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.
My friend Jenny Lawton had a good post on women, voting, and the creative / entrepreneurial efforts of Torrey Strohmeier. Amy and I were talking about women’s rights the other night recalled that women didn’t have the legal right to vote until 1920 (after the amendment was first introduced in 1878). Amazingly, women weren’t eligible to apply for the Rhodes Scholarship until 1977.
If you’re a woman (or a supporter of women’s rights), go to She19 and take a look. Remember the story, be thankful for our rights, and buy a t-shirt.
StillSecure – one of my companies that was founded and run by long time entrepreneur Raj Bhargava (cofounded NetGenesis, ServiceMetrics, Interliant, Quova, and StillSecure) – had a great week.
They started the week by releasing v4.0 of their VAM product (Vulnerability Lifecycle Management). VAM 4.0 is a mature enterprise vulnerability management product that now includes patch management and something we call one-click remidation workflow management (the best workflow management in the security market). We had good pickup on the product release including CMP Systems Management Pipeline and CRN.
Releasing a new version of a product is always a big deal, but we ended the week with a Best Buy award in SC Magazine for Border Guard – our intrusion prevention product, one of the key magazines for security professionals. We tied with Tipping Point and beat out companies like ISS and Netscreen.
The actual review was dynamite. Whenever you get the highest rating in every category, Positives of “easy to set up, comfortable to navigate, and it really streamlined the complex process of intrusion prevention without losing functionality”; Negatives of “nothing much”; and a Verdict of “one of the best in terms of usage and installation” you have something be happy about.
I’ve very proud of Raj and the StillSecure team and decided to shamelessly toot their horn. If you are looking for high quality, cost effective network security software (or know someone that is), please aim them at StillSecure.
I switched from Netscape to Internet Explorer when Windows 98 came out. Go figure. I’ve been stubbornly using IE and refused to even look at Mozilla / Firefox given that I spend so much of my time in email and I always felt (incorrectly) that Outlook and IE would be better integrated than Outlook and Firefox.
I’ve grown increasingly frustrated with IE lately for a variety of reasons, including some bugs that I can’t figure out workarounds for, occassional grungy performance issues, endless popup Windows and Spyware problems, and all the well publicized security issues.
I decided to break down and give Firefox a try. I’ve been using it for two weeks and love it. If you are a heavy browser user and still using IE, you should absolutely consider Firefox. Following are some quick reasons:
- Much faster / more consistent performance
- No Spyware popups
- Tabbed browsing (really wonderful for the heavy user)
- Great password manager
- Bookmark sync to an FTP server (for managing bookmarks across multiple screens)
- Extensive Extensions (https://update.mozilla.org/extensions/)
As a NewsGator user, there’s even an extension for subscribing to an RSS feed in NewsGator.
Thanks Ross for pushing me over the edge.
I received a number of comments, private emails, and a few links to my post on Venture Capital Deal Algebra. The consistent theme was “tell me more about how VC investments work.” As a result, I’m going to write a series of posts on the structural and financial components of a typical venture capital investment. I’m going to use a bottom up approach – talking about individual components over time and then tying them together in a comprehensive term sheet.
An important place to start is the concept of a liquidation preference. Fred Wilson hints at it in his post on valuation. A liquidation preference is a standand (and rarely negotiable part) of a VC investment. It’s the downside protection on an investment that VCs expect to have as a baseline of any equity investment.
The vast majority of VC investments are structured as preferred stock. It’s called preferred because it “sits in front of” the common stock (or is “preferred to the common”) where common stock is the plain vanilla stock that a company has. Typically in VC investments, founders receive common stock, employees receive either common stock or options to purchase common stock, and the VCs receive preferred stock. This preferred stock has a series of special rights which almost always include a liquidation preference. The liquidation preference means that the VC will have the option – in a liquidity event – of either receiving their liquidation preference as their return or converting into common stock and receiving their percentage ownership as their return.
Consider the following example. Acme Venture Capital (AVC) makes an investment in an established company called Homer Software that has been bootstrapped by the founders. Homer Software has shipped a product in an exciting market and generated $3m of revenue in the past 12 months. AVC invests $5m at a $10m pre-money valuation. As part of this investment, AVC and the founders of AVC agree to a 20% option pool for new employees that are going to be hired to be built into the pre-money valuation (see Venture Capital Deal Algebra if this doesn’t make sense). The result is that AVC owns 33.3% of the company, the founders own 46.7% of the company, and 20% is reserved for options for employees. In this example, AVC purchases Series A Preferred Stock that has a liquidation preference.
Now – consider two outcomes.
- Homer Software continues its rapid growth and is acquired for $100m. AVC has a choice – either receive the liquidation preference ($5m) or convert to common and receive 33.3% of the proceeds ($33.3m). Easy choice.
- Homer Software struggles and is acquired by a competitor for $9m. AVC again has a choice – either receive the liquidation preference ($5m) or convert to common and receive 33.3% of the proceeds ($3m). Again, easy choice.
