Startup 129: Term Sheet – Board of Directors
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
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A few golden rules for a great Board relationship
Working with a Board of Directors can be, well, scary. Why? Because they ultimately have the responsibility to hire and fire you. That’s really one of their only jobs. You say you don’t have a Board? A Board might be a group of people or maybe just an individual to whom you are responsible to report on your job results. If you think about it like that, we all have a Board.
Many people have asked how I ensured a successful Board relationship at Vontu. To be honest, I tried to keep it simple and follow a few golden rules:
- Keep your expectations in check
- Pick your board wisely
- Tell them what you are going to do and do it
- Communicate, communicate and communicate
Keep your expectations in check
After our first round of funding at Connectify, my second startup, I sat down with each of the board members and asked what were their expectations of me and what I should expect of them. The board consisted of two venture capitalists, two outside “operating executives”, one of my co-founders and myself. The most interesting feedback was from one of the investors who said,
If you don’t expect more than money, then you will be happy.
Needless to say, this was a surprise. I expected to hear how they would help us to recruit the team, find our customers, get publicity, and on and on. If you read many of the venture capital websites, that is what they promise. Yet his advice was quite sage because the reality is, especially with investors, they typically have 6-10 (if not more!) investments and are constantly looking for new ones. The model for venture capital is one of a portfolio of investments in which the few very successful companies deliver the lion share of the investment returns. And at the end of the day, they are investors relying on you to deliver the results. Does that mean that they don’t help? No. Great board members help but you should expect that the help will be somewhat sporadic and usually only on the really big stuff. I was lucky to have a great board but at the end of the day, it was my job to deliver the results.
Pick your board wisely
If you are afforded the luxury of being a founder, adding board members is as important as anyone else on your team. And you should “interview” them and be sure that you are comfortable that you will work well together. Board dynamics are tough enough without having people whose personalities clash. If you have the smartest people in the room, but they don’t have the right “relational competencies” (see previous post, It’s the people, stupid part II) then it’s likely the board will be ineffective. You say you can’t choose your Board? Well, if your board is your job, then sometimes finding a new job with a great manager is the right answer.
Additionally, especially for startups, it’s really important to have a balanced board that includes part of the management team, some of the investors (but not all if there are lots of them) and some outside board members. That way the discussion is balanced across all the constituents.
Tell them what you are going to do, and do it
This is such a simple idea for a successful board relationship. Actually it’s a great idea for any relationship. Your boss. Your team. Your spouse. Your friends. By setting the right expectations and achieving them, you build trust. If you are a math junkie, its a simple formula:
Success equals Results less Expectations
And to have success, it starts with the Expectations or plan. As discussed in the post “If you don’t know where you’re going, well, you’re lost“, you should make sure the Board agrees with your Wildly Important Goals and the Objectives for measuring their success. They can be consulted on the strategy for how you achieve them but that is ultimately your decision. And try to keep the discussions away from the day to day tactics. Without an agreed upon set of Wildly Important Goals and Objectives, well, the relationship will likely go awry.
Communicate, communicate and communicate
As in most any relationship, communications is another key ingredient. For our Board, we established a rhythm of meeting approximately once a month. During those meetings we would use our Wildly Important Goals and Objectives as the template for how we gave the board updates. And each person on the executive team would review the results from the previous month focusing on top 3 success and top 3 challenges. This way the board always knew how we were doing at any given moment.
This works great for the normal updates, but anything important, typically bad news should be communicated early and often and never wait for a formal meeting. Bad news early and being honest is always the best policy. I remember when we were about to close a $10 million round of funding and weeks before the contracts were signed and the money was wired, I realized we would both miss our sales targets and we needed to let go of a senior executive. I could have waited until after we had the money to tell everyone so as not to risk the funding, but that was not the right way to work. Instead I called the investors, swallowed hard, and told them what was happening. Maybe not so surprisingly the response was one of support. Generally the investors said that by being honest about a short term issue and putting the funding at risk, it made them more comfortable to invest. Granted overall things were going well, but needless to say it made a big impression on the new investors.
In summary, if you keep your expectations low, choose the board thinking about relational competencies, tell them what you are going to do and do it, and constantly communicate, then over time, the board will develop an ever increasing level of trust. This trust means more focused board meetings, support for management’s decisions, and generally less stress. And again, these not only work for a “real” board of directors, but for anyone to whom you are responsible for delivering results whether in your job, community or relationships.
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