How to Think About Corporate Governance as a Board Member
Startup Boards for CEOs Series: Post 7 of 9
I’ve always believed that there is a sliding scale of Board member duties that changes dramatically as companies grow in size. The ratio of time spent on company strategy and coaching management to time spent on corporate governance and financial oversight for a large company board may be as much as 20:80. For a raw startup, it’s likely the reverse – 80:20 (or even more tilted away from formal governance). The reality of startup boards is that the job isn’t fundamentally about governance and oversight. It’s probably also true that on the unusual occasions a startup board is dealing with a governance or oversight issue, they have outside counsel present to help guide them through the specifics. If they don’t, it’s easy enough to demand that counsel as a startup board member.
So while you can attend one of a number of corporate director training programs across the US, be aware that most of them are extremely expensive and time consuming (think multiple full days and $5,000-$10,000). Besides the expense and time commitment, very little of what you learn is relevant day-to-day as a practical matter in your role as a startup board member.
That said, it’s still important to understand the basics of board governance. It’s also important to develop a philosophy of governance and oversight for yourself so you have a framework for engagement on boards – and so you can make sure you and the other directors (and the CEO) are aligned. You’ll need to have a sense of what’s important to pay attention to and you need to know when to call counsel for help, if nothing else – for example:
- An inside financing where investor directors are negotiating with the company
- Any major conflict between directors
- An inbound offer to buy the company or an outbound sale process
- A major ethics concern with respect to management
- A major security or data privacy breach
Brad Feld and Mahendra Ramsighani have a pretty definitive passage defining the basics of governance in Startup Boards which is much better to reproduce here in full rather than to recreate it:
Legal Duties of a Board Member. The state laws in which the company is incorporated along with the company’s charter documents (the articles of incorporation, bylaws, and shareholder rights) establish the legal duties of a board member. For public companies, the Securities and Exchange Commission (SEC) adds some bonus rules. A fiduciary duty is an obligation of a board member to act in the best interest of another party. Every board member has a fiduciary duty to the shareholders. A fiduciary duty is the highest standard of care, and a fiduciary is expected to be extremely loyal to the person or entity to whom she owes the duty (the “principal”): she must not put her personal interests before the duty and must not profit from her position as a fiduciary, unless the principal consents.
Board members are bound by two formal legal obligations: the duty of care and the duty of loyalty. These are defined as follows:
Duty of care: A board member is to conduct all actions in a manner where they see no foreseeable harm. A board member needs to be attentive and prudent in making board-level decisions, act in good faith, and conduct sufficient investigations to provide a logical basis for decisions. A board member breaches his duty of care when he acts in a negligent manner or knows that the consequences of an action could be harmful to the company.
Duty of loyalty: A board member should ensure that interests of the company are always first and foremost in his mind and that loyalty to the company supersedes any other vested interests they might have. Duty of loyalty is breached when a board member puts their personal interest ahead of the company, conducts inappropriate transactions that benefit the board member (known as self-dealing), or benefits personally from confidential information shared in the boardroom.
Since investor board members are also trying to make a financial return, conflicts of interest can arise at every step. As True Ventures managing partner Jon Callaghan puts it, “As long as you are a board member, you have to focus on what is best for all shareholders. This can be difficult for VCs. Afterwards, you can go home and fret all you want about your fund not making a better return.”
There are additional duties referred to as the duty of confidentiality and the duty of disclosure. While these are linked to the duty of care and duty of loyalty, they are just as important. They are defined as follows:
Duty of confidentiality: A subset of the duty of loyalty, this requires a director to maintain the confidentiality of nonpublic information about the company.
Duty of disclosure: A director, pursuant to the duties of care and loyalty, is required to take reasonable steps to ensure that a company provides its stockholders with all material information relating to a matter for which stockholder action is sought. While these duties may sound good conceptually, in practice they are subject to judgment and interpretation based on the specific situation.
A legal construct, referred to as the business judgment rule, governs the specific interpretation. The business judgment rule is used to test whether the director acts in good faith, in an informed manner, while putting his personal interests below those of the corporation. Specifically, the director is following the business judgment rule if he: Does not have any personal interest in the outcome. Has reviewed all information prior to making a decision. Believes that the decision is in the best interests of the company. This rule helps protect a director from personal liability for allegedly bad business decisions by essentially shifting the burden of proof to a plaintiff to demonstrate that the director did not satisfy his fiduciary duties.
