that path simply ask: “Why?”

4. Make an arrangement amongst groups of founders that only a single person — typically the CEO — is going to sit on the board. This is just housekeeping. Create a voting trust if you must amongst the founders saying their representative will seek their counsel and agreement on certain high level decisions.

Voting trusts are a good thing and should be used more often.

5. If the founders own sixty percent of the shares, then they should control the nomination of sixty percent of the board seats — same argument and arrangement as pertains to the investors. Goose. Gander.

6. Be very careful on the nomination of “independent” directors. Independent of what? Typically that answer is independent of management but they should also be independent of any group of investors also.

7. When investors act in concert in a public company they are required to file a SEC Form 13D announcing their intentions. When such a filing is made important considerations may be triggered such as “change of control” provisions when a group consisting of more than fifty percent of the shares begins to act in concert.

This is equally important in a startup and something which should find its way into either the ByLaws or a Shareholder Agreement and an Employment Agreement. [The SEC requirement does not apply to a venture funded startup, of course, but it is an example of something so important it should be noted and memorialized as discussed even in a startup environment]

8. Do not be swayed by the notion that nominating people you know is some kind of an abridgment of some mythical test of independence. It is not. The definition of independence does not require you to nominate strangers to your board. Resist the temptation to nominate “professional board members.”

9. CEOs, et al, will often be challenged that they are nominating friends. This is a strawman argument. Who are you going to nominate? People who are total strangers? No, for the seats you control, nominate people you know, trust and with whom you can work.

10. Do not nominate persons whose only qualification is “expertise” which will be useful to you. Hire talent but put wisdom on your board. If you put a “marketing” guy on your board and then don’t agree with his marketing notions, you have now set the bit of sand that will become the pearl which will be your firing.

Hire expertise. Consult with experts. Retain subject specific advisers. Do not put them on your board. [Again, remember this is intended for CEOs.]

11. Do not put college professors, economists, lawyers and accountants on your board. Do not put friends, relatives, college classmates or clones of investors on your board. Beware all suggestions coming from a VC who says: “I served with Rapunzel on another board.” That is a vote one day to fire you.

12. I have seen it quoted that more than 75% of all CEOs are replaced in VC funded startups, Who do you think is doing the firing? The board? Deal with board structure and nominations as if your job depended upon it — it does.

13. As to numbers — three or five is fine. Seven is too many.

14. As to organization, create compensation, audit, nominations committees and no more initially. Get your people on those committees and have the committee represent the makeup of the board. Have all committee recommendations be by vote and be recommendations to the entire board to be ratified by the board. In this manner if something goes awry at the committee level, it can be righted by the entire board.

 CEOs — your board will fire you one day. Plan for that day right now or, better yet, before you even create the first board. Take a careful review of your ByLaws and any other agreements — such as a shareholder agreement — which may impact board organization and conduct.

This is very important and it is essential that you think it through initially from your unique perspective. Let everyone else look after their own interests. Trust me, they will.

In business you don’t get what your deserve, you get what you negotiate. Negotiate wisely.

If you need some advice, contact The Boss at jminch2011@gmail.com or 512-656-1383. He was a CEO for a third of a century. He can help you.

But, hey, what the Hell do I really know anyway? I’m just a Big Red Car.