Startup 129: Term Sheet – Board of Directors
August 2, 2009 by Joseph Ansanelli
Filed under Recent, Startups, Term Sheet
This post is a continuation of the series about venture capital term sheets. If you have not yet read the previous posts on Valuation and Dilution, Liquidation Preferences, Anti-Dilution, and Voting Rights and Protective Provisions, you might want to start with them. In particular, when thinking about the Board it’s important to understand investors Voting Rights and Protective Provisions, and the requirement of investors’ consent on certain decision. (The links are at the bottom of the post as well…)
There are lots of things to consider for a startup’s Board of Directors including its role, who should be on it, and how to best work with the board.
You’re Fired! (or Hired)
To start, a Board of Directors has one primary job, which is to hire and fire the CEO. Sounds a little like your worst Donald Trump nightmare, eh? What this truly means is that the Board is an oversight organization for all the company’s shareholders and an advisory group for the company’s management.
The Board ultimately holds the CEO and the executive team accountable for meeting agreed upon objectives, manages compensation for the top executives, and works with auditors to ensure appropriate accounting and business practices. This is their “ongoing” job. Additionally, over the life of the company, the Board will vote on key decisions such as raising more money or selling the company.
Term Sheet
Typically the language in a term sheet is very straightforward and will simply outline the number and names of people on the board. The Series A will set the basic blueprint including the representation of the common shareholders and founders. The following example language is from the NVCA’s sample term sheet:
“At the initial Closing, the Board shall consist of [______] members comprised of (i) [Name] as [the representative designated by [____], as the lead Investor, (ii) [Name] as the representative designated by the remaining Investors, (iii) [Name] as the representative designated by the Founders, (iv) the person then serving as the Chief Executive Officer of the Company, and (v) [___] person(s) who are not employed by the Company and who are mutually acceptable [to the Founders and Investors][to the other directors].”
Not only is this common language, but this also happens to be a very ideal structure with two investors, two common shareholders including the CEO and then an outside, non-employee and non-investor board member. It’s ideal because all shareholders are represented and if needed, the outside board member can serve a tie breaking function.
As you raise additional rounds of funding, almost every investor will want a seat on the board which can get quite unwieldy. I strongly encourage companies to have a small set of board members (ideally 5 but no more than 7) who appropriately represent the shareholders. Only if needed, offer to future investors “Board observation rights”. Observer rights allow an investor to sit in on a board meeting but they are not voting members of the Board.
The Board is Your Team
Choosing your board members is as important, if not even more important than the structure. Think about each board member as if you were hiring them to work for the company. Do they have certain technical competencies that make the company better? Ideally each board member brings experience with startup execution or understands the business and market or both.
It is also important that they have the right relational competencies to work well with you, the rest of the board and the entire company. A board of successful people does not necessarily mean a successful board. They have to work well together. (Read It’s the people, stupid part II for more on relational competenticies.)
Making the best of it
Now that you have the board set up, the question is how to best work with your board. Despite what many fear, the Board is not responsible nor does a good board want to run the day-to-day operations of a company. Does that mean that the Board will simply let you do what you want? Probably not but if your board wants to run the company then you have not put together the best Board or, and I hate to be blunt, it could be that you are not doing a good job.
The key to a successful board relationship is leadership. Being a good leader means you have followers. And the best way to have the board “follow” you is to set a plan, deliver on the results and keep in regular communications especially sharing bad news early. I have never heard of a successful company having a difficult board dynamic.
For more on this idea, I suggest you check out the posts If you don’t know where you’re going, well, you’re lost, and A few golden rules for a great Board relationship, and Control Freaks Are Us to learn more about how to ensure a successful board relationship.
Anyway, I hope this helps. Enjoy the other posts and please feel free to share your thoughts or questions. And to get notified about future posts, please to sign up for email updates or follow me on Twitter. Thanks, feel free to share the post with your friends, and go get started…
Related Posts and References
- Startup 124: Term Sheet – Valuation and Dilution
- Startup 125: Term Sheet – Liquidation Preferences
- Startup 126: Term Sheet – Anti-Dilution
- Startup 127: Term Sheet – Voting Rights and Protective Provisions
- Startup 131: Term Sheet – Dilution Calculator
- It’s the people, stupid part II
- If you don’t know where you’re going, well, you’re lost
- A few golden rules for a great Board relationship
- Control Freaks Are Us
- Download sample Term Sheet from National Venture Capital Association
Right on target for startups re: Board of Directors – nicely written, thanks.
And you’re so right that once the Board is established, implementing a good plan and having great, open, timely communications is key to maintaining solid Board relationships and dynamics.
And any suggestion on what to do when a board decides to shaft the founder/CEO?
At what point does an investor with less than controlling interest have the rights to turf founders?
Dean – thanks for the questions.
At a macro level, I personally do not believe that the better investors ever want to “shaft” the founders and CEO.
Yet having the best people in all roles in a company is key to a company’s ongoing success. And sometimes companies outgrow the abilities and skills of founders or CEOs. Just as they might need to replace anyone else in a company. Ideally in the case of founders, there are roles for them that can add value long term. For example, David Filo co-founded Yahoo and while never the CEO, he has continued to have a role in the company that adds value to that which he has exceptional skills, i.e. Yahoo’s overall technical direction.
It’s also important to remember that one of the things that investors prefer never to do is to replace a founder or CEO because it often adds risk and complicates things.
Ultimately, the decision about a founder or CEO should be about an upfront understanding of what the goals and objective measures for success are and if the founder or CEO is delivering the results, then a well structured board would not likely replace the person.
With regard to the question of rights of investors, typically, investors do not have a special right to fire a founder of CEO as it’s a board decision, thus the importance of a well structured board. Sometimes as part of a financing, replacing the founder as a CEO will be part of the Terms. Then it is something that each founder has to decide to accept or not.
I suggest, if you have not yet had a chance, to read more in the two posts “A few golden rules for a great Board relationship”
and “Control Freaks Are Us” which are linked up above.