The second article in the ‘Mechanics of a term sheet’ series focuses on the making of an ideal board of directors that helps with better decision-making
One of the control provisions in an investment that appears relatively simple, but, requires a little more than a hat tip is the appointment of the investor nominee to the board of directors (board) of the investee company. In the last issue, we discussed affirmative rights as a control restriction the investor seeks, in this issue we discuss board representation.
The investor seeking to invest in a company will require that his representative be present at all board meetings and shareholder meetings of the company so as to effectively watch out for the interests of the company. Usually, the board is well represented by an investor, founder, company and an independent person /outside representative. Each such appointment to the board carries one vote.
The founder/CEO must also be cognizant of the fact that different board members come with different experiences and if they are not directly in his line of business he must be very clear as to the intangibles such a board member brings to the table.
Brad Feld, prominent U.S. based investor, categorises boards effectively and highlights the distinct differences that exist in the operational style of the following boards.
Working Boards: These are boards that roll up their sleeves and help the founders and management team of the company get the job done. They meet frequently, have animated, engaged discussions and offer significant ongoing support to the key owners and managers of the company.
Reporting Boards: These are boards that meet four to six times a year for a status report on the company. If everything is going well, they tend not to say much. If there are problems or issues, they are often critical of the chief-executive officer (CEO) and the management team. If things continue to go poorly, they often take action of some sort.
Lame Duck Boards: These are boards that have no influence on the company. In many cases, they are simply rubber stamp exercises for the CEO or founders.
There is no desired composition of the board, but, typically, a start up that raises an angel round would be blessed to have a working board. This would usually comprise one representative each of the company, investor and independent person. A board of three members enables the start up to move nimbly and seize market opportunities swiftly without getting mired in meetings and approvals.
Thinking things through
A good board is not a set up by chance or luck, but, by the entrepreneur thinking through very carefully, levels of engagement that he desires for his company. It would be the CEO’s job to attract talent to the board. Inviting local entrepreneurs is one great way to induct good talent that can advice on local conditions and share vision given similar resource availabilities. This select group of people will play a significant role in the company’s efforts to raise capital, negotiate and cut deals for itself and work with the founders in environments that he/she’s unfamiliar with. A yes-boss kind of person would not serve the interests of the company.
The founder/CEO must also be cognisant of the fact that different board members come with different experiences and if they are not directly in his line of business he must be very clear as to the intangibles such a board member brings to the table. Strategic vision, experiences in foreign markets are some of the intangibles he can look for. The board is aptly called the brain of the company and so their meetings must be used to strategise and move the business from one rung to the next and not be used to sweat the small stuff.
Size does matter
There is no statutory size for a board except that the Indian Companies Act presumes at the least two people should be there for a meeting to effectively take place. (The Indian Companies Act 2013 requires that a Private Limited Company have at least 2 directors and a Public Limited Company have at least 3 directors.) Chairman of the board carries some responsibility in assuring that the board proceeds to business each time it meets. Founders usually reserve a board seat for themselves.
Investors usually also seek one for themselves. I would urge the company to regard co-investors as a single group where possible and afford one board seat to a person nominated by both investors and afford others board observer seats (they carry no voting rights) and at the same make the investor privy to the board discussions.
Also, I urge entrepreneurs to think 10 to 20 years ahead and imagine plodding through a board size of 13 directors flung across the world, whose participation may be severely inhibited solely due to size and process. At all times the emphasis should try to remain on decision making and the board itself should not be confused with a committee or a board of advisors that serve significantly different purposes.
On the compensation front, board members usually expect at the minimum a fee that covers their travel expenses. Various companies’ follows various ways of compensating board members for their time including granting of options, consulting fees, sitting fees and so on. There is no law on the subject, however, it may do good to remember that their expertise, time and involvement should always be priceless to the founder for he must be conscious of setting a precedent for several board members to follow in the years to come.
Ultimately, it is this relationship that the company builds with the board that prepares it to hit the road running. The more evolved this relationship, the more evolved the company.
This article first appeared in Smart CEO and was authored by Aarthi Sivanandh.