I’m really proud of my Uncle Charlie (Charlie Feld – EVP of Portfolio Management at EDS.) He’s one of the most extraordinary managers and leaders I’ve ever met and had the pleasure of working with (and investing in.) He’s got an incredibly challenging task in front of him as he works with Mike Jordan and the rest of the EDS leadership team to turn around an IT institution that’s had a rough few years and in Jordan’s words, “I knew this company, and I knew the founders. This was the Marine Corps,” says Jordan, a former Navy officer. “But when I came here it was the Girl Scouts.”
Charlie has an easily accessible column on Leadership in CIO Magazine. His most recent article concerns the three skills a leader needs to get the job done: (1) Partnerships Need Reinforcement, (2) Decisiveness Demands Confidence, and (3) To Get Focused, Get Together. Part of the magic of Charlie is that his management theory isn’t impenetrable academic stuff or theoretical philosophy based on qualitative and quantitative analysis of a large data set – it’s common sense in simple language and concepts based on deep experience. And – it all holds together. Other articles in this series include “How to Read the Signs” and “How to Build a Great Team.” Go read them – they are short and worth every minute.
As I grew up, I heard from my dad, my uncle, and their dad (who we called – simply – Jack) to tell it like it is. Jack used to say “I’m surrounded by typhoons (he lived in Florida – we never made it to “tycoon status” with him) – just spit it out and say it.” Charlie exemplifies this and provides a model that all CIOs, IT leaders, and managers can learn from.
Jeff Nolan from SAP Ventures has an excellent post titled Pick Your VC Carefully. This is a must read post for anyone that has either taken or is considering taking venture capital money.
I’ve co-invested with a wide range of VC’s in all of the categories Jeff describes. Some have been outstanding partners, some have been horrifying, and some have been in-between (shocking, I know.) However, in almost all cases, I couldn’t have predicted where they would have fallen out based on my shallow perception of their reputation prior to getting to know them. Of course, there’s nothing like working with someone to decide whether they are useful or not, but often that’s not an option – especially for a first time entrepreneur or someone who is developing a new entrepreneur to VC (or VC to VC relationship.)
Partnership is a two way street, so I always encourage entrepreneurs and potential co-investors to talk to anyone about anything concerning me. I try to be completely open book about my strengths, weaknesses, interests, and desires. Surprisingly, very few people go really deep in advance of developing a relationship. Yeah – there’s plenty of “due diligence” – but usually that’s a series of relatively useless reference checks from the “first list of people” that provide little to no insight (I’ve been on the receiving end of a number of these calls lately and it amazes me how much time “serious, experienced people” waste on simpleminded, “check the box” reference calls.) In contrast, I try my hardest to “force” entrepreneurs who are considering working with me to meet with entrepreneurs that have deep (and often – multiple company) experiences with me – a phone call doesn’t qualify – go build a relationship (and – your worst case is that you now have another entrepreneur in your network.)
I’ve learned that I don’t want to work with someone who I don’t have a real feeling for – both in good and bad situations. Fortunately, most everyone now has had some bad experiences (or else they checked out and farmed sheep in New Zealand from 2000 to 2002) so it’s a lot easier to get detailed information about potential business partners. I’ve learned that how someone explains their failure is much more enlightening than how they explain their success, and a real conversation (and potentially shared experiences – but please, not bowling) – rather than a series of “interview questions” – can provide real insight.
A prime example of this done correctly is an experience I had recently with Dave Sifry at Technorati. The company was one that was very interesting to me and in an area that I had both domain knowledge and another investment (NewsGator). My partner – Ryan McIntyre – was uniquely qualified to help this company due to his entrepreneurial experience as a co-founder of Excite and was extremely excited about an investment. I supported Ryan (and shared his excitement) and watched while Dave shook him down pretty hard – spending a lot of time evaluating Ryan, his potential contribution to Technorati, and his cultural and functional fit with the team. However, he didn’t stop there – I spent three hours on the phone on a Saturday talking to Dave in the middle of this process. An hour was “get to know you chit chat”, the balance of the time was a real discussion about where the market his business was in was going, his vision, what I thought about it, why I cared, how I could help, and how I / we thought about companies like his. I’m the back seat driver on this investment (it’s Ryan’s investment), but Dave still went after me hard as part of his evaluation as to whether or not he wanted Mobius as an investor in his company.
