by Scott Kupor
And as anyone who has been in a startup before knows, there is a huge knowledge gap between board members and the CEO and other members of the executive team, stemming from the fact that the board members simply aren’t in the company’s office every day. Without the specific understanding of which employees are capable of doing what, and which product features are most important to the customers—among other things—board members simply aren’t immersed enough in the company to meaningfully drive priorities for the business.
All of that being said, this may not stop VCs from overstepping their bounds. After all, many VCs were once CEOs themselves, thus the temptation to get more involved in the company’s affairs. And the VCs are generally well-meaning when doing this. Their goal is to help the company become successful, even though the impact of their actions could well be the opposite. When VCs find themselves getting too entangled with the day-to-day operations of the business, you as the CEO should engage with your VC board member to understand why. It’s possible that your VC may simply not be aware she is doing this, or there may be a deeper concern she has with your abilities as a CEO that is causing her to increase her level of engagement. Uncovering if either or both of these are present is a good thing for you to do as CEO.
As we talked about in chapter 10, this board responsibility is why board composition is often a hotly contested issue in term sheet negotiations. If the common shareholders control the board by having more board seats, that effectively neuters the VCs’ ability to remove the founder CEO from her role. And the opposite of course is true: if the VCs control the board, the founder CEO might have concerns about whether the VCs will be trigger-happy and remove her from the business prematurely.
2. Guidance on Long-Term Strategic Direction for the Business
Consistent with the commentary above about the need to allow the CEO the appropriate level of freedom (and accountability) to drive the company’s strategy, the board does have a role in at least providing guidance and review of that strategy.
For example, to execute the CEO’s strategy might require a certain budget (or the need to raise additional capital): these are areas where the board’s input is both expected and desirable. After all, we know that, particularly in the case of additional financing, the board will need to vote to approve an action at some point, and the protective provisions will likely grant the VCs a separate voting approval as well. So, if for no other reason than beginning to build consensus around these activities, good CEOs bring these discussions to their board for input well before they are asking for a formal vote.
Aside from items that might ultimately require formal board votes, startup boards are also good places for seeking input on strategic areas of focus, given that experienced VCs tend to have a wider aperture through which to provide guidance. In many cases, a startup CEO might be in that role for the first time, whereas a tenured VC might have sat on tens (or more) of boards over the course of her career, and thus simply have seen more game film that could help inform discussions. Again, that doesn’t mean that the VCs should dictate the strategy to the CEO, but they often can provide lessons learned from prior experiences that can be helpful to a CEO who is doing some of these things for the first time.
3. Approving Various Corporate Actions
Startup boards also play an important part in approving corporate actions. We mentioned approving financings above, and of course major acquisitions or divestitures of assets need to be approved by the board.
Specific to compensation, the board also approves a number of important things.
First, in order to issue stock options to an employee, the board must first determine the appropriate fair market value of the stock. Under US tax laws, if companies issue stock options to an employee where the exercise price of the option is below the then-existing fair market value of the stock, the employee is liable to pay taxes at the time of the grant on the difference between the strike price and the fair market value. Nobody wants that, and boards don’t want to have created tax problems for employees in retrospect by having the IRS challenge fair market value at a later date.
To prevent this, companies will often hire an outside firm to render what’s called a 409A opinion. This is a financial analysis the firm conducts that arrives at a fair market value for the common stock and on which the board can rely to approve this value as the exercise price for options. A 409A opinion is generally good for up to twelve months, as long as there has not been a material change in the company in that time period—e.g., a new financing round or major changes in the financial performance of the business. Thus, as a matter of course, boards will update the 409A coincident with a new financing, or at least every twelve months. For those of you who have joined startups, this is why your offer letter may tell you how many options you are receiving but not tell you the exercise price; it’s only once the board has approved the fair market value and taken the corporate action to authorize the granting of options that you will know precisely your exercise price.
Another compensation-related function of the board is to adjust the size of the option pool as needed to enable the company to make new-hire grants or provide additional options to existing employees. Recall from chapter 9 that our goal is to set the size of the option pool at the time of a financing to be sufficient to handle the company’s forecast hiring needs until the time of a subsequent financing. Best laid plans don’t always work, though, and the board is often called upon to increase the size of the option pool prior to a next financing. Hopefully in most cases this is because the company is doing so well that it has accelerated its hiring and thus needs more options to accommodate. Oftentimes, though, it’s because the initial forecasting was a bit imprecise.
