If you’re following the advice above and looking to incorporate in Delaware as a C-Corp to raise funds from investors, a board of directors is required by law. Not only is it required by law, your investors (especially when you raise venture capital) will also expect to be directors on your board.
Board Structure & Size:
- There are two dominant board structures: unitary and two-tier. Your board will be unitary. This effectively means that there will be a single, non-hierarchical board of directors. In general, U.S. corporate law does not recognize a distinction between board members and every director has equal responsibility and power. The two-tier structure is more prevalent overseas and consists of a supervisory board and a management board, with no overlapping directors.
- Board members are elected. Stockholders elect the board of directors to look after their interests. When you receive funding, you will sign a number of legal documents. Your term sheet will likely include a requirement to elect the investor to the board of directors. You will also have to sign and file additional legal documents. Your investor(s) will have an attorney and you should too.
- Expect the board of directors to be 3 or 5 people. This will consist of 1 or 2 founders, 1 or 2 venture capitalists and 1 mutually agreed upon independent. As a rule of thumb, the number of board members will be odd in case of a vote.
- The board will act as a “committee of the whole.” At this stage of development, you won’t have an audit committee, nominating committee, compensation committee, etc. Essentially, you will have a small board that takes on all of the responsibilities.
Independent Director Definition & Value:
- The definition of an independent director varies. This is true from country to country, business type to business type or even from exchange to exchange. Items that cause this variation include the definition of controlling shareholder interest, the definition of “affiliation,” the amount of money received in payment for services, donations, property, etc., at any time over the course of a number of years. Click the link to see Nasdaq’s definition.
- Your independent(s) must have courage, the will to act and be decisive. If the independent cannot drive consensus, strive to resolve the tough challenges between management and investors or prepare to object if management or the investors are “not playing by the rules,” who will?
- You may need a voice of reason if, and when, investor board members and executive board members disagree. Disagreements can occur when determining valuations and ownership percentages, when to shut the doors, when M&A activity is appropriate, when to IPO, when additional financing is required, etc.
- You may need more hands-on, action-oriented directors at the early stages. This allows a company to gain valuable expertise that might not otherwise be available internally. The more involved directors give you the opportunity, in the most economical way, to gain additional insight, relationships or “access.”
- Outside knowledge and perspective to help avoid fatal mistakes. The right combination of board members can act as a well-rounded “think tank” to help identify and avoid big issues.
- Attracts financing. The recruitment of a key independent board member may send a positive signal to investors that may not have otherwise been interested in the company.
- Attracts employees. The recruitment of a key independent board member may send a positive signal to potential employees that may not have otherwise been interested in the company.
- Value you otherwise couldn’t afford. You might not have been able to afford their salary and benefits, but you might be able to afford them with equity.
Board Roles & Responsibilities:
- Provide general oversight of the business on behalf of the shareholders. The fiduciary responsibility aligns with the interests of the shareholders.
- Nominate suitable candidates for election to the board. Besides nominating the candidates, the board will also decide when to expand or contract the board, determine board needs, provide the orientation of new members, etc.
- Evaluate board processes and performance. The board ensures accountability, identifies and measures key metrics and indicators, selects and oversees auditors, compensates consultants, etc.
- Discuss, review and approve corporate strategy and direction. The board will advise management on significant issues, investments, M&A activity, strengths, weaknesses, opportunities, threats, etc.
- Act on specific policy recommendations and mobilize support for decisions made. Board votes should help legitimize and finalize decisions. Board members should then stand by, support and, if need be, evangelize these decisions.
- Select, encourage, advise, evaluate, compensate and, if needed, replace the CEO. Responsibilities include CEO mentoring, guidance, succession planning, compensation, evaluation, etc.
- Ensure that necessary resources are available to the CEO. This includes human resources, capital resources, strategic resources, etc. The board will help raise money, help mobilize volunteers, help recruit key hires, etc.
- Provide a buffer for the CEO. The board will “take the heat” from special interest groups, from “outsiders,” and from activists. This allows the CEO focus on building the company.
- Monitor organizational performance. This includes focusing on broad trends, marketing analysis and overseeing emerging challenges. The results of this will include more strategy and direction, less micromanagement and an overall efficiency.
- Ensure organization operates responsibly and effectively. The board ensures that the organization conforms to legal, ethical, moral and community standards. In many cases, “perception is reality.”
This is a tall order for most early stage startups where there are only 3-5 people on the board of directors and the founders are primarily focused on developing their product or service while the investors are busy drumming up new deals and likely sit on multiple boards. Considering this situation, your choice for an independent director is critical.