While all the usual cliches about people apply, I don’t think “knowing your potential partners before you do a deal with them” can ever be over-emphasized.
Ross Wehner – a new writer for the Denver Post – had a nice article in the paper this weekend titled Colorado high-tech industry shows some signs of revival. There’s been some perception in Colorado that we got hit harder than other states – primarily due to our emphasis on telecomm – although I think Colorado has experienced roughly the same tech dynamics (boom – bust – normal renewal) that other states have seen.
Ross quoted me a few times. When he called to fact check, he said “hey – I ran across this quote from 2000 about bowling – can I use it?” I told him I wish people would forget about it, but it was fair game since I’d said it and it had been printed. I explained to him that the quote was intended to emphasize that people are my highest order sort when I evaluate an investment (e.g. if I don’t like the people, forget it), but that it had been repeated so many times as to have lost its focus. The quote that’s getting repeated is:
Back in the go-go days of the dot-com boom, Feld used to evaluate the people he was funding by taking them bowling. “The reason I chose bowling is because it’s a stupidly absurd sport,” he remembers saying. “You don’t sweat, you wear funny shoes, you usually eat cheesy nachos and then (you) stick your hand in a heavy ball.”
The quote certainly qualified as pithy and memorable since it resulted in me being the recipient of a bowling ball with my name engraved on it, free passes to a variety of bowling events (with the entrepreneurs who wanted to pitch me), an occassional pre-meeting lunch of bad nachos, an a variety of other bowling related items (I have a really nice velour shirt with my name on it.) And NO, I’m not a particularly good bowler, nor do I like bowling very much.
However, I think it’s a bad quote because it doesn’t capture the essense of what I was trying to say, which was “When I evaluate a new investment, the highest level filter for me is the people. Once I get interested in someone, I like to do something unusual with them to get to know them better. Bowling is one of those things …” You get the picture.
I have a close friend – Jenny Lawton – who is a long time, extremely talented, and irrepressible entrepreneur. For a decade she ran a high-end network integration company that was doing Internet stuff well before Internet stuff was cool. She sold that company to a public company that was a large application service provider and stayed on for several years, playing a number of different leadership roles in that company.
She retired (burned out, got tired, decided to move on) and – rather than dive back in to technology – bought a bookstore called Just Books in her home town of Old Greenwich, CT. Several months later, she decided to expand and opened a second book store (Just Books, Too).
Today she announced that she is buying the coffee shop next to one of the bookstores.
Viva entrepreneurship – way to go Jenny! If you are ever near Old Greenwich (or Greenwich where their other store is located), stop in, tell Jenny hi, and buy some books (and coffee) from her.
I was on a board call for a company today that pays their employees bi-weekly (every two weeks). At some point in time there was a rationale for this since this company has a lot of hourly employees and there was a perception that folks would want to be paid every two weeks. So – presumably this was a logical decision at the time.
However, it creates havoc with our monthly reporting and forecasting as we have at least two months per year with three pay periods. This adds an extra pay period to our expense structure for those two months (and lowers it correspondingly for the other months where we only have two pay periods). As a result of this, we are constantly backing out expenses (or adding it back in) to get “apples to apples” monthly comparisons.
The vast majority of the companies I’ve been involved with pay employees semi-monthly (twice a month – usually on the 15th and last day or the month). While you obviously can do the work to “normalize” month to month expenses if you pay your employees bi-weekly, do yourself and your investors a favor and pay semi-monthly. It’s so much easier to deal with.
Fred wrote two stories on the cliche “if it looks too good to be true, it probably is.” I saw it right after I responded to a few comments on my To Participate or Not post and was chewing on the notion of the behaviorial dynamics and mismatch that often occurs between investors and entrepreneurs, even when both sides are behaving as rational actors.
Amy and I have a saying that “The fantasy is better than the reality.” It comes up when incongruent situations appear in our life, where something that hasn’t yet happened appears irrationally magnificent in comparison to something that already either exists for us or something that is also a good thing and more achievable, but not as magnificent. After we chew on it for a while and think about the unintended consequences and side effects, we often conclude that we’ll stay with what we have, but enjoy thinking about the fantasy. Now – I’ve never been accused of not “going for things”, so you need to imagine “big fantasies” here.
This is a corollary to Fred’s anecdotes – which rang true with me this morning.
