Some startups have a difficult time getting their mind around the topic of corporate governance. I think many startup CEOs believe it’s all common sense. They assume everything will be fine if they simply ‘do the right thing’. Though doing the right thing probably works for many situations, subtle pitfalls can destroy a company. When your startup’s board of directors isn’t properly composed unforeseen issues can arise.
Before Issues Arise, Avoid Creating Them
Because I’ve served on over thirty boards of directors, I have seen many companies make incorrect legal assumptions. The law is not always intuitive, and can be tricky. So, I find it troubling when the CEO is reluctant to call a lawyer when discussion turns to a complex legal issues. I’m not sure what it is. Maybe some CEOs have had a bad experience with lawyers in the past? But I have seen a lot of problems that could have been avoided by calling an attorney.
This is an example of the company’s management not operating as effectively as possible. You won’t encounter problems like these if your startup’s board of directors is able to evaluate management issues objectively.
Your Startup’s Board of Directors Has Certain Obligations
Your startup’s board of directors should be composed in a way that allows for objectivity. Why?
Because one of the primary responsibilities of a board of directors is to ensure that the company’s management is operating as effectively as possible. The board must periodically evaluate the performance of top executives, including the CEO, and replace any top executive if it is deemed necessary. Below I’ll give an example of what can happen when this is not the case.
Don’t Fall Into A Corporate Governance Trap
Here’s an example of a situation where a company took a series of small, seemingly innocuous steps that ultimately destroyed the company.
The company, after completing financing, hiring a CEO, and with several years in operation, ended up with a board of directors composed of:
- The CEO
- Their VP of Marketing
- Two representatives of the venture capital investors
- One supposedly neutral fifth member, who, unfortunately, was a friend of the CEO
The CEO effectively controlled three board seats—his own, his employee’s (the VP of Marketing), and his friend’s (the newly appointed Chairman). The lesson here is to not passively create a similar structure for your startup’s board of directors.
Objectivity is Essential in Your Startup’s Board of Directors
That CEO did a good job of performing operational duties for the first several years. Still, it became gradually clear that this person did not have the skills to raise more venture capital or attract strategic partners. It became obvious that the CEO was failing at that part of the job. The board attempted several fixes, but none worked.
They were never able to perform one of a board’s most important tasks—to objectively assess the CEO’s performance and decide whether or not to replace the CEO. So, instead of replacing the CEO, the board retained him, though he could not raise capital or negotiate strategic partnerships. The board took no action due to its composition. They held almost no meetings for several years, and the company drained its cash reserves. Ultimately, the company’s lawyers dissolved it.
You can avoid this, and similar scenarios, by assuring your startup’s board of directors is informed and unbiased.
It’s Up to All Board Members to Enforce Proper Governance
As I pointed out earlier, a disaster could have been avoided by paying proper attention to simple corporate governance matters. This dictates maintaining a proper balance between investors, shareholders, and managers. Build your startup’s board of directors in a way that allows the making of informed and unbiased decisions about upper management.
If Your Startup’s Board of Directors Falls Short, Legal Issues Can Arise
Legal questions can arise from many different directions in a startup. One fairly common issue that can come up is the CEO, or another director, owning property leased to the company. This kind of transaction is okay if the company takes steps to assure that the fees are paid “at market”. But this usually requires a third-party evaluation.
Another tricky issue can occur if a startup receives its first funding when it is fairly mature and most, or all, of the directors serve at the invitation of the founder. Investors try to respect these situations, but they can lead to corporate governance issues similar to those I described above.
Therefore, your startup’s board of directors should be neutral and objective, and ensure that all operations are lawful. So, when potential legal issues arise, consult an attorney.
Having worked with over a hundred startups, I have learned two important lessons about lawyers:
· Don’t pretend to be one; legal issues are too complicated.
· Call your attorney sooner rather than later when dealing with legal issues.
Remember, the purpose of a startup’s board of directors is to make informed and unbiased decisions about upper management, to act in the best interest of its stakeholders, and to ensure it operates lawfully.
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