Good boards should also review CEO and broader executive compensation every one or two years. When we discussed stock vesting, we noted that VCs are always keeping an eye on the amount of vested versus unvested stock for founders (as well as other key members of the team). This is because the VCs want to ensure that the people most critical to the company’s success have sufficient economic incentive to remain important contributors over the long term. Unvested stock options provide this incentive by tying economic rewards to continued tenure with the company.
As a result, good boards should both evaluate the performance of the CEO on a regular basis and, where appropriate, ensure that key contributors have sufficient unvested equity to incent the desired behavior. As we’ve noted before, doling out stock options is not costless, as the option pool may need to be expanded to accommodate this, and the pool’s expansion dilutes the VCs’ ownership in the company. So VCs will want to ensure that any such expansion is really likely to increase the value of the company as a way to offset the percentage ownership dilution they will feel in the short term.
4. Maintaining Compliance and Good Corporate Governance
We are going to explore the various legal duties of board members in chapter 13, but recall that we talked earlier about how the directors and officers generally want to protect themselves from taking on personal liability for any legal mishaps of the company. That’s a good goal, but it requires that the board operate consistent with its legal duties and maintain good corporate governance. So an important role of the board is to simply meet on a regular and consistent basis to keep members informed of the business, enabling them to act in a manner that is consistent with their fundamental role of increasing long-term shareholder value for the common stock and, particularly in the case where the value doesn’t materialize, protect themselves against personal liability.
You’ll hear lawyers talk about this as protecting against a piercing of the corporate veil. That’s a fancy way of saying that boards want to make sure that they get the benefit of the limited liability that a corporate structure is intended to provide. The way to do this of course is to satisfy the various legal duties that boards owe the company and its shareholders—e.g., holding regular board meeting
s that reflect the board’s deliberations about the state of the business and ensuring that board members don’t get too entangled in the day-to-day of the business.
5. VC-Specific Roles
There are also nonlegal/nongovernance roles that VC board members often play with the goal of helping to improve the prospects for the business. Many times a VC board member is an informal coach to the CEO. Again, because a VC generally has had the benefit of simply having seen more startups in action or been a founder herself, she is often in a good position to be a helpful mentor and coach. Admittedly, this can be a little weird in that the CEO of course ultimately reports to the board and can be removed by the board, so she might be a little reserved in her willingness to open up to the VC board member. Nonetheless, this is an area where VCs can be helpful.
Another informal role of the VC board member is to open her network to the benefit of the CEO. Sometimes this may be to introduce potential executive candidates or external advisors for the company. Other times it may be to introduce potential corporate customers or partners. And some VCs have institutionalized this beyond the board member herself to include teams of others at the venture firm to help with this activity.
6. The Board’s Non-Roles
We’ve hinted at this earlier, but the board’s non-roles are as important as its roles. Most starkly, the role of the board is not to run the company or dictate the strategy, in particular the product strategy; that is the job of the CEO. There is no way that the board members—independent of how much they engage with you as the CEO—understand the detailed capabilities of the company in a way that they can meaningfully influence product strategy. Only you know what each organization is capable of delivering and how the orchestration of those deliverables can ultimately be accomplished. Good boards recognize this distinction; bad boards overreach.
As painfully obvious as that sounds, some boards do in fact cross this line sometimes. The board’s mechanism to “run” the company is to evaluate the CEO and coach, or ultimately fire, her if they don’t like the way the company is being run; it is not to interfere with the CEO’s ability to manage her team directly nor to dictate a particular product strategy.
If you see this kind of overreach from the board, you should address it directly with your respective board members. The innocuous explanation may be that you have inexperienced board members who simply need to be reminded of the best ways in which they can be helpful. The more serious explanation may be that the board is losing confidence in your ability to continue running the company—and this is simply their way of demonstrating that. Either way, as CEO, you want to know!
More generally, a big part of your job as CEO is to manage the board. That might sound odd in that managing typically applies to your direct reports—whom you have the ability to hire or fire—whereas you serve at the pleasure of the board. That notwithstanding, there are several things you can do with your board to help manage them indirectly.
First, set the right expectations up front about what you want from your board members. Many CEOs like to do regular one-on-one meetings with board members to ensure that they have time outside of the board meeting to share information and receive feedback. In addition, do you expect them to help you identify future members of the executive team, interview candidates for executive roles, open their Rolodexes to identify sales prospects, etc.? This goes without saying, but you should also set expectations about how you intend to run the board meetings—e.g., do you expect people to have read the deck beforehand and plan to use the meeting largely as a discussion of open questions?