Last week, I was asked to write up my “Top 10 bootstrapping actions” for a book on bootstrapping that should be coming out later this year. Bootstrapping must be in the air as Fred just wrote about how he teaches about it in his course at NYU Stern and Jerry just wrote about it for his Inc. Magazine column Forget VC Money, Fund Yourself. I recognize the potential dissonance about VCs writing about bootstrapping (or – “how to create a business without taking money from VCs”) – I know Fred, Jerry, and I all feel strongly that VCs are only a small part of the entrepreneurial / company creation ecosystem and the vast majority of companies that get created never take VC money (my first business raised $10 – we had 10 shares of stock at $1 each – and – when we sold it – each share made a share of Google seem like a penny stock – although we only had 10 of them.)
I spent some time with the author – Marcus Gibson – and felt his questions and probing style were very good. Following is my Top 10 list and commentary I gave him to work with.
- Figure out how much cash you really have: When someone says to me, “I’m thinking about starting a company” I typically ask them “how much cash do you have.” They usually answer something like “none”, not realizing I am asking them about their personal resources, not the business resources (or investor dollars). I clarify and explain that they are likely going to have to go a period of time with no salary, pay for expenses out of their own pocket, and invest in various things for their new business. I’m not being nosy (and in fact don’t care what their answer is) – I’m trying to make the point that they need to make sure they are cognizant of the potential personal economic toll that starting a business entails. Obviously, some of this is mitigated by an angel or venture investment, but there’s almost always a period of time prior to this investment (and could be forever in the case where no money is ever raised) where the entrepreneur is essentially funding the business, whether it’s through their own lost opportunity cost of not having a job or – more likely – through writing checks or loading up on personal credit card debt to get the business started. It’s critical for a bootstrapper to understand how much financial capacity they actually have.
- Figure out how much time you really have: The cliche “time is money” applies to starting a company. The amount of time one has to get a business going is often directly linked to the answer of how much cash one has to get a business going. Often, entrepreneurs overestimate how much time they really have, either by only partly dedicating themselves to their new business (e.g. working a full time job and trying to start the business on the side) or setting expectations that the business will be up, running, and generating enough revenue and income to pay full salaries within an unrealistic period of time. In almost all cases, an entrepreneur is going to have to invest substantial time in a startup to get it off the ground. Understanding how much time you have before you run out of cash, energy, spousal patience, or market opportunity is important to think about going into the startup phase.
- Pick a domain and go deep: If your answer to “What kind of company are you going to start?” is something like “Well, I have a few different ideas…” stop immediately. You should pick one idea in one domain and go extremely deep on this idea. Optimally, it’d be something you already know a lot about so that you’ll be leveraging your personal experience and presumably one of your passions. Hedging your bets by thinking about and playing around with a variety of different ideas is a huge waste of energy – you need all of your focus on the one thing you are going to do. Early in my life as a VC, I was in a meeting where an experienced VC asserted that one of the most important questions for a venture-backed company to answer is “What do you want to be the best in the world at?” I think this question broadly applies to all entrepreneurial endeavors.
- Surround yourself with experienced people: This is often easier said than done. When I started my first company, I had a very small network which consisted mostly of my father and several of his business friends. Fortunately, I had the advantage of age (or lack thereof) on my side and several of my early clients took me under their wing and acted as mentors for me and my partner. After I sold my first company and shifted my role to be an angel investor in startups, I helped start several companies with young, first time entrepreneurs. I saw first hand how impactful having experienced folks around the first time, inexperienced entrepreneur can be as my new first time entrepreneur friends were perfectly willing to make exactly the same mistakes I had made eight years earlier when I was starting out (hopefully I was able to help them avoid most of them while we made new and exciting mistakes together.)
- Find angels: This is a corollary to surrounding yourself with experienced people. While angels are typically associated with “angel investors”, they can also be part time advisors that will work for equity to help you get your business off the ground. I’ve found that finding people that are willing to help for equity (and no cash) are surprisingly easy to find. The trick is finding “angels” (vs. devils) – folks that can really help you and are on your team, rather than people who have an agenda other than helping you succeed and are willing to make a buck in the future if you are successful.
