Board Evolution and Turnover
Startup Boards for CEOs Series: Post 3 of 9
Now that you’re committed to getting the size and composition of your board right as the foundation to develop your board as a strategic asset, you need to think next about board dynamics. This is particularly important as your company grows. The board that you start with isn’t necessarily the one that will grow with you, nor should it be. You should be thinking about how your board will evolve over time.
So what models can you look at to understand board composition evolution? As I noted in BLOG POST 2, here are three stages of growth that impact your board:
- Pre-VC startup. At this stage you can easily benefit from just 3 members. You (the CEO) and 2 independents who you name to the board.
- Series A/B startup. At the Series A or B stage you should have 5 members. You (as CEO) and then either 1 investor and 3 independents or 2 investors and 2 independents, depending on how aggressive your investors are to obtain a board seat.
- The final stage is a later stage, after early funding rounds and really, when you’re in scaleup mode. At this stage you’ll have 7 members. You (as CEO), 3 investors and 3 independents.
Seems easy enough, doesn’t it? It’s just a linear process, right? Not so fast. There is a problem that can crop up between the second and third stages. Frequently companies live in this zone for many years and through multiple financings, each of which comes with a new lead investor insisting on a board seat. It can be very easy to end up with a 5- or 7-person board dominated by investors between these stages, or between the first and second stages if you’re not vigilant about adding independent directors early on.
The best thing you can do is to stake out multiple independent board seats early on (before investors) and then limit the number of investor seats as the board grows. Fred Wilson addressed this point recently and wrote:
“When a startup board is created, there should be two independent seats on it. Day one. I know that will mean that founders will be unable to control their boards early on but these “independent seats” can be nominated by the founders to allay those concerns. And founders should put diverse people (gender, race, life experience, etc) into these independent seats."
It is highly unlikely that an investor will insist on removing an independent director and it’s highly unlikely that investors will be excited about sitting on a 7- or 9-person board too early in a company’s life–there’s just not enough complexity for them to make a big contribution. So if you stay firm on the number of independents and on the total size of the board, you’ll be forcing a difficult conversation among members of your investment syndicate, potentially multiple times along the way. Which investors get actual board seats and which ones become board observers?
You’re likely to get investor pushback on limiting the number of investor board members, but I’d suggest that you hold firm because independent board members help diversify the board and that diversity has a big (positive) effect on company performance. Here are two tactics you can use to deal with the likely investor angst.
First, you can change the mix of covenants in your corporate governance to give shareholders additional voting rights or blocks, so that not all critical decisions are approved only on a board vote. The benefit is that, even if investors don’t have a board seat and board vote, you can allay their fears of not having a voice in a critical matter they care about. A word of warning here: You have to be careful that you’re not adding too many restrictive covenants that hem you in over time. You also have to ensure that you’re not giving individual shareholders a block on something as opposed to a majority of shareholders, and that you’re not making your life too complicated by mandating shareholder votes too often or too broadly. You could run into this problem if you have a ton of angel investors so consult a lawyer on the specifics!
A second tactic to deal with investors that want a board seat and vote is to ask an investor director to designate a non-investor to hold their board seat. This is second prize at best since the independent director is still technically a representative of the investor and the investor firm’s interests – but it does allow you to work collaboratively to add a more diverse board member, and to add an operator, in lieu of adding another investor. I’ve heard of at least a few top-tier VC’s willing to do this – or even willing to step aside – to make room for board diversification, so this may become more of a trend now.
Finally, as your board evolves I want to address the topic of board member tenure or term lengths. This issue is more or less focused on independent directors because investor seats usually come with the cap table, and the CEO seat usually runs with the life of the company. Somehow, and I’d file this under the heading of “because that’s how it’s always done,” independent board members tend to get four-year option grants that imply a four-year term. That is a big mistake in my view, especially for early-stage companies. The things you need to get out of a Board in your first couple of years change dramatically as you get more mature. I’ll dive into this issue in more detail in a subsequent post. At the early stage of a company you should think of an independent director the same way as you think about a senior executive, and just like hiring a new senior executive, you never know. You never know if board members are going to be effective and a good fit until you have hands-on experience working with them. And someone who is super helpful at helping you find product-market fit as a board member in year 2 of your company may be ineffective at helping advise you on scaling the GTM part of the business in year 3 of your company. A four-year term is a big risk on your part for an unknown.
I will say, though, that I have had independent directors for almost 10 years who have been brilliant advisors at every single turn of events. But don’t expect that from every independent board member because I have also had independent directors who I just loved in the interview process and were brilliant with their advice…in their first two meetings. After that, they proceeded to give nothing but the same three pieces of advice in every subsequent meeting. If you’re going to get 100% of the value of a director in a few meetings, it’s not worth taking up that slot in perpetuity (or even four years) with that limited perspective. For these two reasons, I’m going to give my independent directors at Bolster 1 or 2 year terms out of the gate (and commensurate option grants). We can always decide to keep a director on longer and add more equity compensation. But a shorter term is a good forcing function for all parties to determine whether or not the relationship is working and the director is adding enough unique value to continue on the board as the company grows and its needs change.
Size, composition, and tenure are the three key things to think about as you’re starting to build your board. A fourth component, diversity, is perhaps the most important and I address that in the next post. As Fred Wilson noted above, independent directors are often your only shot at making your board more diverse; otherwise you’re stuck with investors (who are mostly homogeneous) and you, the CEO.
- Matt Blumberg, February 23, 2021