Everything You Need To Know About Building the Best Board of Directors for Your Company
Over dinner recently, my 14-year-old daughter asked me when she would be allowed to drive. My first inclination was to tell her that she would never need to drive, because Tesla was going to figure out this self-driving car thing in the next 24 months. Unfortunately, I realized that I was probably part of the last generation of fathers who would have to deal with this rite of passage (thanks a lot, Elon). “You can drive as soon as you’re ready,” I told her. “For some people, that is when they’re 16 years old, for some people that is never.” (Insert your favorite bad driver joke here.)
A few weeks later, I found myself giving a successful entrepreneur friend the same answer, “As soon as you’re ready,” to a different question:
The entrepreneur had grown his business from five to 75 employees in 10 years, but it had begun to nag at him that he might need to create a formal board of directors for the first time. Reluctant to turn his “baby” over to a group of strangers, he had his doubts. Aren’t boards just a bureaucratic waste of time? What kind of control does an entrepreneur give up when creating a board? What was his company missing out on by not having a board?
Establishing a formal board of directors isn’t necessary for all entrepreneurial ventures — venture-backed companies routinely start out with a board from day 1, but privately held companies, those that bootstrap their way to success, may be small enough to navigate day-to-day operational issues without one. There are a few scenarios where creating a board not only makes sense but can be a critical part of growing the business to the next level.
One example is if the owners are contemplating big moves. Businesses that have significant growth opportunities or face significant threats or decisions can find a board very helpful. In these situations, the perspectives of talented professionals who have experience in new markets, in a particular expertise like mergers and acquisitions or partnerships, can be extremely helpful.
Or if the CEO or owner decides to step down, a board can provide effective oversight and support to a new CEO. Boards can also be instrumental in finding a new CEO, supporting his or her transition, and holding the person accountable to the owner’s objectives. In this case, board members with previous CEO or other high-level executive experience can be particularly helpful.
In my friend’s case, he thought a board would help with his plan to bring his children into the business. Parents often find it difficult to orchestrate the handover of the keys to the family business. A board composed partly of senior and next-generation family members can be an important part of the succession process, in which parents, adult children, and advisers can discuss business issues and make decisions together. This gives the parents a chance to teach, the children a chance to learn, and allows both generations to raise their game with the help of experts from outside the family.
For many entrepreneurs who have become successful doing things their own way, the formality of board meetings, like those we’ve seen in the movies, can be off-putting. But that doesn’t have to be the case. There are a range of board types to consider, each appropriate for different situations.
1. A board of insiders
This is a board composed of shareholders and company executives who come together to make decisions on key issues related to the business. It can resemble an executive committee or other senior leadership group. This type of board can be appropriate for closely held businesses that are not necessarily facing major issues, but want to lay the foundation for the future by taking some of the first steps toward more formal governance.
A board of insiders can also be an effective way to involve the next generation of family owners in the process of making major decisions. These types of boards are relatively easy to assemble, requiring little if any legal setup, and can be an effective forum in organizations that lack sufficient debate and interaction at the senior leadership level.
2. An advisory board
Advisory boards are generally composed of a combination of insiders and outsiders, but they don’t hold their positions on the board in an official capacity. Owners get the benefit of outside thinking and expertise, but in a less formal context.
Advisory boards work well for owners who are not ready to give up any control, but want advice and support on a range of issues. This can apply to businesses that have a relatively small ownership group that are facing major long-term strategic issues in which a consistent, outside perspective can be helpful.
3. A fiduciary board with a minority of independents
Fiduciary boards have a formal role in the organization. The members have decision-making authority laid out in the corporate bylaws and are also subject to the liability associated with board membership. Keeping the number of outsiders–those unaffiliated with the company or the ownership group–in the minority keeps the decision-making firmly in the hands of insiders. This can be more comfortable for owners who want to maintain their authority while moving to more independent oversight.
Ownership groups that are considering major changes in their ownership structure, either by raising capital or selling a part of the business, may elect to form this kind of board to demonstrate a level of governance and oversight that will be important for outside investors.
4. A fiduciary board with a majority of independents
This is what you see in most public companies and many large privately held companies. With a majority of outsiders, the board generally functions more objectively and independently than if it were dominated by insiders. While still acting on behalf of the owners, the board is more likely to drive the strategic agenda and have more authority.
These boards also typically can and need to attract members with a higher level of expertise and experience. Most privately held businesses that pursue this route have an ownership group that, for a variety of reasons, has decided to turn the majority of the key decisions over to a board. Perhaps the founders have sold their stakes in the company, ownership has passed on to a next generation of owners who don’t know much about the business, or the owners are preparing to go public or pursue some other liquidity event.
Once you’ve made the decision to proceed with forming a board, how do you actually go about doing it?
- For a first-time board, you should aim for five to eight members, to ensure a range of opinions but not so many that everyone will be fighting for airtime. I advised my friend to look first for people in his network before going to a search firm or recruiting more broadly.
- With regard to pay, you should expect to pay board members enough to make them feel appreciated, but not so much that they feel like they are doing it for the money. One useful rule of thumb some companies use is they compensate the board at a daily rate equal to the CEO’s effective daily rate.
- Finally, no friends, customers, suppliers, or personal trainers. Even one person who is obviously underqualified or has a conflict of interest can compromise the effectiveness of the board. Everyone you choose for your board should be there because he or she has something to contribute and is willing to deliberate the issues carefully before, during, and after the meetings.
Once the board is up and running, here are a few guidelines to get the board off on the right foot.
- Make sure the board functions well as a team. Just like a sports team, it’s as important to get a group who work well together as it is to get people with the right experience or expertise. Effective discussion and decision making requires good chemistry, so interview for personal fit and character as well as what is on the résumé.
- Give the new board members some breathing room to be effective. Initially, it can be tempting for you as the owner to set the agenda, dominate the discussions, and focus only on what you are interested in. You need to make sure you are listening, especially early on. After all, you formed a board, presumably, to get support and guidance from others. Consider going as far as giving the chairmanship or other important responsibilities to other members of the board to distribute the balance of authority.
- Define the board’s authority clearly. Be clear about what decisions they can make and which ones they cannot. This will help focus the discussions on what they can affect and reduce confusion between the roles of the board, owners, and CEO.
- Finally, set the tone that every board member works on behalf of all shareholders. It can be tempting for board members to align with one or a group of shareholders, especially if they were introduced to the board by said shareholders. For the board to stay focused on what is best for the company and thus the entire shareholder group, they should avoid pushing a particular shareholder’s agenda.
To address your fear of somehow losing control by bringing in a formal board, it’s important to make clear that the board reports to you (and your partners) as the owners, not the other way around. This is generally documented in the corporate bylaws. You, as owners, will retain the ability to make the key decisions, including selecting board members, while delegating only the decisions you choose to the board.
Many owners look back at the founding of their board as a critical moment in the long-term success of their business and in their own success as owners stepping away from the business. Understanding that boards can be designed to fit the unique needs of every business can ensure that you get the expertise and support you need without the unnecessary bureaucracy or any unintended loss of control. Like my friend, if you consider the range of options for how to build a board, you’ll be far better positioned to know when you’re ready for one.