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Startup founders often put in years of hard work to get their companies started, pitching their products to many investors to secure their first round of funding. They are then faced with an important question: should they set up a board of directors?
There are many benefits to forming a board of directors early in a startup’s lifecycle. A strong board can help a startup avoid many potential risks early on. But building the right board of directors is also a big challenge because any mistakes early on can be devastating to a startup company. That’s why the leadership of a startup needs to take the time to look at all the options available to them and make the right decisions about setting up a board.
This article will look at how you can build a startup board of directors, how to find the right people for your board, and how the role of the board changes as your company grows with each funding round.
What Does a Startup Board of Directors Do?
The board of directors is the most important part of a startup’s management structure. The direction the startup takes will depend in many ways on the board’s decisions, from fundraising and acquisitions to who belongs in the C-suite and what the budget limits should be.
The board oversees many of the company’s main goals and decisions, including hiring the CEO and issuing stock. A startup board of directors will be responsible for hiring and firing senior management and overseeing the company’s finances through debt financing and equity investments. Compensation in the form of salary and stock options will also have to be approved by the board, including the CEO’s salary.
Startups that incorporate as C Corporations or S Corporations must have a board of directors. Sole proprietorships and LLCs do not need a board.
Members of a startup board can serve as board members, advisory board members, non-voting board observers, and non-active board members. There are several kinds of board directors:
- Common Directors represent the common stock and shareholders. They often include company founders and might consist of seed investors.
- Preferred Directors represent preferred stockholders. A startup’s preferred directors are usually lead investors representing all investors in making their decisions.
- Independent Directors are third-party members whose role is to represent the company’s interest alone. Independent directors do not have stock in the company.
Some startups decide not to have a conventional board until they have outside investors. Instead, they might put an advisory board in place, which can provide advice and investment to the company’s leadership without controlling the founders in the way that a board would.
Deciding on the right strategy for having a board is very important for startups. Many companies wait until they receive Series A funding to put outsiders on their board, and choose trusted advisors and seed investors instead. Once they receive the funding, they can bring in outsiders, starting with one or two venture capitalists (VCs).
A startup board of directors has to ensure that the company is managed with the interest of the shareholders in mind. In addition to providing oversight of the company’s CEO and management team, board members can foster collaboration and strengthen relationships between the company and outsiders. Each board member has their own network of contacts that can serve as important connections to help startup founders and leaders access necessary funding and resources.
Members of a startup board of directors are fiduciaries because they act as trustees managing the business on behalf of stockholders. They have fiduciary duties to the company’s stockholders. That means they are responsible for acting in the stockholders’ best interests and maximizing the company’s value for them.
With those responsibilities come significant risks. Stockholders can sue the startup board of directors if any of the board members fail to perform their fiduciary duties. This could lead to very costly litigation. That is why startups and their boards need to consider having fiduciary liability insurance and especially directors & officers insurance (D&O), which will be discussed further below.
Who Should Be on a Startup Board?
When a company is incorporated, it is legally required to set up a board of directors. The board can initially be as small as just one director, usually the startup founder and/or CEO. As the startup grows and evolves over the course of several funding rounds, the board will expand to include more members. Those can include external investors, independent directors, and board observers.
One serious mistake that startups can make at an early stage is to have a board that is either too small or too large to start. For a new company, three to five directors is often a good number. This will include the founder or founders as well as a seed or angel investor.
A startup board should include:
- The CEO, who is likely to be the founder or co-founder of the startup, and is responsible for running the company
- The Chairperson, who moderates the board meetings and facilitates productive, balanced discussions on issues relevant to the startup’s future. The CEO or founder can often act as the chairperson, but some investors might insist that the two roles remain separate.
- The other Directors, who include executive directors (CEO, CFO, COO, etc.), non-executive directors who are not employed by the company and oversee the executives, and independent directors, who don’t have direct ties to the company.
Hiring independent, outside directors provides growing startups with a valuable perspective different from the company’s internal team. Those directors often have the kind of skills and experience that most startups lack and need.
How to Build a Great Startup Board of Directors
A board can make or break a startup. That’s why building a startup board is so important. Having a great board is all about choosing the right people. When setting up a board, you should look for people with a wide range of expertise and experience to help guide the company. Those can include:
- A financial expert, who can oversee the startup’s finances and offer connections to important funding sources and investors.
- An exits specialist, who can offer guidance while the startup pursues an exit strategy.
- A marketing expert, who can help the board understand the market and audience for the company’s products and services.
- Experts in other important departments such as sales or product development who can provide valuable expertise and insights into the company business.
