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For CEOs For Investors

Size and Composition of Boards

Startup Boards for CEOs Series: Post 2 of 9

How large should your board be? That’s a pretty critical question every CEO contemplates at one time or another. A rule of thumb is that the size of your board is directly related to how large and complex your company and shareholder base are. If you are pre–Series A financing, then a board of three is plenty. Once you have raised a Series A, you can have a five-person board for a long time, until you are starting to think about going public. At that point, increase your board to seven people. I’m not sure it matters all that much to stick to these numbers as a hard and fast rule as long as you have great directors and a manageable conversation during your board meetings. But at least these sizes during your growth are the customs – and nothing is wrong with them as long as you have enough freedom to appoint independent directors, which I’ll address in a subsequent post.

One thing to note about the size of the board is that the performance of the board is pretty much independent of the size. There are unruly boards of three and high-octane boards of seven. How you manage the board is more important than the number of people on it. As a side note, although it’s NOT permitted in a handful of states and countries, it’s okay to have an even number of directors if you have a good and high-functioning board. Many CEOs shy away from an even number in the event of a “tie vote” on some issue. My prior company had long stretches of time over the years with four or six directors. As I always said at those times to our board, “If it comes down to a tie vote about something big and contentious, we have bigger problems.” So, I wouldn’t stress out about having an even number of board members.

Ok, so you have 3 board seats to play with. Or 5 or 7. How do you fill them? To start, you need to recognize that there are three kinds of board members – management - people who work in the company day in, day out, investors (institutional investors who typically hold large blocks of preferred equity), and independent directors (people you choose to be on the board who are not company management and not representatives of institutional investors, even if they do own some stock options or made a small angel investment). When it comes to board composition, the trick is to keep the right balance of the three director types.

Let’s start with the easy one, which is management. My rule of thumb is simple for this. Boards should include one, and only one, member of the management team – the CEO. My logic is twofold. First, boards help govern the company and watch out for shareholder interests. Even if your C-level managers are shareholders they shouldn’t be on the board, and they don’t need to be since their interests are managed by the board–without influence. Boards hire and fire the CEO, and that’s an area where C-level managers do not need to be present, and oftentimes don’t have the skills to evaluate a CEO. And — more and more every day with large public companies — boards keep management honest. How can all these critical functions–shareholder interests, CEO evaluations, and honesty, occur when a Board has too many members of the management team on it? They can’t.

Second and more importantly, boards give outside perspectives and strategic advice to the company’s leadership. You have a limited number of board seats to fill. Why would you ever fill one of them with someone else on the management team, even a co-founder? You have 100% of that person’s mindshare on your business already and presumably you have the benefit of their perspective and strategic advice all day long. Adding a second member of the management team to the board is literally taking away the opportunity to add outside, diverse talent and brainpower to your inner circle. You might get pressure from co-founders to be on the board, and you might feel “more comfortable” having a co-founder on the board, but don’t cave in. The power of the board is diluted significantly if you add even one person from management beyond the CEO.

My friend Scott Kurnit elegantly wrote in a guest post on Fred Wilson’s blog several years ago that:

There’s only one CEO, one leader. And that’s why people who work for the CEO can’t also be the CEO’s boss. Yes, fundamentally, that’s what Boards are… the CEO’s boss. Here’s the simple logic. The CEO can’t be in charge 29 days out of the month and then report to her subordinates on the 30th day. That screws up the crispness and clarity for the 29 days. A CEO should not be giving compensation or making non-objective decisions concerning subordinates, in order to make sure her own comp and Board decisions get approved on day 30. Ridiculous. You often end up with a horrible combination of dysfunctional board member and insubordinate… subordinate – all wrapped up in one person. You can’t be both a worker and a boss at the same time. Sorry, co-founders… you can observe at Board meetings… but you don’t get a vote. Period. And when the CEO tells you to leave the board room… well, she’s the boss.

While the management slots on your board are pretty easy (note: only one seat, the CEO), the investor slots are far more difficult to manage because a lot of institutional investors will push to have multiple members. Seth Levine, from Foundry Group had a great post a couple years back on the investor director. Seth cited a study done by Correlation Ventures proving that there are limits to how many institutional investors you should have on the board. Spoiler alert: not that many.

There’s value to having VCs on your board. In fact, there’s value (or at least a correlation with success) to having multiple VCs on your board. But this value diminishes – and does so rapidly – as you add too many…I think it’s important to point out here that, at least in my experience, that having too many VCs around the table is bad for companies even if those VCs are good, helpful, competent people.

Seth’s post is worth reading in full, but I’ll pull in the key chart that really sums it up – companies with more than 3 investor board members performed worse than those with 3 or fewer.

The number of investor directors on your board is the most difficult part of the equation to manage. The above data suggests that you want 2 – but you can’t just wave a wand and make that happen. Board seats are a critically negotiated part of any venture financing, and most VCs who lead rounds will insist on a seat – and sometimes, follow-on investors will insist on board seats as well.

And that leaves the third type of director - the independent. Independent directors give you an opportunity to bring in different sets of experience and perspectives to your board. They give you the perspective of a business operator or functional executive or customer around the board table. As Fred Wilson wrote a few years back:

As a company moves from founder control to investor control, the notion of an independent director crops up. An independent director is a director who does not represent either the founder or the investors. I am a big fan of independent directors. Boards that are full of vested interests are not good boards. The more independent minded the board becomes, the better it usually is. I would argue that an investor-controlled board is the worst possible situation. Investors usually have a narrow set of interests that involve how much money they are going to make (or lose) on their investment. It is the rare investor who takes a broader and more holistic view of the company. So while investor directors are a necessary evil in many companies, they should not dominate or control the board. The founder should control the board, and independent directors should control a board where the founder does not control the company.

So, in the beginning, as you’re putting together your board it’s important to be intentional about the size and the composition and to follow the general guidelines I’ve suggested. If you can, place only one person from management, try to limit the number of institutional investors, and choose experienced independent advisors as a counterweight to you and the other board members.

In the next post I’ll take this one step further and provide some thoughts on how the board evolves as you grow and what to watch out for.

- Matt Blumberg, January 25, 2021