The Startup Guide To Creating A Board Of Directors

Published on:

Internal governance is the bedrock of any company, and governance begins with the Board of Directors. In many cases, startups do not give full attention to creating a board until the first financing round when the angel or first investor demand a board seat, possibly for a colossal equity stake. Founders usually forge ahead with product development and go-to-market. However, startups need to detail a strong foundation for organizational continuity.

It is necessary to initially list up to three board members when incorporating a company, which usually comprises the founders and co-founders. However, to actually develop the Board of Directors takes work. The board needs to set up the corporate directions of the startup: setting stock, salaries, planning financing ratios, approving budgets, guiding company compliance and transparency, and the hiring of senior management. The board is also most instrumental in planning and guidance of exit strategies such as IPOs or acquisition. And as a startup, the board is very important to founders for an introduction to strategic partnerships along all lines of the supply chain. We can see that founders cannot go at it alone by simultaneously acting as senior management and the board.

Protect Your Blind Side

I recommend that founders generally plan their long-term stake in their startup well before inviting investor and independent directors to the board. Protect the blind side – founders can be fired from their own company. It happened to Steve Jobs so it can happen to any founder! This conversation should come up when the founders are considering exit strategies, long before go-to-market. If the exit strategy is pure sale or acquisition, should founders say goodbye and move on to the next, or is the plan to remain on the Board of Directors, Board of Advisors, or remain as a board observer? Such strategic planning even before engaging legal to appoint a board bodes well for future events such as firing or hostile takeovers.

After having founder conversations and written strategic objectives for the startup, secure legal to vet what type of board structure would be amenable to the startup’s long-term goals. Some startups plan to go many funding rounds with a variety of investors – a strategy which makes for greater scalability but greater organizational complexity. A ballpark number for the early stage is 3 – 5 while at a much later stage it is 5 – 7 directors. Setting board roles and responsibilities in the company bylaws is most important before bringing anyone on deck. As well, I recommend ensuring that legal sets rotating board terms up to 3 years. Remember, Angels and VCs who ask for a board seat would come with their own terms, so be prepared beforehand for best negotiation. Also, Europe tends towards the two-tiered board structure that separates general management and more detailed supervisory responsibilities. So, European startups need to decide with legal guidance which structure is best initially.

Get An Independent Director First

With legal in place, founders can then approach board members. It may be wise to obtain an independent director before giving a seat to an angel or VC who has vested interest (aka money) in the company. This is unconventional advice since, generally, the industry dictates the ensuing board seat goes to the initial investor. However, an independent director who has strong expertise in the startup’s service area is ideal. It will be necessary to provide compensation to an independent director. Early stage startups with a pre-money valuation under 5€ million may offer 0.25% to 0.5% equity initially, with set terms to increase equity and cash compensation upon reaching later stage milestones. A strong independent director makes or breaks governance even more than board directors with vested interests due to her possible ‘tiebreaker’ status on the board.

How do founders recruit the board? Inside directors other than founders would be initial investors other than friends and family, while independent directors can be colleagues with a strong background in either the startups’ industry or with a strong background in governance. Professional board member sites such as BoardProspects offer premium founder/prospective board member exchanges. However warm referrals are always best. Founders need to structure an interview process for prospective board members, inclusive of angels or VCs who request board seats. Inc. Magazine gives great interview tips for the board interview.

Questions you need to cover:

  • How will the board member add quantifiable value in building the startup? Specifically, what is the board member’s input in strategic direction to reach the startup’s sales targets?
  • What is the board member’s interest in the company? Is it mainly from a mentoring or structure perspective, is it an addition to his/her portfolio of startups, or is there only profit motive? If it is only about the bottom line, there could well be fiduciary breaches in the future. Be careful.
  • What compensation is required? Almost all board members are offered percentage equity unless they opt to be only board observers. Angels and VCs who have invested shouldn’t receive further cash compensation as a board member but naturally would have a higher negotiated equity stake.
  • Does the board member require Directors & Officers Insurance? This insurance usually is required for later stage startups that have an advanced board structure and can cost up to 50,000€.
  • Is the board member willing to be evaluated on an annual basis, and also willing to be rotated? The suggestion made by Inc. is to have the independent director serve 1 year, and then be rotated for a longer term once evaluated.

Legal counsel is required to structure the startup’s chosen board of directors, update the bylaws and structure the capitalization table accordingly, especially once funding is secured and board seats requested. And so, your startup now has an excellent organizational foundation!



Sharing is caring!