This post was originally published on EspressoCapital.com.
Boards of directors help CEOs build their companies by serving as a strategic asset that can accelerate business growth while providing the experience and expertise necessary to navigate an array of challenges. Beyond supporting the CEO, boards help to ensure that the interests of shareholders, whom they represent, are protected, as well as those of employees, customers, and other stakeholders.
While that’s a very high-level overview and only begins to explain the potential value that a board of directors can provide, it nevertheless highlights why assembling the best board possible is so important. As a CEO, having the right people on your board based on your needs and the stage of the business, should always be among your top priorities.
Board composition basics
Before diving into some of more nuanced aspects of assembling an effective board, let’s quickly review the fundamentals, starting with the three types of board directors:
- Management. Typically the company’s CEO, there should generally be no more than one management team member on any board. That’s important because it eliminates the possibility of muddling reporting lines by, for example, having someone who is the CEO’s subordinate in the business effectively also be his or her boss in the boardroom. It also ensures that all other board seats are held by outsiders, which is essential for bringing much needed external perspectives to the CEO. Sometimes there are reasons to keep a founder on the board if he or she has passed the CEO role to a new executive but remains in the company, but this usually has just as many cons as it does pros.
- Investor. Usually venture capitalists, these directors put money into the business in exchange for a board seat and the ability to influence how the company is governed. The challenge that investor directors face is that they effectively wear two hats. They have to balance their fiduciary responsibility to the company with their desire to both safeguard their investment and maximize returns. While these two things aren’t necessarily in conflict with each other all the time, they can be tricky to rationalize, such as in a financing negotiation, particularly in a down round.
- Independent. Generally compensated with stock options in the case of early-stage companies, independent directors have none of the same potential conflicts as investor directors, and can therefore, in theory, be truly independent when making decisions and offering advice. In practice, however, that’s not always the case. Just how independent these directors actually are often depends on who appointed them. An independent director appointed by all shareholders, for example, will likely be far more independent than one appointed unilaterally by an investor or a CEO who could decide to remove the director at any time if they were ever at odds over a particular issue.
Conventional wisdom says that early-stage boards should have three directors, mid-stage boards should have five, late-stage companies should have seven, and public companies should have seven or more. And while that’s not always the case, no matter how many board members you have, I generally recommend following what I call The Rule of 1s. That means that in addition to having only one management director, you should have one independent director for every investor director.
Importantly, that rule doesn’t always hold for later-stage companies. Boards should get more independent over time (leading up to public boards, which are often mostly composed of independents). That’s because investor directors generally have similar backgrounds and skill sets, meaning that adding more of them often doesn’t provide the same incremental value that adding additional independent directors can. Getting the balance of investor and independent directors right can be challenging and often requires careful management.
Board member considerations
When looking for board members, seek out people who are what I call great corporate athletes. They should be great communicators, both in terms of how they listen and how they articulate their ideas. They should also be highly strategic, understand numbers, and know their way around a P&L statement. While every board member will each have his or her own unique strengths and areas of expertise, they should all be talented business people.
Nevertheless, there may be times when you want to add a highly specialized person to your board who isn’t a corporate athlete. Maybe you’re in the fashion industry and want to add a designer to your board or you’re in sports and want to add a renowned tennis or soccer player. While that can make sense in some situations, know that you’re doing so at your own peril. Giving voting rights to someone who may not be equipped to make sound business decisions can easily become problematic.
With all of that in mind, let’s look at some of the more nuanced points you should consider when evaluating potential investor and independent directors:
- Investor directors need to be able to distinguish between speaking on behalf of the fund they work for and the company whose board they are sitting on. Importantly, they should recognize that they’re not there to micromanage, but rather to give advice and hold you accountable as CEO. This can be tricky if you end up with a junior person from an investment firm on your board who lacks substantial business or operating experience. The old saying that investor directors should have their noses in the business, but keep their fingers out of it rings true.
- Independent directors allow you to bring a greater breadth of experience to the board than you’ll typically get from investor directors. Exactly what to look for in an independent director depends largely on your particular company, but keep in mind that they are there, in part, to serve as a counterbalance to the investor directors and therefore shouldn’t be afraid to speak up when they have a different point of view.