- Figure out who you want to look like in 5 years: In 1990, I was sitting in an Inc. Magazine / YEO Birthing of Giants retreat which, at the time – was by far the best professional development experience I’d ever had. I got to spend four days with 59 other entrepreneurs who were running companies from my size (10 people, $1m in annual revenue) to much larger ($250m in annual revenue). We sat together all day, listening to lectures from MIT and Harvard business school professors, other entrepreneurs, and each other. We partied at night and got to know each other well. One of the recurring themes that came up over the long weekend was to look out into the future. I took away an idea that I continually use – I pretend that it’s five years later and I define what my world / business / life looks like. I then look backward and write the story that got me to this point. When you are starting your new company, use this tool. Figure out where you want to get to. I can guarantee with almost 100% certainty that it won’t play out the way you initially envision, but at least you’ll have a vision for where you want to get to that you can start with and adjust over time.
- Get customers: Customers can help address almost all the issues that a startup faces. Most importantly, customers generate revenue and cash. But customers also help shape the product, business parameters, validate the ideas, and provide “honest work” for you to do. In the MouseDriver Chronicles, the authors state that business consists of only two things – making and selling. Getting and having customers helps you focus on this. Successful customers will also typically help generate new customers as well as confidence that your business is doing something useful.
- Learn everything you can about what you are about to do: This is the corollary to “pick a domain and go deep.” Great startup entrepreneurs are intellectually insatiable about the thing they are trying to create. Learn everything you can about your product, market, competitors, and customers. If you are starting your first business, make sure you spend time learning about yourself and your motivation; figure out what is important to you and why. Be relentless about learning how other entrepreneurs do things, especially those that have had both great success and great failures. If you can figure out how to build continuous learning into what you are doing – without it being a rationalization for not succeeding (e.g. I can’t stand the phrase “We had a lot of ‘learning’ from that experience” – it’s both poor English and shallow thinking – don’t “have a lot of learning” – dig down deep and get to the essence of what is going on a talk about that) – you’ll both have a better chance of succeeding while having a lot more fun.
- Figure out your fallback plan: You might fail. It happens. A lot. Your initial idea might be stupid. Potential customers might not care. Competition might be more significant than you thought. You might do a lousy job of delivering your product or service. Failure can be terminal to a business, or it can merely be a setback. If you’ve thought about a fallback plan, especially if you have limited financial resources, you’ll have a different mode you can shift into planned in advance. Time is always working against you when you start a company – the more you’ve thought through the different scenarios – the greater your chance of ultimately being successful.
- Figure out what to do if you fail (face your fears before you start):One of my favorite quotes is from Dune – “Fear is the mind killer.” I’ve always believed that fear is one of the most completely useless emotions. “What if I fail” is one of the biggest fears of a startup entrepreneur. Face it – play with it – figure out what happens if you fail. In most cases, failure is not going to be death (although it could be very uncomfortable). Understanding what your fears are and trying to stare them down in advance of actually encountering them will help you enormously in the process of trying to create a new company.
Shortly after I sold my first company, I got a call from Len Fassler – my new boss (the co-chairman of the company) – who asked, “Can you start sending me your DOC (pronounced “dock”) report?” I had grown to like Len during the deal process – he seemed to understand me, my general flakiness about whether or not I wanted to sell my company at the time, and was patient with my overall business naivete. However, at that moment, all I could think of was the cliche “the honeymoon must be over” since I had absolutely no idea what he was talking about.
After I meekly asked Len what he meant, he explained that he was looking for a “Daily Operating Control” report – basically a daily report that summarized the key financial metrics driving our business. Aha – I thought – this is easy. We were a consulting company and our major revenue driver was the number of hours each of our consultants billed per day times their rate per hour (which often varied based on the project they were working for at the time.) Almost everything else in our business was a highly predictable cost on a monthly basis. We relied on a home grown time accounting system that we fondly referred to as FT-BIL. We had built a discipline of entering our time daily so I literally had current month to date revenue numbers within 24 hours. I cranked out a number of FT-BIL reports, including daily billings by consultant and by client and sent it on as an example of what we had.
It turned out that Len didn’t actually want this granular a level of data from me on a daily basis (we were a small part of the overall company), but was more concerned that I had this data, was using it, and understood that it was an important tool to help manage our business performance. This was an instructive early lesson to me about the value of key financial metrics and how they are timeless in managing a business. It still amazes me that companies I’m involved in that have professional services as part of their business – including some of the law firms that work with me and my companies – can’t seem to get a system in place to collect this data on a near-real time basis.
