Often startups and early stage companies struggle to find willing board members. There are certainly material risks associated with board service, and these businesses frequently do not have the funds to cover the cost of D&O (directors and officers) insurance (which is the subject of an upcoming article).
As a result, it can be very difficult for entrepreneurs to engage quality board members.
Often, founders will overcome this challenge by appointing family and friends to their boards, if they have a board at all. Having a board, even if it is populated with family and friends, is an essential requirement for fundraising.
Without a board, investors are usually very reluctant to invest, since they will have serious concerns about corporate governance — who is watching their money to ensure it is being spent to further the stated business objectives upon which they made their decision to invest?
As with many aspects of getting a business up and running, structuring a board seldom is a top priority for entrepreneurs. In my experience, founders usually put off engaging board members until they develop the business to a point where they need to raise funding. Only then do they scramble to find willing board participants.
The rush to secure board members typically results in, as stated above, the necessity of seating family and friends. What is needed for board service is at least some independent members.
What does “independent” board membership really mean?
An independent board member is one who does not have a direct, existing personal or business relationship with the founder(s) or other C-level management team members. It is someone who typically comes from the same or a related industry, and who understands the intricacies of operating a successful business within the target industry.
Often a lead investor can be a valuable independent board member, especially if they made their money through building and selling a successful business within the target industry.
Independence means that the board member can make decisions unencumbered by any pre-existing relationship, duty or obligation — real or perceived — to or with the founder(s) or other management team members.
The negative consequences of having a board without independent directors are well-documented. One of my favorite examples is Suntech Power, the first major Chinese solar company to list in the United States, and was led by founder and CEO Shi Zhengrong.
Shi failed to secure an independent board; made a series of very poor decisions, including locking the company into long-term contracts to buy silicone at high prices, using a massive amount of debt financing, including a lot of short-term debt, the repayment of which far exceeded the company’s cash flow generation; and continued to expand operations even as the industry became highly commoditized, and the 2008-2009 global financial crisis loomed.
Elon Musk is another example of a founder and CEO who could use an independent board. Tesla is imploding as I write this article. Musk is clearly out of control and there is no one to step in and stop him from destroying the company. An independent board would, in all likelihood, fire him as CEO, or at a minimum, reign him in.
An effective board hires the CEO, and fires the CEO, if they do not conduct themselves in a manner that is in the best interest of the shareholders. Clearly, this is not occurring at Tesla, but there is no independent board to stop Musk from destroying the company.
Rather than waiting until the last minute, when the business is in dire need of capital and the entrepreneur has little time to seek qualified, independent board candidates, the smart entrepreneur will plan ahead, securing valuable board members at the earliest possible time.
One way to find quality candidates is to seek out experts in the industry as mentors or early investors. Angel groups that focus on the type of business or industry within which the company operates are a good place to start.
Many angels are more interested in providing their expertise than their capital. Often, the best way to get an angel investor interested in investing in the business is to first engage them as a mentor or consultant.
In my experience, having a “champion” within the angel group — a member of the group that recommends the company to the membership — is the most effective way to generate meaningful interest within that angel group, in terms of securing funding from the membership.
Regardless of how the entrepreneur goes about finding independent members for his or her board, the importance of securing those independent members cannot be overstated. As stated above, waiting until the need for external investment capital before starting a search for board members is almost always ill-advised.
I recommend starting to engage potential board members immediately after formation of the legal entity for the business. This process can be time-consuming, and finding appropriate and willing board members will take significant effort. That effort will be well-rewarded when the time comes for raising capital.
— Craig Allen, CFA, CFP, CIMA, is president of Allen Wealth Management, and has been managing assets for foundations, corporations and high-net worth individuals for more than 25 years. He can be contacted at craig@craigdallen.com or 805.898.1400. Click here to read previous columns or follow him on Twitter: @MPAMCraig. The opinions expressed are his own.