As CEO, you have both an executive team and a board as sources of strategic input and advice. To build the best board possible, think about how all of those people fit together as if they were parts of a jigsaw puzzle. Try to identify what’s missing — maybe it’s the voice of the customer or someone with deep experience navigating exits and IPOs — and use open independent board seats to fill those gaps.
Balancing board dynamics
One of the hardest things for private companies to manage is having a board made up of either too many investor directors or investor directors who have competing interests. Handling the first of these issues is relatively straightforward. I recommend letting potential investors know that you never want to have more than three investor directors on your board at any given time. That way you can roll off early-stage investors as you add later-stage investors to your cap table. Most reasonable VCs understand that having too many VCs on a board isn’t helpful and are willing to accept that.
Managing investor directors who have come into the business at different cost bases, and therefore may have competing interests in certain circumstances, is far more challenging. While there’s no elegant way to handle this, what you can do is carefully manage and keep track of the rights you give your investor directors. What you want to avoid is taking on new late-stage investors who want the right to block any potential deal if they don’t like it or it doesn’t yield the return they’re looking for. You can also make sure early investors, including management, are able to sell a reasonable portion of their stock in higher-valuation rounds so they have some measure of liquidity along the way.
Be sure to hand out rights like these very sparingly and carefully. And remember, as CEO, your job isn’t to make your newest investors happy or to generate the greatest IRR for them. It’s to look out for the best interests of the company, its shareholders, and its other stakeholders.
I also always recommend giving independent directors a two-year term at the early stages when you have no idea what your future needs might be. If at the end of those two years, you think the person is right for the next two years, give them another grant. On the other hand, if you think they’re not, thank them for their service and ask them if you can keep them on your website as an adviser and then appoint someone else.
At later stage companies, it’s not unusual to have independent directors stay on for a decade or more, provided that they are able to continue to be helpful and provide value at the different stages of the business’s evolution. That said, it is helpful to get fresh perspectives and opinions. Being able to cycle in new directors can be very beneficial, so always weigh the pros and cons of keeping existing directors versus bringing on new ones.
The evolving face of boards
There has been a push in recent years to ensure greater diversity on boards of directors. Given that founders and venture capitalists are very often white men, the best way to achieve that diversity may well be through your choice of independent directors.
Although board diversity is more valued now than it was just a few years ago, diverse boards certainly aren’t universal just yet. Part of the reason why is that as a CEO, in order to create a more diverse board, you often have to be willing to invite someone onto your board who has never served on one before. That’s because the people who have board experience are still predominantly white and male.
To be clear, there are many talented senior executives who have never sat on a corporate board but who would still make incredible board members given their breadth of experience and expertise. More CEOs just need to be willing to give them the chance to do so. If you really want to do work to change the diversity in the leadership ranks of corporate America, widening the funnel of director candidates is a good way to start.
Board composition pitfalls
There are a few common mistakes that I see CEOs make when building their boards. The first is confusing board members with consultants. A CEO might ask himself what voice is missing around the table, recognize marketing as a weak point for the business, and conclude that he should add a marketer to the board when in fact what he really needs is a new CMO. It’s important not to confuse your operating needs with your strategic advisory needs. Remember, board members give advice, while consultants produce deliverables.
At the other end of the spectrum, some CEOs make the mistake of hiring trophy board members. Theranos is a great example of this. The company’s board was composed of former secretaries of state, four-star generals, and other seemingly highly desirable board members. As impressive as these people all may have been, they ultimately didn’t know anything about, or didn’t care to exercise, effective corporate governance at a healthcare startup — a fact that certainly only contributed to the company’s spectacular failure.
Build your board with confidence
Whenever you create or rotate the members of your company’s board of directors, it’s important to think carefully about the composition of that very important group of people. Finding the right mix of people to help you navigate the challenges of growing your business is critical and takes careful consideration.
But wait! There’s more
Building a strong board is only the first step to leading a high impact board. You have to be very intentional about running your board like a team, producing excellent and easy-to-follow board materials, and on being a skillful meeting facilitator. For more tips on building and running successful boards, check out “Startup Boards: Getting the Most out of Your Board of Directors.” You might also enjoy my co-author Mahendra Ramsinghani’s post, “The quarter just ended. Did you share the highlights with your investors?”
-Matt Blumberg, January 10, 2024.