Several years ago, some of y’all may remember an event called “the bursting of the Internet bubble.” Immediately preceeding this event, companies (and investors) focused on growth at any cost. This growth took various forms ranging from the one key financial metric that everyone cared about at the time (revenue) to non-financial metrics such as eyeballs, click-throughs, and affiliates. Shortly after the bubble burst, people started focusing on net income, cash flow, cash on hand, and other financial metrics. Not surprisingly, these were things that most rational business owners had paid attention to since – oh – the beginning of time.
As we were riding down the back side of the bubble bursting, we put a discipline in place at Mobius Venture Capital to track a set of financial metrics on a monthly basis for each of our portfolio companies. Monthly data we collect (and consolidated so everyone in the firm sees it on a weekly basis) includes revenue, cost of goods, operating expense, EBITDA, headcount, cash burn, cash on hand, debt, projected insolvency date, additional cash required to breakeven, and projected first quarter of profitabiity. In addition, each partner began writing a weekly status report with brief updates (typically one to two paragraphs) on each of his companies that was distributed along with this financial data.
In hindsight this seems like an obvious thing to do; however, in my experience, very few venture firms focus on this level of data firm wide on a consistent basis to understand the health of their companies, especially as their portfolio’s grow and they find themselves with a large number of companies. It’s our version of a DOC report (ok – maybe we should call it our WOC report – for “weekly operating control”, but that makes me hungry) and it’s been invaluable to us as we collectively watch and manage our portfolio. It’s clearly not a substitute for regular, deep portfolio reviews, but it creates a consistent baseline knowledge of our companies across the firm.
I’ve tried to instill an equivalent discipline in my portfolio companies. I’ve been successful in some cases, but not in all. I definitely see a correlation between rigorous collection and management of core financial performance data and business success, so I encourage every entrepreneur (and manager) to step back and consider if they are seeing their version of a DOC report.
I thought I’d give you a break from the DNC coverage in the blogosphere (and everywhere else).
I wrote the following article on “financial fitness for entrepreneurs” last year for the Kauffman Foundation’s Entreworld web site so it’s reasonably fresh; I got a lot of positive feedback and it ended up in USA Today. It’s aimed at any entrepreneur – not just those running venture funded companies. While it’s aimed at an early stage entrepreneur, I think it’s useful whether you have one employee (you, the founder) or thousands of employees in your business. It was “professionally edited”, so it lost some of my special voice (you’ll notice the lack of cuss words.) Enjoy.
While creating a growth business can be exhilarating, many entrepreneurs – especially those starting a company for the first time – don’t pay enough attention to some core issues surrounding the financial management of their businesses.
Often, founders don’t have formal training in finance – they’re “techies” launching the next Apple Computer or Netscape, professionals putting together advertising, management consulting, or human resources agencies, or super-salesmen types who’ve figured out how to sell a pizza or deliver a package faster, better and cheaper. Always, they’re intimately involved with their core product or service. Often, they are too busy to burrow into the details of some of the company’s functions, of which finance is the most critical.
These entrepreneurs are savvy enough to know they must work with financial professionals, such as their CFO and outside auditors or CPAs. However, no matter what their background or inclination about finance, founders need to have a working understanding of the basics. An elementary level of financial literacy means they’ll work more intelligently with their financial advisors and become the first line of defense for spotting potential problems in the young company.
What follows are some fundamental financial tenets that all early-stage entrepreneurs should be aware of, understand, and heed.
- Cash is king: No matter what, don’t run out of money. Nothing else in this article matters if you run out of money. This means know your burn rate (the net cash that is flowing out of your business each month) and be aware that your low cash point for any given month may not be at the end of the month. In other words, don’t get caught planning based on full month figures only to find that you do not have enough money to pay your most important vendor on the 15th because your customers don’t pay you until the 30th.
- Put in real financial systems from day one: Lots of entrepreneurs figure that they’ll “get around to putting in real financial systems someday soon.” Of course, that rarely happens, especially if no one on the founding team has a strong financial background. The cliché, “It’s better to build on a strong foundation,” applies. Put the foundation in place early so that as your business grows, you are on solid financial footing.
- Measure everything: If you have real financial systems in place, you can measure everything. Be obsessive about it. Some things that you’ll measure will be similar to what most other businesses measure, such as your P&L, balance sheet, and cash flow statements. Other things will be unique to your business – oriented around your specific customers or products. As your business grows, make sure you evolve and expand what you measure to best reflect the current state of your business. Look especially for metrics that will help tell you where your business is going, not just where it has come from. Financial systems can and should capture more than just historical financial results.
