How to be an outstanding Board Member of a Startup (1/4)

This is the first in a series of four articles that explain what it takes to be an outstanding member of the Board of Directors of a Start-up and help it succeed. This training was delivered by the Start-up Board Academy over four half-days.
The trainers were Virgine Verdon and Michel Jaccard.
Registration for subsequent sessions here: http://bit.ly/StartupBoD

Understanding each other’s role and setting the right expectations

This is the first and most critical step in the process through which the Board of Directors will create value for the startup:

  • On the one hand, the Management Team and the Founders need to understand the role of the Board, and consequently pick the right Board Members who can bring the value required when the start-up needs it, and not just look pretty in a slide deck. They also need to consider what reward(s) the Board Members will get for delivering this value, like any other advisor to their start-up (legal, accountant,…).
  • On the other end, Board Members need to understand that this is not a honorary position anymore, real work and value-add will be expected, especially if and when the going get rough (and it probably will, because it is a start-up…). So aspiring Board Members need to have the time to dedicate to the Start-up, they need to live up to their role and promises and will be held accountable to that. Becoming a Board Member is more than just being an Investor – there is more skin in the game (much more risk than just losing your investment).

Before accepting to join a Board, a due diligence will be required (Finance, HR & team, Legal and IP rights, SWOT analysis, Operations and Sales pipeline) and a number of specific points will need to be checked:

  • Company’s status
  • ALL shareholders agreements in place
  • Shareholders’ structure and list of all shareholders
  • BOD organization rules
  • Minutes of meetings of BOD (1-2 years)
  • Company’s accounts quarterly or year end, if it exists?
  • Company’s cash-flow
  • Company’s reporting system
  • Proof of social charges payment
  • Company’s business plan or business model if it exists?
  • Company’s investor presentations

Also assess how your questions are received and what kind of behaviour they generate.

It is paramount to check that there is full alignment between the Board, Management and Shareholders on the start-up’s objectives and the means to achieve these objectives.

Roles and Responsibilities

1) Board of Directors is responsible for management of start-up unless responsibility has been delegated to Management Team

– Shareholders are ultimately responsible, but a start-up environment is not conducive to them exercising this responsibility (takes time to get them into general assembly)
– So in essence Board is responsible
– Board can delegate management responsibility to Management Team through a valid resolution which needs to be implemented through right organisation and governance (i.e. lived)
– Such arrangement would also need to be reflected in the shareholder agreement / articles of association
– Delegation generally covers Financial Management, R&D, Operations – it’s advisable that the Board keeps an eye on Legal matters (e.g. main contracts) and the IP licensing (especially if at core of the start-up) as well as the hiring process for the first 5 keys employees

2) Board of Directors actively follows what is happening at the start-up

– Directors should not necessarily expect large and detailed reporting packages (not just like a big corporation)
– CEO / Management Team most often lack time to put such packages together
– Board Members need to stay informed about daily business and should ask the right questions themselves

3) Directors need to attend Board meetings

– Minutes of Board Meetings are kept vague by purpose (legal advice)
– Just reading the minutes won’t suffice to bring in the value-add expected
– Not attending the meeting does not discharge the Board Member of his/her duties – its a personal assignment, nobody can attend at your place
– Generally recommended to have 8 meetings a year / quarterly meetings is not enough

Status and Liabilities

1) Personal assignment: no entity, no proxy

– Personal liability: no true protection or defence by D&O insurance
– D&O: false insurance and not the best route to live serenely, even if insured you may be called to the courts
– don’t forget to check the renewal clauses + check whether the D&O insurance will pay the litigation costs
– Duty of loyalty towards Company, not towards electing/majority shareholder
– Particularly important for sharing Information / Reporting with shareholders: any additional information required by shareholders in addition to info for annual meeting will need to be negotiated and mentioned in the shareholder agreement – particularly important for Board Members who represent a group of Business Angels
– Valuation / Share transfers: need to be transparent and all shareholders should be treated the same and for exits need to be transparent especially if different classes of shareholders
– Joint liability: all Board Members are liable for all damage suffered

2) Conditions for liability of Board Members

– Directors and Officers can be sued by the company itself, by its shareholders, its creditors or by any third party which suffered a loss
– There will need to be damage incurred by either the claimant or the Company i.e. how is the net wealth impacted by either wrong decision or lack of decision of the Board (burden of proof and cost of proof is on the claimant)
– Adequate causation will need to be demonstrated
– Action(s) of the Board Members will be assessed against “bonus administrator” i.e. what you presented yourself to be (so show as little as possible, if you present yourself as a professional investor with x years of Board experience, your liability will increase significantly)
– Board liability cases do occur almost exclusively in cases of bankruptcy caused by:

  • either breach of general duty of care: finances, accounting, no appropriate organisation, no proper delegation, „wrong“ investments/transactions, or
  • Failure to make social security payments

Office des Faillites will propose systematically to sue the Board (trend to use criminal law), especially if one/several Directors have deep pockets and shareholders will go for that, banks will also if they have collateral to recover, Social Security will definitely do, employees rarely as they have to finance the claim

3) Mitigation strategies for Board Members

– First and foremost, try to avoid bankruptcy and possible liability cases resulting from it:

  • Anticipate and sell assets quick enough to avoid situation to deteriorate further
  • Get a third party to assess and make recommendations on situation and share findings with the Founder(s)/Management Team => they will generally agree to any solution that saves the company and keeps it going, even if it means selling the company
  • Generally when the lawyers get involved and says everybody is going to go to jail if there is no agreement, people then tend to agree pretty fast
  • Keep employees in the loop, to avoid that they learn by the press
  • Talk to provider/suppliers as soon as the startup is running into trouble