You can see from Brad and Mahendra’s description that “governance” is more than being the boss of the CEO and it involves a number of duties and obligations. If you’re not familiar with the principles of governance for your state, I’d suggest spending some time with the legal counsel at your company and do a deep dive on the specifics.
Fred Wilson brings some of the issues of governance to life in a post about director responsibilities:
About ten years ago, I was in a board meeting when management told the board that they had uncovered significant accounting issues in a recently acquired company. This was a public company board. And these accounting issues had flowed through to several quarterly financial statements that had been reported to the public. Every board member who was also a material shareholder (me included) knew that the minute this information was disclosed, our shareholdings would plummet in value. But there was no question what we had to do. We had to hire a law firm to investigate the accounting issues. We had to immediately disclose the findings to the public. And we had to terminate all the employees who had an involvement in this matter.
Things like fiduciary responsibility seem very theoretical until you find yourself in a moment like this. Then they become crystal clear. Directors often must act against their own self interests. They must do the right thing for the company, its shareholders, and its stakeholders. There is no wiggle room on this rule. For directors, it is the golden rule.
My Board at Return Path had a few moments over the years that tested our mettle a bit when it came to good governance. More than one time we were negotiating the terms of an inside financing where the VCs on the Board had to wear two proverbial hats – as directors trying to look out for the best interests of the company and its common shareholders, and as investors trying to look out for their own interests and those of their limited partners. To cut the tension in a board meeting where we were conducting this somewhat awkward negotiation, I brought in Return Path logo hats for the directors to wear during the conversation…and gave each of them two such hats in different colors – their director hat, and their shareholder hat. It was a little goofy, but I think they all appreciated that they literally had to put on the hat that represented whatever point of view they were sharing at a given moment. The conversation had a very friendly and successful outcome, I think at least in part as a result of being explicit about what “hat” a person was wearing.
There are two important areas in which you should understand your own point of view as an independent director and be able to articulate that to the CEO and other directors of a board you’re considering joining – then act accordingly once you’re on the board. I’ve found that a lot of people don’t think about these two important areas before joining a board and so we address them specifically in our board needs assessment and board screening process at Bolster. There’s no right or wrong answer for either one, but some level of alignment across a board is important – or at least a conscious understanding around a lack of alignment, as in “you are here to play X role on this board.”
Active participation. The first important area concerns the role of the board and how active directors are in company operations. Popularized by Reed Hastings, a long-time member of the Microsoft Board, some board members believe that a board’s role is to hire/fire/compensate the CEO, and not much more, other than obvious areas of governance and financial oversight. Other board members believe that a board’s role is to engage deeply with a company’s strategy, their management team, and operations. For this second, more active model, think about a private equity-owned company where the CEO and CFO are sending weekly cash reports and KPI decks to their board members and then receiving comments back from the firm’s associates. Of course, many board members are somewhere in between those two extremes, but you should think about your own approach to a board–hand’s off or more active participation?
Interests. The second important area concerns the question of whose interests do directors need to keep in mind first and foremost when making governance decisions. There are directors who believe in the letter of Delaware law for C Corporations and LLCs that “The responsibility as a director is to maximize shareholder value” and others who have a broader view that “The responsibility as a director is to maximize the value of all stakeholders,” which is basically the B-Corporation definition of fiduciary responsibility. A C-Corporation board making decisions using B-Corporation rules runs a significant risk of a shareholder lawsuit – but board members also have to live with their own consciences, and in startups, there are times when the interests of employees and customers (and less often, suppliers and external stakeholders like the environment) do need to be factored into a decision.
The majority of venture-backed company boards tend to live somewhere in between the two extremes in terms of how active the board is, and they probably tilt more to the “shareholder value” perspective, but that doesn’t mean you need to live in the same place. Pick the spot on those two spectrums where you’re comfortable, articulate the reason why to yourself and others, and act accordingly in the boardroom.
-Matt Blumberg, May 25th, 2021