When cash or public company stock is used in an acquisition, the valuation can be mathematically determined with certainty. However, when the acquirer is a private company, the valuation is much harder to determine and is often ambiguous as it depends on the value of the private company and the type of stock (common, preferred, junior preferred, or some other special class) being used. In these cases, the use of the liquidation preference is less clear cut and it’s critical that the company have objective, outside (independent) directors and experienced outside legal counsel to help with determining valuation.
One exception to the liquidity event is an IPO. Typically, an IPO will force the conversion of preferred stock to common stock, eliminating the liquidation preference. In most cases, the IPO event is an “upside liquidity event” so the need for the liquidation preference (and corresponding downside protection) is eliminated (although this is not always the case).
Next up – To Participate or Not (Participating Preferences) – an often maligned and typically hotly negotiated issue that is a more complex form of liquidation preference.
Educating Esme: Diary of a Teacher’s First Year is my new best book of the summer. It’s a diary of Esme Raji Codell’s first year as a public school teacher (fifth grade) in Chicago. It is hilarious, sweet, sad, inspiring, disheartening, uplifting, and deeply insightful.
Esme’s got a great web site at Planet Esme – A Wwwonderful World of Children’s Literature. This woman needs a blog!
Esme Codell has a new fan – me.
Dan Bricklin has a great essay on his site today titled Software That Lasts 200 Years. Dan is indubitably one of the world’s great software visionaries and his thoughts are always worth reading.
This essay was especially poignant for me since the first significant custom software application I wrote is still in use today. I wrote the Bellflower Dental System (a patient management, scheduling, and insurance billing system) for a large dental practice in 1985 and deployed it in 1987 (amazingly, their phone number is the same as it was in 1985, except the area code has changed from 310 to 562). Bellflower Dental Group is a large practice (at the time, they had over 50,000 patients) and the system was incredibly complex. My first company – Feld Technologies – continued to do work on it through 1993 when I sold the company to AmeriData. AmeriData continued to support the application until I left in 1995 since by that time I was pretty much the only person around that could modify the software without breaking everything. Once a year, until about 1999, I got a call from my friends at Bellflower and made a trip out there to tune things up. In 1999, we had to modify a bunch of the system for the year 2000 bug (yes – we had it everywhere – who would have thought that this would still be working 15 years later in 1985). I hired Dave Jilk – who was my partner in Feld Technologies and between gigs – to do this since I simply didn’t have time to do it. After this experience, we finally hooked them up with some local consultants that knew DataFlex – the language the system was written in (amazingly DataFlex – is still around today) and the software – as far as I know – has continued to work. Twenty years is a long time for any software system – especially the first one I actually created.
Now – a dental billing system is not an example of what Dan calls Societal Infrastructure Software (SIS), but it is an example of Software Durability, which is one of the tenants of Societal Infrastructure Software. In his essay Dan states, “We need to start thinking about software in a way more like how we think about building bridges, dams, and sewers. What we build must last for generations without total rebuilding. This requires new thinking and new ways of organizing development. This is especially important for governments of all sizes as well as for established, ongoing businesses and institutions.”
Dan’s argument for the need for Societal Infrastructure Software includes:
- Meet the functional requirements of the task.
- Robustness and long-term stability and security.
- Transparency to determine when changes are needed and that undesired functions are not being performed.
- Verifiable trustworthiness of all three of the above.
- Ease and low cost of training for effective use.
- Ease and low cost of maintenance.
- Minimization of maintenance.
- Ease and low cost of modification.
- Ease of replacement.
- Compatibility and ease of integration with other applications.
- Long-term availability of individuals able to train, maintain, modify, determine need for changes, etc.
Dan uses the analog analog of civil engineering in his essay. The first formal computer science classes I took at MIT was Course 1.00: Introduction to Computers and Engineering Problem Solving so the analog struck close to home. Dan is clear that these ideas are only for one part of the software world. He specifically is responding to his thoughts as a result of writings and actions of the Massachusetts State Executive Office for Administration and Finance as it deals with its Information Technology needs.
The essay is definitely worth reading if you are in the software industry.
I appear to have several people in my life (Amy Batchelor, Dave Jilk, Chris Wand, and Steve Bayle) who view correcting my grammar, spelling, punctuation, and word usage as part of their role on this planet. I did not ask for this; however, I tolerate it because they have other useful traits (Amy just looked over my shoulder and said, “Great use of the semicolon; hot!”)
In an attempt to lower their workload, I read Eats, Shoots & Leaves: The Zero Tolerance Approach to Punctuation. I learned a lot which will hopefully be reflected in my future punctuation efforts. Unfortunately, the author is a brit so you might get some foreign usage.
This book is a ton of fun and a must read for anyone that writes anything (including text messages). One of my chronic problems is the placement of punctuation when quotes are involved. Truss, the author, has a good section on this where she enumerates the rules (with examples – although I’ll just give you the rules so I don’t spoil the book for you.)
