Editor’s note: Investor and entrepreneur David Gardner is the managing partner of Cofounders Capital in Cary and is a regular contributor to WRAL TechWire.
CARY – Occasionally, board creation and composition becomes a sticking point in a terms sheet.
I continue to hear entrepreneurs say that they have “been advised” not to create a board until their company is much further along. Their reasoning is that they don’t want to “give up control” of their company.
There are a number of problems with this position, the least of which is that no professional investment firm is going to turn over a lot of money with absolutely no oversight. It would be a violation of the commitment they made to their fund investors who expect and hold them accountable for this.
Boards do not want to control the companies they oversee or make any management decision for that matter. Boards are charged with approving certain decisions where the CEO may have a conflict (such as establishing his or her salary) and matters pertaining to equity that could adversely affect investors. A board’s job is to makes sure that the management team is faithfully running the venture and utilizing the invested funds to build the company and accomplish its stated mission.
As an investor and board member, I tell my entrepreneurs that other than those things that require a board vote, I am only an advisor and that they are solely responsible for making all of the tough calls and living with the consequences, good or bad. Even when my entrepreneurs try to get me to make a hard decision for them, I push the decision back to them. CEO’s cannot be held responsible if they shirk off management decisions to investors.
At Cofounders Capital, our term sheets typically require a three-person or five-person board initially. It does not matter so long as the number is odd to avoid a tie and the board is balanced. By “balanced” we mean that there is an independent director and an equivalent number of founders and investors seats. Founders typically select half of the board seats and investors the other half with an independent investor being the “swing vote” to break a tie should one occur. The independent director is mutually agreed upon by the other board members but in practice usually nominated by the founders.
The independent board seat is usually a respected business person in the industry who is not associated with either the company founders or the investment fund. This is referred to as a balanced board because if the CEO/founder and investor disagree over an issue requiring board consent then the tie can be broken by the independent board member and the business can keep moving forward. This sets the tone for fair decision making that takes all stakeholders into account, which should be the primary fiduciary responsibility of all board member not just the independent seat.
Boards are constructed this way so that neither founders or investors have 100% say over matters that require board approval and so that the company can have a path forward should a deadlock occur. I’m happy to say that after three decades in business, eight of my own startups and over fifty investments, I have never seen a situation where the independent board member had to break a tie. I’d like to think that this is largely because we vet our entrepreneurs and board candidates carefully for a track record of fairness and balanced decision making.
A professional and balanced board adds tremendous stability and legitimacy to an early stage venture. The board protects founders from personal law suits and appearance-of-evil criticisms. As entrepreneurs look to future rounds of funding, a professionally run board communicates to potential investors a desire for transparency and fairness.
A board has many important functions but day-to-day management of the company is not one of them. Entrepreneurs who manage to avoid the creation of a real functioning board are robbing themselves of the benefits a board provides.