March 17, 2019

When to Form a Board of Directors (It's Never Too Early), How Much to Pay Your Board Members, and How to Work with Your Board Outside of Board Meetings

Initial board of directors of
Yeeko Inc. where I serve as
the board's chairman
The previous post on this blog focused on EY's annual report on top priorities for boards of directors of companies in the United States. This topic connects well with an event I attended on Mar. 6, 2019 about startup board management. The event featured Len Jordan, Managing Director of Seattle, Wash.-based Madrona Venture Group; Forest Key, founder and chief executive of Pixvana, a Seattle software startup; and Alan Smith, partner with Fenwick & West, a law firm. Erika Shaffer, Madrona's director of strategic communications, authored an article that provides an excellent summary of the panel discussion.

Based on my professional experiences, I strongly agree that it is never too early for a startup to form a board of directors. Ms. Shaffer's summary notes that "[i]n the early (pre-A series) stage, your board should be small – you, an angel investor, an independent advisor with strong business and domain expertise – would be a good size. You have to keep in mind that as you add investors in venture rounds, those investments usually come with a board seat. And if the board gets too big, it's not that useful."

Brad Feld, a partner with the Foundry Group, a venture capital firm headquartered in Boulder, Colo., wrote an op-ed, "Start Building Your Board Early," in the Wall Street Journal that accurately explains: "Boards of directors play different roles at different points in a company's life. Early stage board of directors should be focused on being an extension of the team, helping the entrepreneurs get out of the gate, and get the business up and running."

Mr. Feld further says that "[w]hile you will eventually have investors on your board of directors, I encourage all entrepreneurs to add at least one outside director early on in the life of the company. The best early stage directors are other CEOs who can be peers to the founders and help them with things they don’t understand, are struggling with or are just missing. These CEOs should be more experienced or have different experiences, but they should also understand your domain and be willing to commit the time to helping you."

On the topic of compensating board members, the three panelists agree, according to Ms. Shaffer's article, that "[i]nvestor board members generally do not receive compensation from the company but independent board members and advisory board members need to be compensated. You would want to draw up agreements for each of these members that outlines the payment and vesting schedule – and puts some time limits in place for re-evaluation. Typical compensation is a standard stock option grant in a range between .25-.5% of outstanding equity. The amount should be the same for every director."

While the panelists did not provide recommendations for how much to pay independent directors, Bernie Tenebaum, Managing Partner of Lodestone Global, wrote an article, "How Much Should I Pay My Directors In 2018?" presenting the following highlights from his firm's Private Company Board Compensation Survey for 2017-18:
  • Median total compensation was $39,700, with Technology and Real Estate firms leading all industries. Total compensation was ~10% higher than the $36,000 reported last year (see chart below). This 10% increase (6% in 2016) is the result of increases both domestically (+14%) and internationally (+5%);
  • Median total compensation was $41,000 for U.S. directors vs. $37,700 Internationally;
  • Boards continued to have a strong impact on company performance, with 97% of companies reporting increased revenues and 95% reporting increased EBIT (earnings before interest and taxes); and
  • These results support the notion that a board, particularly with the right directors, can be essential to achieving corporate goals and improving profitability.

Source: Lodestone Global

Mr. Tenebaum adds that "51% of the survey respondents were family owned companies. The high participation rate of family majority owned respondents highlights the importance of professional corporate governance to family companies. The median number of board members was 6, with 3 independent directors. This has not changed over the seven years the survey has been running. A significantly larger board leads to inefficiencies, while a smaller board risks limiting diversity of perspective so essential to driving effective strategy."

"How do you work with your board outside of board meetings?" is a question I often receive from startup founders and small businesses owners. I agree with the three panelists who collectively said regular communication with board members is highly encouraged. They further recommend sending weekly or monthly updates (depending on size and your inclination) and do not hide the bad news. "Put that upfront and be transparent," one panelist said. I also support their suggestion of business owners or chief executives scheduling one on one meetings with board members outside of the board meeting. "That is where good ideas come up and you can more easily discuss challenges."

Lastly, Mr. Jordan of Madrona referenced a guest post he wrote for TechCrunch where he provides the following ten tips on how to work with your board of directors:

1. Have a plan, and get your entire company and board to understand and support it.

"A company's business plan and strategy is the map of where we are going. The plan almost certainly will change, but the best CEOs keep everyone informed about where we said we are going, where we are currently going, and why we changed plans if we did."