The right combination of experts to have on the board will depend on the nature of the startup and its business. However, all board members should stay focused on the major goals of the startup and its value to investors and stockholders.
Having the right structure for the startup board of directors is important as well. The board should have written policies and clearly defined roles and responsibilities in place. You might also consider term limits as a condition for board membership.
Startup boards typically meet in person once every quarter. The actual number of meetings will differ based on the startup’s growth stage and the needs and interests of various board members. Startups in the early stages of their development might find it useful for their board members to meet more frequently, either in person or online. During significant events, such as an acquisition, the board will be expected to meet more often than usual to guide the company through the process.
Finding the Right People for Your Startup Board
The importance of the board to startups means that companies should invest the time and resources needed to assemble the best group of people possible. The board of directors needs to be made up of people who understand the company and know the startup’s industry.
There are several factors that go into finding the right people for your startup board:
- Clarify the board positions: all positions on the board should be clearly described in terms of their title and goals so that potential members have a strong sense of what they are signing up for from the start.
- Pick a leader: when choosing members, look for someone suitable for the position of chairperson, who can lead discussions and manage the relationships between the board members.
- Focus on the future: consider both the medium and long-term goals of the company, and each board member’s potential to contribute to the company’s growth.
- Stay objective: as the CEO and founder, you need to put the company’s interests first. That means putting emotions aside and selecting board members you can respect who are interested in protecting the company.
- Look for honest and brave candidates: instead of going with people who will flatter you and avoid disagreement, look for candidates who are honest enough to disagree with you when needed.
- Aim for diversity: having a broad range of directors with different backgrounds will expand the range of opinions and options available to you.
- Have a vision for a shared future: build a board of directors who ultimately share the same goals and vision for your company and stockholders.
How Does the Role of the Board Change as the Company Grows?
The role of the board changes as the startup’s mission and goals change. Startup founders usually have to allocate a seat on the company board to someone who led the initial seed round. Usually, the board at this first stage will include two seats for the founders, allowing them to remain in control of the board, and one seat for the investor.
After that, with each new round of investment, a new board seat is usually given to the lead investor at that investment stage. Startup founders should keep in mind that accepting new investments means making room for the lead investors on the board.
Often, an independent seat is created on the board of directors following the second round of financing, for a person who is not a founder or investor but has valuable expertise and connections in the industry.
As the startup grows with each funding round, so does its board of directors. If the startup board of directors becomes too large, the company can bring in investors who act as observers. They are non-voting members but get to participate in the meetings and decision-making process.
Here is an example of how a startup board of directors can evolve with each funding round:
- Seed Stage: 3 board members (2 founders and one seed investor)
- Series A: 4-5 board members (2 founders, one seed investor, 1 Series A venture capitalist investor, and possibly one independent director)
- Series B: 5 board members (2 founders, 1 Series A VC investor, 1 Series B VC investor, and one independent director)
- Series C: 5-7 board members (including the above, plus 1 Series C investor and possibly one more independent director)
Protecting Your Board of Directors with the Right Insurance Coverage
Each startup growth stage comes with increased opportunities and responsibilities. But that involves taking on more risks, especially since startups have to embrace risk-taking to innovate and grow. The members of a startup board of directors have to make difficult decisions at each stage of the company’s growth. That’s why they need to be protected with the right kind of insurance coverage.
If you’re aiming to attract investors and raise money through venture capitalists (VCs), you will almost certainly be required to have directors & officers insurance (D&O). Most venture capital and private equity firms require startups to have D&O insurance in place before approving the funding round.
D&O insurance provides coverage for board members and executives, offering them protection for their personal assets. It is designed to protect the members of the startup board of directors and company leaders if they are named in a lawsuit alleging negligence, breaches of fiduciary duties, or violations of state or federal law. D&O also protects the company by reimbursing it after indemnifying a director or officer.
Any startup with a board of directors should also have D&O insurance, preferably as part of a larger insurance coverage. Embroker’s D&O insurance policy is specifically designed for venture capital (VC) backed startups. The management liability insurance package combines D&O insurance with employment practices liability insurance (EPLI) to protect startups and their leaders from various common business risks. Embroker’s Startup Insurance Program includes D&O insurance, EPLI, and fiduciary liability insurance for even greater protection.
A startup board of directors plays a vital role in guiding the company forward on its mission to grow. Startup companies should therefore dedicate the time and resources needed to build a solid board of directors that will consist of people who can realize the company’s growth potential, empower its leadership, and maximize its value for investors. Along the way, it is important to have the right insurance coverage in place to protect board members as they take on the necessary risks to help the company grow and innovate.
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