In April 2006, almost two dozen VCs, CEOs, and industry experts came together to form the Working Group on Director Accountability and Board Effectiveness (whew — quite a name! I’ll take the liberty of using “WGDABE” instead :->), chaired by Pascal Levensohn. The impetus for the formation of WGDABE was a sense that VC-backed companies lack metrics for judging board effectiveness, and that having such metrics might help executives and boards assess where board performance could be improved. (That’s probably also true of many non-VC-backed companies, though WGDABE seems to want to focus on the VC subset of companies.)
This can be particularly critical for new ventures, where:
- many directors (e.g., founders, new VCs, first-time CEOs, or industry executives who are serving on a board for the first time) are not experienced in the role of director – for instance, my post here provides some data on how board composition is particularly skewed towards many of these people during the early stages of venture growth;
- dysfunctional board behavior often emerges at the worst times – e.g., when crisis hits or when critical exit decisions have to be made; or
- there may be strong conflicts between the interests of the various parties involved (as I’ve examined in some of my case studies).
Note: In addition to the link above, my other board-related posts have covered the board’s role as a mentor of venture executives rather than solely being a monitor of them, and have presented data on how the board’s composition and functioning is affected by the stage of company development.
Last week, the WGDABE released a white paper entitled, “A Simple Guide to the Basic Responsibilities of VC-Backed Company Directors.” (Pascal’s download form for the white paper is here.) Since my first look at a draft of the paper, the WGDABE has made some nice additions and clarifications, and the official white paper will hopefully be of use to many of the readers of this blog. (As I indicated above, the “VC-Backed” part of the title is a bit too limiting; most of the paper also applies to the broader set of non-VC companies.) In particular, the paper:
- can help educate many founders, non-director senior managers, and other first-time directors about the board’s roles and responsibilities, regarding both business and legal issues;
- highlights some practices that seem to separate effective vs. ineffective boards; and
- provides a user-friendly checklist with which you can evaluate your own board and identify where it can improve.
I also like the fact that this paper is only part of an overall effort to improve board effectiveness.The members of the WGDABE are supposed to be pushing for their own companies to implement the checklist and other parts of the white paper, and the WGDABE is planning to do follow-up analyses of whether those companies gained any of the expected benefits from doing so. (They’ll hopefully get a large enough sample and do a rigorous enough set of analyses that they’ll be able to draw statistically- and practically-significant conclusions!) At the least, it’s an interesting experiment in improving governance, and if it reaches its full potential, it could be quite a productive effort.
Great post! Something the paper hints at, but doesn’t directly address is the issue of “board succession.” Much has been written on the topic of “CEO succession” and how certain CEOs are “startup-,” “growth-” or “exit-” stage CEOs. Often times (particularly in the VC community) CEOs are labeled as “Series A/B” (i.e. early stage) or “Series C/D” (i.e. growth or exit stage), but I have not heard that applied to directors.I wonder how early stage venture funds think about board membership in growing companies. Does the company ever outgrow a board member? Have you ever heard of a VC firm voluntarily giving up a board seat because they don’t feel they are meeting the expectations described in Pascal’s paper?Every A-round VC investment I have seen includes perpetual rights to a board seat (which can sometime be negotiated away during negotiations for future rounds), but I’m curious to hear if any entrepreneurs out there have managed to sunset board seats or to put performance/expectation requirements on keeping them. Or even better yet, stories about a VC board member who voluntarily raised there hand to say, “we need to get someone in here with more experience because I’m not meeting my own expectations.”
The issue of VC director succession is not a mystery- it is discussed often among board members of early stage companies. A natural time for this discussion to occur is in advance of a new round of financing. Depending on the board’s early structure, this may be an easy discussion or a difficult one. New capital has a “natural gravity” impact on board composition. If a new investor completes thorough due diligence, the need for any board optimization should become apparent early in the process- it is usually not a mystery. It often makes sense for the new investor to specify the board size and composition in the term sheet as a condition of the financing. During more difficult board composition transitions, such as during a recapitalization of the company or a down round, the lead investor should take advantage of the opportunity to “refresh” the board and require a board reconfiguration as part of the financing. One of the goals of “A Simple Guide…” is to create a forum for board skill set discussion through peer review. This will allow directors to comment on signs that there are underperforming directors on the board early and address precisely the issues raised by Anonymous in a less confrontational manner. In my own experience, we have successfully restructured a number of boards across a wide range of circumstances in order to maximize the positive contribution that the board can make to the commpany.
