I had a group of ex-students out to the ranch who were puzzling over a dilemma – they’ve been working hard on their startup, were close at finding product/market fit and had been approached by Oren, a potential angel investor. Oren had been investing since he left Google four years ago and was insisting on not only a board seat, but he wanted to be chairman of the board. The team wasn’t sure what to do.
I listened for a while as they went back and forth about whether he should be chairman. Then I asked, “Why should he even be on your board at all?” I got looks of confusion and then they said, “We thought all investors get a board seat. At least that’s what Oren told us.”
Uh oh. Red flags just appeared in front of my eyes. I realized it was time for the board of directors versus advisors talk.
Roles for Financial Investors
I pointed out that there are four roles a financial investor can take in your company: a board member, a board observer (a non-voting attendee of board meetings,) an advisory board member, or no active role. I explained that as a non-public company there was no legal requirement for any investor to have a board seat. Period. That said, professional venture capital firms that lead a Series investment round usually make their investment contingent on a board seat. And it sounded like if successful, their startup was going to need additional funding past an angel round to scale.
In the last few years, it’s become more common for angel investors to ask for a board seat, but I suggested they really want to think hard about whether that’s something they need to do now.
“But how do we get the advice we need? We’re getting to the point that we have lots of questions about strategic choices and relationships. Isn’t that what a board is for? That’s what we learned in business school.”
What’s a board for?
I realized that while my students had been through the theory it was time for some practice. So I told them, “At the end of the day your board is not your friend. You may like them and they might like you, but they have a fiduciary duty to the shareholders, not the founders. (And they have a fiduciary responsibility to their own limited partners.) That means the board is your boss, and they have an obligation to optimize results for the company. You may be the ex-employees one day if they think you’re holding the company back.”
I let that sink it for a bit and then asked, “How long have you worked with Oren?”
I kind of expected the answer, but still was a bit disappointed. “Well we met him twice, once over coffee and then over lunch.”
“You want to think hard about appointing someone to be your boss just because they’re going to write you what in the scheme of things will be a small check.”
Now they looked really confused. “But we need people with great advice who we can help us with our next moves.”
Advisory Board
“Do you know what an advisory board is?” I asked. From the look on their faces, I realized they didn’t so I continued, “Advisors are just like they sound. They provide advice, introductions, investment, and visual theater – (proof that you can attract A+ talent.) An advisor that provides a combination of at least two of these is useful.”
A “board” of advisors is not a formal legal entity like a board of directors. That means that they can’t fire you or have any control of your company. While some founders like to meet their advisors in quarterly advisory board meetings, most companies don’t really have their advisory board meet as group. You can connect with them with them on an “as needed” basis. While you traditionally compensate advisors by giving them stock, I suggest you ask them to match any grant with an equal investment in the company – so they have “skin in the game.”
Equally important is that an advisory board is a great farm team for potential outside board members. It allows you to work with them over an extended period of time and see the quality of their advice and how it’s delivered. If they are world-class contributors, when you raise a Series A round and you need to bring in an outside board member, picking someone you’ve worked with on your advisory board is ideal.”
Finally I suggested that Oren’s request to be chairman of a five-person startup seemed to be coming from someone looking to upgrade their resume, not to optimize their startup.
No Outsiders Until a Series A
As we wrapped up, I offered that there was no “right answer” (see Brad Feld’s post) but they should think about their board strategy as a balance between the amount of control given to outsiders versus the great advice outsiders can bring. I suggested that if they could pull it off they might want to consider keeping the board to the two founders for now, surrounded by great advisors which may include their seed investors. Then when they got a Series A, they’ll probably add one or two professional VC’s on the board with one great advisor as an outside board member.
As they left they were going through the experienced execs they knew who they were going to take out for coffee.
Lessons Learned
- Your board of directors is your boss
- Your advisory board is your friend
- Not all investors get board seats, it’s your choice
- Date advisors, marry board members
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Steve, in response to your comment –
“While you traditionally compensate advisors by giving them stock, I suggest you ask them to match any grant with an equal investment in the company – so they have “skin in the game.”
Some advisors want to be on the side of the table as the CEO, Founder and not represent investors [the other side], therefore they decide to serve as an advisor but against investing. Their goal is to help the CEO, Founder and have their best interests in mind at all times. Some advisors think their guidance may be tainted if they sit on both sides of the table.
This is a very important topic, thank you Steve. In the past, my priority has been to establish a great advisory board very early in the life of the startup, even before any outside investment. In addition to advice, some of these people have become angel investors in the business (and brought others). Furthermore, I have used the experience of working with them, as advisors, as means of evaluating their suitability for a board of directors seat when the time is right to add non-founders.
In a future article, it would be helpful to get your guidance on selecting, permitting and managing board observers.