– Second strategy: if you think a decision is bad for the company, ask to have minuted that you are not in agreement with the specific decision – you will still be liable in case of lawsuit, but you will be able to go after the other Directors later to split the damages

– Resignation can be tricky:

  • In a situation of distress might cause personal liability as the Director has failed to act when the company was most in need and when he/she should have contributed to the right decisions being taken
  • If you resign, you will need to show that the bankruptcy has nothing to do with you when you were Director (that were the minutes of Board Meetings will be important) and you will still be part of the litigation anyway as the suitor will go after all the BoDs for the past 2-years
  • But resign if you can not add value or can not take your role anymore ; resignation with immediate effect + send copy to Register of Commerce, or wait for the next shareholder meeting to get the discharge from the shareholders (should attenuate the risks although it only works for the information that were disclosed)

4) Key elements to be vigilant on

– Social Security payments

  • In case of doubt, get an estimation, call the office of Social Security and check with them
  • Often lots of denial from Founders about whether the situation is under control
  • Social Security office is generally forthcoming, they will check you are a Board Member and will then share the information
  • Be careful: investors are often richer than Founders, so if there is a gap to plug, guess who will pay?
  • Attention to unemployed people receiving benefits and who are developing their startup without being paid: they should pay Social Security => Board of such start-up might be breaking the law
  • Attention also to Founders not being paid but working to develop the startup and accumulating equity capital according to time spent developing the startup: might be accrued as salary, and therefore subject to Social Security payments

Money laundering

  • As Board Member you need to investigate where the money (investments) are coming from
  • If going through a bank or notary it’s fine
  • If person paying the money is not the person receiving the shares you need to investigate

Best Practices

1) Should CEO be part of the Board?

– Yes, unless the CEO is not the Founder (e.g. CEO recruited externally just before an exit)
– Need good reason for Founder/CEO not being at the Board e.g. when start-up is highly involved in technology and founder should be CTO instead and therefore not at the Board
– If Founder/CEO does not want to be at the board, this is early warning sign that he doe snot want to have skin in the game

2) Independent Board Member

– No case law in Switzerland as to what independence means, so difficult to establish what “Independent Board Members” are
– Independent Board Members can be an useful buffer between the BoD and pushy investors that are not sitting at the Board

3) Observer role

– Difficult place for a shareholder as he could be deemed to be active Board Member still
– Need to remain non-involved

4) Board need to be diverse

– Diverse skills and competences
– Have corporate governance experience if possible (ex-Board Member of big firms, Audit/Legal or M&A)
– Good gender and age balance
– All members to be educated in Finance, this is key
– You can hire the other competencies e.g. as advisors, like Legal, M&A or Compliance for example
– Board Members need to spot the issues by listening and interacting with CEO and sparring ideas ; once issues have been spotted, Management’s role is to find a solution (not BoD)

5) Role of Chairman of the Board

– Founder/CEO should not be Chairman of the Board
– Chairman is interface between the BoD and the shareholders: so its a real job, it needs an “outside” view and needs to smooth things up
– Responsible for managing the conflicts of interest (CEO/Founder not well placed for that)
– Needs to manage the shareholder meeting (needs to be smooth operator and able to manage a meeting)
– Needs to be an unifier/leader
– Must have sufficient time (not full time but close)
– Is paid in shares // can not do that professionally and not be rewarded (you pay peanuts you get monkey) e.g. 20k/year for Chairman and BoD, with lots of volunteers in the startup ecosystem
– You wont get rich as a Chairman, you do it for other reasons

6) Need to be formal

–  Need to have proper invitation to Board Meeting with agenda and material
– Need to take minutes and votes need to be minuted
– Need to have a quorum
– This might sound too formal if only a couple of Board of Directors meetings but needs to be in place for the future
– Templates are available from all good lawyers

7) Advisory Board

– New trend appearing, but no legal reference, mostly a marketing play for the pitch to leverage the Bios/background of the Advisory Board Members
– Needs to be in the Shareholder Agreement or subject to a resolution of the Board which will set the rules of engagement, explain what to do with it, expectation of the role, compensation, how to fire members, and how decisions taken shall be implemented
– As Advisory Board, attention: you could have the same liabilities as a Board Member => if Advisory Board is seen influencing the Board, they will be treated as Board Members unless it is clear who does what and who takes the decisions according to known rules
– Normal practice is that the Board of Directors instructs and seeks advice from the Advisory Board, the Chairman of the Board also attends the meetings of the Advisory Board
– You need to understand how you can leave this Advisory Board

8) Managing conflict of interest

– Disclose potential conflicts of interest to the Chair
– Decide if you would better serve the start-up as a service provider or a an Advisor Board Member

Key take aways

  • Understand the law and the Shareholder Agreement
  • Formalize the running of the Board and stick to it
  • Seek professional advice – and make informed decisions => making decision without having the fact or having taken reasonable steps to the facts might be held against you
  • Not making a decision, leading to delay, is #1 spot for personal liability
  • Real failure is not to close a business, it is to fail to pay people because you did not take the decision to close the business at the right time
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4 thoughts on “How to be an outstanding Board Member of a Startup (1/4)

  1. Pingback: How to be an outstanding Board Member of a Startup (2/4) | Lionel Guerraz' Blog

  2. Pingback: How to be an outstanding Board Member of a Startup (3/4) | Lionel Guerraz' Blog

  3. Pingback: How to be an outstanding Board Member of a Startup (4/4) | Lionel Guerraz' Blog

  4. Pingback: Entrepreneurs: how to get the most of your start-up Board of Directors? | Lionel Guerraz' Blog

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