- Build an annual operating plan: Be disciplined about creating an annual operating plan and budget every year. You should have it finished before January 1. This is your easiest benchmark to measure against – your own expectations. If you don’t set them, you won’t know how you did.
- Use your vendors to fund your business: Vendors love to get paid on time (or early). However, as a young business, your vendors will appreciate consistency of payment over timeliness. While most vendors will want to be paid within 30 days (or less), it’s typical to stretch payables 45 to 60 days. The key is to pay consistently – if you have a vendor from whom you continually use services or buy products, don’t store up your bills and pay in one lump sum sporadically. Instead, send regular payments. Also, don’t dodge calls from vendors about paying late. Tell them when you are going to pay them, and then make sure you follow through.
- Use your customers to fund your business: Customers – especially ones that value your products and services – will often be willing to pay on very short terms. Don’t be bashful about asking them to prepay, especially if you are a service business.
- Be careful of personal guarantees: Banks love personal guarantees. Entrepreneurs hate them. You should avoid them if you can – only sign one as a last resort. You are already investing a huge amount of your personal assets and energy in your business. If you can’t get financing based on the strength of your business, you should question whether it’s the right kind of financing. In the upside scenario, when your business succeeds, the personal guarantee doesn’t matter. It’s the downside case you should be worried about, because you could lose major personal assets like your house.
- If it sounds too good to be true, it probably is: While this is generally true in life, it’s especially true concerning financial issues surrounding an early stage company. Your books should always balance, financings will always have a cost, and investors are always going to have strings attached to their money. Ask questions, be wary, and know what you are getting into.
- Finance your business appropriately for what you are trying to create: One of the most common mistakes an early stage entrepreneur makes is trying to raise the wrong kind of money for the business. It makes no sense for a service business that could potentially be a $5 million company within three years to try to raise $10 million of venture capital. Correspondingly, it doesn’t make sense for a capital-intensive company that needs to build a plant to raise $250,000 of angel money.
- Choose professionals carefully: It may be tempting to use your wife’s brother’s friend’s neighbor as your lawyer, because he will give you a great rate and you see him at the neighborhood barbecue, but you get what you pay for. The same is true for accountants and other services that your business will use. Find professionals who know what they are doing and have experience with young companies.
- Don’t take anything for granted: Double-check everything. If you have the right systems (did I mention that you should have good systems?), this is easy. If you don’t, reread the second bullet point and put in the right systems.
- Pay your taxes on time: Unlike customers and vendors, our local, state, and federal tax authorities don’t appreciate being used as financing sources for your business. In addition to potentially incurring onerous penalties, missing or delaying tax payments is often a serious crime.
That’s the list. Read it over, familiarize yourself with it, and begin developing a lay entrepreneur’s understanding of finance. You’ll then be able to work deftly with your pros to put the company of your dreams on the sound financial footing necessary for success.
I wrote the following article for The Kauffman Foundation’s Entreworld web site some time in the late 1990’s. Someone reminded me of it the other day and I looked it up. It’s especially relevant today after all the major public company scandals of the past few years, the passage of Sarbanes-Oxley, and the renewed attempts at activism by boards of directors. A few of the comments – such as the one on D&O insurance – are dated (D&O insurance for private companies is economical, although not often that useful). I’ve sat on plenty of boards and when I reflect on them am sad to say that they are spread equally between the first two categories I list below (I’ve been on lame duck boards, but have resigned quickly after realizing that’s what they were). I wish I could say they have all been (and are all) working boards, but I can’t. I guess it’s up to me to continue to be vigilant about changing that in the future.
Every large public company has a board of directors. The news is filled with stories about prominent people joining boards, about boards kicking out presidents and founders, and about personal liability of members of the boards. In a large public company, the board plays an incredibly important, and often controversial role in the governance and development of a company.
Given this, should a startup or small entrepreneurial company have a board of directors? I say, emphatically, YES!
By definition, every corporation has a board of directors. The minimum legal size of the board varies by state. In some states, the minimum size is three people (typically a president, secretary, and treasurer–also referred to as the officers of the company). In other states, the minimum size is linked to the number of shareholders–if there is only one equity holder in the corporation, there only needs to be one board member. Of course, there are several different types of companies, such as partnerships or sole proprietorships that do not require a formal board.
