Tuesday, July 22, 2014

Should Startups Have Boards of Directors?

All corporations are required to have a board of directors by law. LLCs are not. However, an LLC can be structured so as to have a board of managers (some even refer to managers as directors). At formation, founders become the sole directors of their startup corporation. They alone are responsible for the long-term vision and the daily management of their company. Creating a real board of directors may be viewed as giving up control. However, at some point the board composition is likely to change. The question is: do all startups need to have a board of directors? And if yes, then at what time should they create one?

In my opinion, not every company needs to have a board (or, if it is a corporation, then a board that has outside members). If a founder prefers to closely manage the affairs of his or her company, then having a board of advisors may be sufficient. A board of advisors is an informal body that usually consists of industry experts. A CEO may consult any of the advisors throughout the year on an informal basis, through a series of meetings or conversations, but ultimately, all decisions are the CEO’s.

A start-up may, however, be asked to create a board regardless of how the founders feel about it. This typically happens if the startup is about to receive an investment and the investor wants a seat on the board. This is not an unusual request. So, if a board of directors were to be created, what would the ideal board look like?

An ideal board would be (mostly) independent and active. Its members would have a lot of experience and advice to share with the founders. A perfect board would have a financial expert, a marketing expert, persons who have previous startup experience, connections in the industry, and connections with potential investors. The perfect board would be there to help, not judge. The majority of its members would be outsiders, and would not be influenced by other motives (such as, for example, the need to make a successful exit in 7-10 years).

A startup does not need to have a large board. Typically, 5-7 members is perfect. Personalities of directors are also important. The board has to function well and efficiently as a unit, and get along well with the management. A board should meet monthly (or quarterly) and discuss the long-term strategy of the company. The day-to-day operations are left to the management. The board reviews the management’s performance and determines their bonuses on a yearly basis. This means that, if the board is not satisfied with the performance of any of the managers (including the founders), it can fire them. Unfortunately, this does occasionally happen. It recently happened to one of my clients, who originally created a board comprised of industry experts and then the board voted to fire him. Of course, this created a ton of emotions and negative feelings. All I can say is that founders should ensure that their vesting accelerates if they are fired for “no cause” or are asked to leave for a “good reason.”

The board members do not receive much compensation. This is not why they serve on the board. They typically get reimbursed for expenses incurred in attending board meetings and are given restricted stock or stock options.

Directors in a corporation owe fiduciary duties to the corporation and its shareholders. These are duties of care and loyalty. I previously wrote about them, and the business judgment rule, here and here. The corporation should ensure that, when creating the board, its articles of incorporation are amended to limit directors’ liability to the maximum extent allowed by law. Also, the corporation should consider getting a D&O insurance (although it can be expensive and cost prohibitive for a startup).

In conclusion, I would note that creating a helpful, independent and active board can certainly bring your company to the next level. This is the necessary step in transitioning from a startup to a “grown up” corporation.  Last, but not least, read this book "Startup Boards: Getting the Most of Your Board of Directors" by Brad Feld.  He really knows what he is talking about.  

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

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