In terms of measuring the effectiveness of a board in a start-up, I was wondering whether some lessons can be drawn from the existing body of research focusing on measuring board effectiveness in large corporations.See below two interviews from HBS Working Knowledge, both from HBS professors, for discussions on such research:<>Mapping Your Board’s Effectiveness, by Robert Kaplan<>.:< HREF="http://hbswk.hbs.edu/item/4341.html#1" REL="nofollow"> http://hbswk.hbs.edu/item/4341.html#1<>.<>How to Build a Better Board, by Jay Lorsch<>.:< HREF="http://hbswk.hbs.edu/item/3834.html" REL="nofollow"> http://hbswk.hbs.edu/item/3834.html<>.The reason I argue that valuable lessons could perhaps be drawn from large corporations is that I think the fundamental challenge for board effectiveness in startups and large corporations is the same : <>how to keep the board strategically involved in the firm’s decision making <>.Practically, this means having the board involved as an advisor in the following types of decisions: - performance appraisal (evaluate management),- long-term goals (corporate policies, plans, etc…),- capital allocation, strategic planning- HR planning (elect top management and succession issues)- Etc…On this, Kaplan notes (in the above cited article):<> “To engage board members’ expertise <>much more around the strategic direction<> that the company is taking would require giving different types of information to board members and having different discussions in board meetings, but the effort to revamp the meeting process and agenda would be <>well worth the trouble<>.” <>Again, the effectiveness of a board should be measured against the role it is invited or expected to play. There is obviously some dual purpose the board, in terms of legal and business responsibilities. Therefore, it should naturally serve as a <> “monitoring” (legal) as well as a “mentoring” (business) function<>. This relates to Noam’s previous post on < HREF="http://founderresearch.blogspot.com/2005/09/building-board-mentorship-monitoring.html " REL="nofollow"> Building a Board: Mentorship? Monitoring?<>.It is debatable which of these two roles is more important at which point in a firm’s development, or perhaps both should permanently co-exist. My personal opinion is that the “mentoring” function for the board is more critical in the context of a startup (where the CEO is often less experienced and the business model needs refining from more mature perspectives), while a larger corporation generally would tend to profit more from the board playing a “monitoring” function (due to the larger complexity of the firm and its more laborious capital allocation process). However, the opposite could also be argued.On this, Lorsch notes (in the above cited article):<> “The design that a board chooses depends on the <>role that the board decides to play<>. And boards do have a lot of leeway within legal frameworks to decide exactly what they’re going to do, what decisions they’re going to make, what things they want to monitor and oversee, and also the areas in which they want to offer advice and counsel to their CEO.” <>Thus, while the main challenge of the board is the same, firms in various stages of development needs different types of board members. See Noam’s previous post < HREF="http://founderresearch.blogspot.com/2005/09/building-board-impact-of-company-stage.html " REL="nofollow"> Building a Board: The Impact of Company Stage <>.To contrast this difference further (in terms of mentoring vs. monitoring functions), we can illustrate by looking at the selection criteria for directors for large vs. small corporations.From a large corporation perspective, here is Warren Buffett’s “director selection criteria” from his 2006 shareholder letter:<>In selecting a new director, we were guided by our long-standing criteria, which are that board members be owner-oriented, business-savvy, interested and truly independent… Charlie and I believe our four criteria are essential if directors are to do their job… Yet these criteria are usually ignored. Instead, consultants and CEOs seeking board candidates will often say, “We’re looking for a woman,” or “a Hispanic,” or “someone from abroad,” or what have you. It sometimes sounds as if the mission is to stock Noah’s ark. Over the years I’ve been queried many times about potential directors and have yet to hear anyone ask, “Does he think like an <>intelligent owner<>?”… <>Buffett obviously places the emphasis on his ability to have board members that act like owners, meaning they will monitor corporate activity and books as if they were the owners.From the start-up perspective now, here is a quote I came across and liked from Brad Oberwager, CEO and founder of startup juice and produce company Sundia, who just landed outgoing Sunkist CEO Jeff Gargiulo to serve on the board of his startup:<>“The people on my board are people I would love to hire but could never afford. They sit on our board because they’re excited about our company and want to have a real impact.” <>Oberwager places the emphasis here rather on the advisory/mentoring nature of his future ideal board members, rather than strictly on their monitoring capability.Therefore, again, the main fundamental challenge (keeping directors strategically involved) of the board is very similar or same for startup and large corporation, independent of size. On the other hand, I think the director selection criteria (illustrated above), the governance mechanisms and the effectiveness measures will all show some significant differences in startups vs larger corporations.Therefore, this seems to imply that we could not simply import from large corporations the existing board governance mechanisms (like balanced scorecards, for example) for start-ups. I think the main differences with startups in terms of measuring board effectiveness stem the <>capital raising process<>, which almost inevitably generates additional conflicts of interest and poses different new threats to effectiveness.But, in the end, the questions persists: - How do I assess the actual effectiveness (or even better, the value) of my board of directors in a start-up vs. in large corporation? - What are the key differences, and why? - What are the metrics? - How are they related to how fast and how smoothly they help us meet the growth objectives of the firm?