This is the last 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.
The focus of this last session was to apply some of the concepts learnt during the previous sessions and carry a Board due diligence on a real start-up to determine whether to become a Member of their Board and what action(s) to recommend in this capacity. This article focuses on the lessons learnt from the Board due diligence exercise.
Registration for subsequent sessions here: http://bit.ly/StartupBoD
1. Board Member Due Diligence vs Investor Due Diligence
Whether you want to become an investor or you want to join the Board of Directors of a start-up, there are many overlaps in the due diligence approach, as by definition you will endeavour to find out more about the company, what it does, how it executes and what its future perspectives are.
Indeed, any Board Member due diligence will normally start by a pitch from the start-up which looks furiously like an investment pitch. The reason is relatively simple: a start-up has in general only one standard pitch, which it uses to raise funds, first and foremost. So when meeting with prospective Board Members, it will use the same pitch as for investor meetings.
Similar to any Investor due diligence, the immediate tasks will be to understand the business of the company, understand whether it brings a solution to an existing problem that has been tested and for which a market exists (or could develop) and who the team that leads this company is and whether they have what it takes to make the company successful.
The next level of probing will then go into the various aspects of the business model, to determine how the product or service is being built and delivered, how clients are being identified and acquired, how the product or service is being priced and money collected from the clients.
At this stage however, the two due diligences will diverge in their focus and it is important for the prospective Board Member to actively resist the temptation to fall in love with the start-up and its product and/or team, as this might cloud their judgement. This is an error that can be costly for any Board Member: while an investor may end up losing their initial investment if they forgot to ask about any important aspect, Board Members will in fact risk much more if they let slip some red flag because their blinded enthusiasm! So, Board Members beware!
While the Investor due diligence will seek to probe the purpose of any capital increase and the prospect of seeing capital returned with profits in the future, the Board Member due diligence will instead focus more on the details of the start-up governance and interactions between the various stakeholders.
Key questions to focus on include:
- What is the alignment of the founders with existing shareholders about their vision for the company?
- What is their view of the current development of the company and what next step(s) they would like it to reach?
- How attached are the founders to the company and in particular their need for control?
- What role(s), if any, they would like to have in the future and what this would mean for the company development?
- What sort of shareholder agreement is in place?
- What Board is already in place and what company governance is followed?
In a second phase, the questions also need to help build a better understanding of the strategic environment of the start-up and topics where the Board will be intervening:
- What are the next steps in the growth trajectory of the start-up? i.e. new product or new market, new factory, etc… What means are required to reach this step?
- What is the financial situation of the company, both in terms of financing (balance sheet and indebtness), but also cash flow positions and what is required in term of capital to reach the next milestone(s)?
- Is the company lacking any resource and/or skill(s) in order to allow it to grow and scale up to the next stage? (this is particularly true for any technology based company where the founders are in fact well-suited to become the CTO / R&D leader but have little ability and/or wish to be involved in developing the sales and marketing function, or the finance function beyond the initial efforts that are required to bring the start-up to life and create the initial traction).
2. Do not forget to ask ALL your questions, especially the difficult ones!
Becoming part of the Board of a start-up will come with additional responsibilities, in particular with regards to personal liability in case “any faecal matter strikes the rotating object” and the start-up goes bankrupt for example.
It is therefore important for the prospective Board Member carrying a due diligence not to spend too much time on the product and the market, and instead to look into every angle, and in particular the areas where issues are most likely to arise, that will later become potential headaches for the Board.
Key difficult questions to ask here are:
- What are the most important contracts in flight? How are things going on those contracts? Is there any difficulty, from the start-up side or from the other side, to stick to the terms of the contract, be it the delivery and/or quality of the product/service, payment or any other term?
- Is there any conflict at the moment, with either some employee, some supplier, some client, some shareholder and/or Board Member? If so, what is at stake? What potential mitigation is in place?
- What are the risks towards clients? Is there any legal case open? What are the liabilities that delivering your service or selling your product create towards the client(s)?
- Is there any risk for your staff? In particular if there is a production unit, are all the environmental, health and safety risks covered? (don’t forget to also enquire about competition risk and key-man risk).
- How is the relation with your shareholder(s)? Do you have a shareholder agreement and articles of incorporations? Do they have all the standard terms and clauses? Are there any exotic terms in use? If so, why and how are they being managed?
- What are your current Board dispositions? Who sits at the Board, any independent Director? Who is the Chairman of the Board? How often does the Board meet? What is being discussed? Who does what?
- If not covered in the first part of the due diligence, when discussing the financial aspects, you then need to clearly ask how the start-up stands with regards to indebtness and article 725 – that would be silly to walk into that issue from the get-go!
Carrying such due diligence in a group will allow to split roles and to play bad cop/good cop, which should alleviate the pressure that some of the above questions will generate – but remember that this pressure is required, especially because not asking these questions now and discovering the facts after you have taken your decision to join the Board, will lead to a more awkward situation for you afterwards. Better safe than sorry!
3. It is also a selling act from the prospective Board Member
Just like it takes two to tango, joining a Board of Directors implies not only that you, the prospective Board Member, are willing to join the Board, but also that the founder(s), and the existing Board of Directors, are satisfied that as a new Director, you will bring a positive contribution to the development of the start-up.
As such, the due diligence goes both way, and as a prospective Board Member is it important to showcase what strength(s) and expertise you can bring to the start-up, be it industry knowledge, network or specific skill like company management, finance, or sales & marketing. This needs to be evident through your personal pitch, but also throughout your questions during the due diligence and finally through the suggestions that you will make as part of your due diligence report.
The due diligence report is a professional way to share the conclusions of your audit of the start-up with the founder(s). It needs to give a personal, fair and unbiased assessment of the start-up, based on your review, as well as key propositions that you would support, should you join the Board. Of course, it is also an elegant way to indicate to the start-up whether you would be willing to join their Board, and what conditions or pre-requisites, if any, would be attached to such an offer.
However, remember that joining a Board comes with strings attached, and therefore you should not compromise on your questions, no matter how hard you wish to be picked. Avoiding unpleasant discussions during the due diligence with the founder(s) and the existing Board in order not to upset them, is the wrong approach and the penalty for joining the Board of the wrong start-up can be high.
So conduct your due diligence with care, ask the right questions and trust your instinct.
If you want to read the other articles in the series:
- link to How to be an outstanding Board Member of a Startup 1/4
- link to How to be an outstanding Board Member of a Startup 2/4
- link to How to be an outstanding Board Member of a Startup 3/4