by Evangelos Simoudis, Ph.D., Senior Managing Director at Trident Capital
One of the hardest and most critical decisions every entrepreneur has to make concerns the selection of independent members for their company’s board of directors. As an investor, I’ve seen even experienced entrepreneurs often use wrong criteria or misplaced priorities in making this decision. As a result, they bring individuals to their company’s board of directors who are better suited for the company’s board of advisors.
There are several reasons for a startup to recruit independent members to its board of directors:
- Coach the CEO to help them become a better executive
- Help the company establish or refine its business model
- Balance out the investor board members
- Improve the corporate governance
- Increase the company’s brand while providing customer and partner introductions
These reasons change during the startup’s lifecycle. For example, it is not uncommon for an early stage company that is led by a first-time founder/CEO to recruit an independent board member to work closely with the CEO to help them improve their executive skills. In many such occasions, we find that the independent member becomes the board’s chairman. When the CEO needs a lot of help, the independent board member takes an additional hands-on role in the company’s operations and is elevated to the role of executive chairman, implying that, in addition to chairing the board, they become a member of the company’s extended management team. As its needs evolve with growth, a startup may need to change independent board members. For this reason, independent board members are elected for a particular time period, typically two years. Their appointment can then be renewed as appropriate.
The selection of the right independent board member is particularly challenging, since a board of directors typically has one to three independent board members, whereas, as I discussed in my previous post, a company may have several advisors.
The selection of an independent board member is a matter handled by the startup’s entire existing board of directors. This is because of the position’s importance and also because it is necessary to ensure that the independent members have the right chemistry with the rest of the board. In a typical startup, the initial board of directors consists of one or more of the company’s founders and its investor representatives. If the company has a CEO who is not one of the founders, then the CEO is also a member of the board. In later stage companies, the board may appoint a search committee consisting of a few board members to identify a suitable independent board member.
Because of the role’s importance, it is necessary to ensure that the candidate independent board member is willing to undertake the expected responsibilities and devote the right amount of time. For example, early stage private companies hold a board meeting every four to six weeks. Late stage companies may hold four to six board meetings per year. Early stage companies frequently interact with their board members even outside the board meeting. Board members of later stage companies may meet less frequently as a board, but they have heavier committee-related work than those of startups. As a result, we expect that an independent board member will be able to spend around 50-60 hours per year fulfilling their responsibilities towards the company. It is therefore important to find out whether the candidate will be able to allocate the expected time.
It is crucial to identify the number of boards the prospective member is already serving on or intends to serve on. This will enable you to determine if there are any conflicts between these companies and yours, as well as how much time the candidate can devote to your board. In addition to the time commitment, you will also need to determine if the candidate is willing to become a member in board committees, particularly the audit committee. Many candidates don’t want to serve, or don’t have time to serve, on board committees. Finally, we expect the independent board members will be able to participate in-person in at least 80% of the board meetings. This is because face-to-face interaction between the board members themselves, as well as between the board members and the executive team (which typically participates in the board meetings), specifically the company’s CEO and CFO, is important and benefits the company. You will need to ensure that the board member can accommodate this. These requirements and expectations can further limit the board candidates a startup will be able to consider.
Unless there is a need to help the company’s CEO, startup companies should operate at least a couple of years before recruiting an independent board member. This way, the company’s board (founders and investors) has the opportunity to gel and learn how to work well together — something that doesn’t happen from day one. Even after a sufficient amount of time passes, it is important to ensure that every independent board candidate has the right chemistry with the rest of the board members. I’ve seen several boards eliminate independent candidates because of the lack of chemistry, despite their strong qualifications. Founders and CEOs must work with their investors to find the right independent board members. A good way to start is by creating a specification that reflects the company’s priorities and needs. Don’t select a board member so that you can say you have added an independent member on the board. Select with purpose.
It’s also important to note that independent board members are compensated with options that typically vest during the time of their appointment, which is typically two years. Some board members, such as executive chairmen or members of pre-IPO companies, may also receive additional cash compensation.
When building your board, remember that a strong candidate must have relevant experience, be willing to undertake the board activities including committee work, be able to devote the right amount of time to their position, and be able to provide introductions to prospective customers and partners.
Evangelos Simoudis, Ph.D. is a Senior Managing Director at Trident Capital, where he focuses on investments in Internet and software businesses. Find him at blog.tridentcap.com and on Twitter: @esimoudis.