Second, get agreement among your board members as to how they will provide you feedback. Some boards ask a single member to consolidate feedback from all the others and deliver it one-on-one to the CEO. Others may have an executive session with just the board and the CEO at the end of each meeting to provide group feedback. There is no required mode of operation, but you should both make clear your interest in hearing the feedback and agree on the best avenue.
Third, make sure that you and your board agree on engagement outside of a board meeting with members of your executive team. Good board members will make sure that you know if a member of the exec team has reached out to them to meet, and provide appropriate feedback to you as the CEO if critical questions are being raised. Bad board members will interfere with your relationships with your direct reports and likely raise concerns among your team about your viability as the CEO.
Finally, you need to orchestrate the board meeting itself and the agenda. This doesn’t mean not sharing bad news or being selective in your disclosure of important information to the board, but it does mean figuring out what topics are worthy of board discussion and not spending time on topics that are appropriately delegated to you as the day-to-day manager of the organization. Sitting down with your board members at the outset to solicit their feedback on what they would like to see as part of the board agenda is a great way to avoid missing the mark during the board meeting.
CHAPTER 13
In Trados We Trust
As we’ve mentioned, in performing their jobs as board members, directors are generally entitled to protection from liability. But doing so requires that they fulfill their core legal duties to the common shareholders of the company. Let’s take a look at what those duties are and how directors can ensure that they get the benefit of them.
A word first on this chapter. I am sure that some of you might be tempted to skip it because we are going to be talking about legal things, and we’ve already fairly exhaustively talked about board members. I get it. You may have other more exciting things to do right now (like, maybe, work on your startup?) but allow me to at least put in a plug for this material.
It’s one thing to start a company and have it fail. That sucks, no doubt, but at least you gave it your best and didn’t lose all your money in the process (at least I hope that’s the case). But it doubly sucks if you fail and then you end up in a legal battle for years beyond that trying to defend yourself from any number of decisions you made (or didn’t make) that are now being second-guessed by some of your shareholders.
If you didn’t bankrupt yourself from the company’s failing, the chances are pretty high that you will do so on the legal bills alone that accompany a lawsuit. Nor is it great to have your company succeed, make a bunch of money, and then find that some of your earlier shareholders feel as though they were screwed eight years prior and lost a lot of money as a result. Coming out on the losing end of that suit may mean that some of the gains you thought you had earned will disappear in the form of legal fees or a monetary damages award.
You don’t want to be in either of those situations—whether as a founder CEO or as a VC board member. And you don’t have to, because if you take the time to read this section, you’ll see that there are some common-sense ways to help prevent you from getting into trouble.
Of course, all the usual caveats apply here—I am not your lawyer and am not providing you formal legal advice here (in fact, I’m not really a lawyer at all since the state of California says I am now an inactive member of the bar and thus not properly licensed to practice law). So when you start your company, and if you ever find yourself in a legal quagmire, hire a real lawyer to help you navigate your way through. The path is pretty well-worn.
Let’s start by reviewing the duties of a board member.
Duty of Care
The duty of care is a foundational responsibility of a board member. At its most basic level, the duty of care says that you need to be informed about what’s going on in the company to perform your basic role of maximizing value for the common shareholders. Specifically, you need to keep informed consistent with what a reasonable person would want to know in order to be able to evaluate the company’s prospects.
You’re not required to be prescient and see around corners to predict how some incredibly smart computer science student from Stanford is going
to eat your company’s lunch. All you have to do is be informed—read the board materials, show up at the meetings, don’t sit on your iPhone the whole time texting your bookie about the spread on the upcoming WWE match, and ask relevant questions. The joke is that you can probably satisfy your duty of care by not being asleep at the board meeting. I’m not sure that anyone has actually ever tested this, but that ought to give you a sense of the relatively low bar you have to clear.
Duty of Loyalty
The duty of loyalty requires that a director not self-deal or enrich herself. Rather, she should be motivated solely by what is in the best interests of the company and its common shareholders.
As we’ll see shortly, while this sounds pretty straightforward, in the particular case of venture-funded startups, navigating the duty of loyalty can prove challenging. That’s because of the dual fiduciary problem we talked about. How does a VC board member balance her duties to the company and her duties to her LPs if in fact those are in conflict? Where there have been legal cases brought against venture capital firms (and there are not very many in total), they almost always focus on this basic question.
Duty of Confidentiality
This is just as it sounds. If you are on the board of a company, you need to keep confidential any information that you learn in the course of your tenure.