- When a piece of dialogue is attributed at its end, conclude it with a comma inside the inverted commas.
- When the dialogue is attributed at the start, conclude with a full stop inside the inverted commas.
- When the dialogue stands on its own, the full stop comes inside the inverted commas.
- When only a fragment of speech is being quoted, put punctuation outside the inverted commas.
- When the quotation is a question or exclamation, the terminal marks come inside the inverted commas.
- When the question is posed by the sentence rather than by the speaker, logic demands that the question mark goes outside the inverted commas.
- Where the quoted speech is a full sentence requiring a full stop (or other terminal mark) of its own, and coincidentally comes at the end of the containing sentence, the mark inside the inverted commas serves for both.
For the Americans in the crowd, a full stop is the same as a period and inverted commas are the same as quotation marks. Oh – and Truss graciously says something to the effect of “none of this applies in America since American grammarians insist that, if a sentence ends with a phrase in inverted commas, all the terminal punctuation for the sentence must come tidily inside the speech marks, even when this doesn’t seem to make sense.” If you’ve followed all of this, now you understand why Her Majesty’s Kingdom lost the Revolutionary War.
Does this remind you of the interminably long hour a day of ninth grade honors English you had to endure from Mrs. Dowdywonker? I’ve decided on a new rule which is “do whatever the hell you want with the punctuation near ending inverted commas!”
I don’t read much history – for some reason I don’t get into it. I do like biography and get most of my “history reading” from it. So – it’s always special when I can get a bunch of biography, history, and – well – CHARACTERS – all in one book.
Amy and I were with our friends Nick and Helen Forster at The Kitchen in Boulder about a month ago. Somehow the topic turned to our families and genealogies. Nick was talking about growing up in this old mansion in upstate New York and eventually suggested that I read The Astor Orphans: A Pride of Lions. Nick’s a fascinating guy that – with Helen – runs etown (a weekly radio show produced in Boulder) – so I figured it’d be fun to find out more about his ancestors, especially a group he referred to as “eight kids who were direct decendents of the Astor’s who lost their parents when the oldest was a teenager and rattled around in this huge house I grew up in.”
What a book. The Astor Orphans are the ten owners of Rokeby who were bequeathed the property by their mother – Margaret Astor Ward Chanler – for them to “share and share alike.” The next year, the children (aged fifteen to three), lost their father John Winthrop Chanler. These kids were direct decendants of John Jacob Astor (the richest man in America at the time). They belonged to America’s social and economic elite (which you can infer from their names – Winthrop, Stuyvesant, Livingston, Astor, Beekman, Armstrong, White, Ward – you get the picture).
The book traces their lives. Several died young, so the main characters were the eight kids who lived to be 50 or older. They accomplished amazing things in their lives, had great adventures, and were hugely entertaining and – in many cases – scandelous characters for the age they lived in.
After I finished, I dropped Nick a note saying “It was fabulous – definitely a different world then the one I grew up in. Now that I have all the relationships / context, tell me how you fit.” Nick wrote back “My great grandfather is Lewis Chanler, the one who was Lieutenant Gov. of New York and one of the brothers who committed Archie to Bloomingdales asylum. He was also the pioneer of Legal Aid, apparently, going down to the Tombs and representing clients for free. The house, Rokeby, is where I lived before I moved to Colorado in ’75. Oddly, the current batch of cousins in Rokeby are equally related (by marriage) to both my mother and father.”
What fun! The Archie that Nick refers to was the oldest (and wildest) brother. His younger brothers decided he was crazy and put him in an insane asylum named Bloomingdales. Given the laws at the time, Archie ended up getting stuck for four years! He eventually escaped to Virginia and was declared sane there, but couldn’t go back to New York for fear of being put back in the asylum. Seventeen years later he was finally declared sane again in New York, after waging a huge legal war on his situation and the “lunacy trust” of the United States. He coined the phrase ‘Who’s Looney Now” and – ironically – turned into a major eccentric as he got older. In a complex, magnanimous gesture, he “forgave” his “ex-brothers and ex-sisters” (as he referred to them) after he was declared sane, saying “let bygones be bygones.”
This book is 300 pages of riotous stories around the history of this incredible group of wealthy and eccentric orphans. As with any biography, there are tedious parts, but precious few, as the flavor and history of the time they grew up in is a fascinating contrast to our always connected email cellphone airplane (eventually teleporting) world.
There are also great lessons, as Nick finished his note to me with “My mother, Clare Chanler, also was raised in England and then came back to NY in the 30’s. She had the full glory of the family fortunes, but it pretty much ran out on her generation, which was fine with me – truly. I went to some good schools and grew up around a lot of beautiful houses, but I could see that the dough was not the secret. I have the benefit and the burden of learning that early and then trying to combine ambition with purpose, a tricky balancing act. ”
May we all be so lucky, talented, and humble as Nick.