For many companies, the board of directors ends up being the founders of the company. However, I believe there is huge value in expanding the board to include “outside” directors–those that do not work for the company, but offer their time and advice to help shape and guide the company. These outside directors serve a similar function to those of a public company, but often with a much different approach.
It is important not to get a board of directors confused with a board of advisors or a strategic advisory board. These other boards are incredibly valuable tools for a company, but they serve a dramatically different purpose which I will discuss in a separate article.
I have been a member of many boards of directors and I have come to classify each board as one of three different types:
- Working Boards: These are boards that role up their sleeves and help the founders and management team of the company get the job done. They meet frequently, have animated, engaged discussions, and offer significant ongoing support and help to the key owners and managers of the company.
- Reporting Boards: These are boards that meet four to six times a year for a status report on the company. If everything is going well, they tend not to have much to say. If there are problems or issues, they are often critical of the CEO and the management team. If things continue to go poorly, they often take action of some sort.
- Lame Duck Boards: These are boards that have no influence on the company. In many cases, they are simply rubber stamp exercises for the CEO or founders.
The only type of board that I believe is useful for a small, entrepreneurial company is a working board. The pressures in an entrepreneurial company are great enough that the founders and the management team need everyone involved doing everything they can to make the company successful. This does not mean that everyone agrees on everything, or the members of the board are not critical of the management team. But, it does mean that there is an active, open commitment to work with the founders and management team to make the company succeed wildly.
Board members come in many shapes and sizes. In my experience, a good size of a board is five to seven people, including the insiders. If there are only one or two insiders on the board, a total board size of five is plenty. If there are more than two insiders on the board, seven board members is more appropriate. I recommend that several of the outside board members be highly experienced entrepreneurs in the market that the company is going after. The rest of the board members should be experienced entrepreneurs in other business segments, but with a particular interest in something about the company.
The chairman of the board is often one of the insiders, such as the president or CEO. However, in many cases, you may want the chairman to be one of the outsiders, especially in a situation where one of the outsiders helped start the company by putting up some of the initial seed capital. The role of the chairman varies dramatically, but it often raises the level of commitment of the individual board member that is the chairman and the overall board in general.
Significant outside investors, especially venture capitalists, will want board seats. I recommend you limit the number of outside investors on your board, unless they fit the criteria listed above. A venture investor only needs one board seat – if you have a syndicate of venture investors (several different venture capitalists that invested together in the round), consider offering one board seat and extending observer rights (e.g. the right to attend any board meeting) to the other investors. These rights should be negotiated as part of the investment.
In addition to functioning as a regular sounding board for the management team, board members can contribute substantially to the business, both as a group and individually. Board members can be incredibly useful during financings, merger and acquisition activity, general corporate strategy, and executive recruiting. Do not overlook the experiences and skills of each of the individual board members–they can often play high value, short term consulting roles as needed.
Board members should be compensated for their efforts. At the minimum, their travel expenses should be paid. Most entrepreneurial companies should set up an option package for the board members – depending on the level of effort requested of the board, this could be as little as 0.25 percent of the company or as much as 2 percent of the company vesting over four years. In addition, many board members are interested and willing to invest in the company. I always believe that it is in the best interest of a company to have the board members have a meaningful equity stake in the company.
In some cases, the directors that you recruit will have a substantial personal net worth. In these cases, they might ask if the company has “Director and Officers Insurance” (D&O Insurance). This is insurance that protects the director from having personal liability in case the company gets sued. Small companies cannot afford D&O insurance (in fact, most private companies cannot afford this), while most public companies must have this as a requirement of the underwriters in an initial public offering. So, when confronted with the question, the best solution is to make sure that the articles of incorporation of the company provide the directors with the highest limitation on liability afforded by the state the company is incorporated in. Don’t waste your time investigating D&O pricing – it won’t be economical.
Finally, take good care of your board members. These are busy folks that are making a substantial time and energy commitment to you. They share in the rewards if you are successful, but their time and energy is at risk since their primary form of compensation is equity in your company. Feed them. Make them comfortable. Have fun together! You’ll be pleasantly surprised how much faster the relationships evolve and how much more valuable they become when everyone is working hard, but having a good time together. Don’t ever let your board get bored.
This article can be found on the Kauffman Foundation’s Entreworld web site at the following link.