2. Tell us if the plan changes for "small reasons."

"Most plans change for tactical reasons — e.g., the product is earlier/later than expected. Or customers are adopting/buying earlier/later than planned. I like a process in which, if the plan shifts, the CEO pre-emptively throttles the investment/spending without being asked. For example: tell us what level of business progress/metrics (e.g. downloads, installs, usage, trials, bookings, contracts closed, etc.) you want to see to feel good about spending to the plan (or below it if necessary), even if we are not yet certain about exceeding revenue during the current period."

3. Tell us if the plan is changing a lot for "big reasons."

"Sometimes plans need to change for strategic reasons. The best CEOs are continually testing and retesting their basic hypothesis. Is there still a fundamental problem we are solving, or market opportunity we are addressing? Are we still pursuing the right product? Are we selling to the right customers? Are the ways we are selling and marketing right for the market and product? Are we as competitive as we thought? Is our team as good as we had hoped?"

4. Strategy mistakes are harder to admit than execution mistakes.

"It's hard to admit when a strategy is flawed. It’s very easy, on the other hand, to decide that the market, customer and product thesis is correct but sales-and-marketing execution is weak. I've seen too many companies delay making a tough strategy choice by first trying to fix the flaw through a change in execution. If execution is flawed, fix it, but look beneath the veneer to make sure the substance underneath is sound."

5. The average of two strategies is usually not a strategy.

"Whether you have a board or not, you have to commit to a cohesive strategy. In tennis you can play at the net or the baseline, and both can be great strategies, depending on the circumstances. The average of the two — playing in the middle of the court (commonly referred to as 'no- man’s-land') — is the worst place to play and is never a good strategy. Too many startups split the difference: They continue with the old strategy, add a new strategy (like a new product), under-resource both and fail at each."

6. Email is good for delivering straightforward information; board meetings are good for explaining complicated information and discussing alternatives.

"I love short (above the fold) weekly email updates from CEOs on key progress points (product development, hiring, revenue, key partnerships, etc.), but it's OK if they are less frequent (coming every other week, or once a month). But bad news should travel fast—this includes losing a key customer, a key engineer quitting, etc. The road has bumps; I'd rather know about it when it happens than after it leads to some other issue (like a product delay or a revenue miss). Also, I'd prefer that problems/opportunities not only get communicated, but that options be developed to address the problem or opportunity. Frame the situation and assess the pros and cons of a few choices—it makes it easier to help come up with a reasonable solution."

7. Board meetings are not pitches. You have our money, so let's figure out what to do with it.

"The best way to earn trust from your board is not to tell us what's going well; it's to tell us what's not going well. Better yet, make everything run well but tell us the things you want to focus on that could become problems if not addressed. If you do #6 , the board meetings can be less about updating the board and more about discussing key strategic choices/decisions and ways we can better tune our execution. A basic review of financials, customer progress, product development, partnerships, hiring, etc. would be great, but we'd also like you to expose key strategy elements (SWOT) and get us to discuss and react."

8. Ask for help — we work for you. Really.

"We like helping recruit employees and partners (customers). Put us to work, let us brag about you to potential employees and provide context and support. We can assist with strategy questions. You should know more about the business than we do, but our distance can provide perspective. And perhaps we have seen patterns that can be applied from other experiences. This can be incredibly valuable as long as we don't over or mis-apply the patterns in the wrong instances based on the wrong attributes."

9. Involve your exec team with the board.

"It's good practice to have at least one board member interview all exec hires; different perspectives can be good. Having the exec team in the board meetings can be great, especially if they present the area of their responsibility (product development, sales, marketing, finance). That said, it's also important to have a closed session of the board that is just the board plus counsel, to discuss board-only matters."

10. Tell us how we are doing.

"We hope to add value but will make mistakes and can often manage things better. Tell us about these areas and we will try to get better. We will do the same with you. And tell us when we should stay out of the way — you run the company, and sometimes the best thing we can do to help is let you do that.

"The average early stage company takes nine to 10 years before it will exit. So we likely are going to work together a long time. Let's make it productive, rewarding and fun."

What recommendations do you have in effectively forming and utilizing a board of directors?

Aaron Rose is a board member, corporate advisor, and co-founder of great companies. He also serves as the editor of GT Perspectives, an online forum focused on turning perspective into opportunity.

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