This is the best advice I (as an entrepreneur) ever got. Thank you Steve. I have invented a superb product (most comfortable chair and mattress) , I am about to complete the prototype in a month. After reading your advice I decided to make my company as a private limited company and make my investors as share holders of small percentage each so that it is easier for me to bring investment and it will be my choice who should be my advisors. Thanks again.
In many cases, what lies behind the investors check is often where the true “value” can be found (or not).
A 10 minute conversation with an experienced entrepreneur can often save 10 years of pain. Seek these individuals out like your companies life depends on it (it actually may). Discerning the value of money and the value of experience is a skill. Unfortunately, more times than not it does not extend from the same hand…
Steve – Great Post.
I’m encouraged by your commitment to these former students. They need a clear head who’s traveled these roads and is unclouded by the wad of cash dangling out front.
I’ve seen this in non-profit organizations, too. Boards are packed with big one-time donors or local personalities, all of whom are really too busy to meet corporately anyway. Meanwhile, budgets are floundering and the organization is sinking further and further into stupid debt.
Since I managed a bachelor’s degree without stepping foot in a business building, your advice is invaluable. I love the idea of forming a board of advisors and will be implementing it as soon as possible.
What if a VC firm invests in your seed round?
Anna,
Smart VC’s definitely don’t want a board seat for each seed investment they do, or else they’d run out of time and bandwidth.
steve
Thanks, useful info as always!
Steve,
Thanks as always for great perspective and applicable advice — news you can use! These are the nuances new entrepreneurs are looking for from seasoned pros like you; your IP generosity is quite valuable, so thanks again from all of us in the start up community, most of whom, like me, dont have an MBA and didn’t go to GSB, etc.
Bill Hewson, fledgling entrepreneur
Easton, CT
thanks!
My advice for startups is to try and find first a coach, or a lead mentor.
Once you have this guy on board and establish a relationshiop based on trust and respect, then he would be a key person to help you build the Board of Advisors, as a second step.
Rami Gazit, Israel.
Rami,
Agree. I wrote about mentors and coaches here.
steve
Thank you Steve. This post is very informative.
I wonder if we have a community to match founders and advisors? (based on interest, market, expertise, etc.)
The startup boom is relatively new here in London, and most of the angels ask for a mandatory board seat. If the startup refuses = NO investment is made.
On the contrary, I am on your side and prefer to be “just” an advisor.
An investor who want to be in every board of every early stage startup is not enough organised (thus a bad advisor) or not enough requested (thus looking to boost his resume -> thus a bad advisor). Cheers
Great timing for your post Steve. A little side note here – I moved into a artist loft work space 1 year ago here in MN and I serve on the co-cooperative board where I initially thought was to empower artist. Since reading your 4 steps to the epiphany I found this structure does nothing to empower these 150 or so bright artist, designers and entrepreneurs to innovate and apply your educated start ups methods. It in fact oppresses us… In light of your past post of “Rent Seekers” agenda “I see the light” as to why this art co-op business model is counter productive to artist slaving away 2 jobs just to make rent!
In a nut shell I want to start up perhaps a revolution in business here in our arts district. Have you overlooked any activity around the United States where your protocols are taking place in larger artist work spaces? What I see is some sort of leadership team to start educating people and perhaps incorporating it into the branding structure of a revised live work shop center for launching and refining new products. Perhaps we could even employ a team to coach people through the process here… Do you have workshops get people on track? I want the people in my community to be the head, not the tale. Thanks Steve…
“You can’t pay someone
to do your thinking for
you” applies here. Why
is Oren needed when
they’ve got Steve?
Great perspective Steve! Since it appears that Oren likes inflated titles why not appoint him as chairperson of the advisory board. I sense that Oren is in the business of buying credibility…
Fantastical article. Currently I am working on setting up a company and faced the same issues when I went to get investors.
This is a great article. I actually sought advice last week about board formation from a board member at a mid-cap, publicly traded company and he echoed many of your points, Steve. He also stressed that the focus should be on assembling high-level decision-makers as opposed to loading up on technical expertise.
Great post. Concerning asking an advisor to “match any grant with an equal investment”, how do you determine the investment amount to ask for if your company is pre-revenue?
Hi Joel,
Perhaps they could use the Delphi method as one of their determining estimations?
Regards,
Cheweyyy
Hello Steve,
I am a first time reader of your blog and perhaps do not have the right to comment but this post is of great interest to me as I had a lecture on Corporate Governance at university last week and the seminar that followed it turned into quite a heated debate.
Perhaps I have a lack of understanding, but having read the “Visible hand of Management” by Chandler, I had the understanding that today corporations have gotten so large that we have a new class of manager. The professional manager and not simply the old fashioned system of managers than own and owners that manage. As I understand it, this results in an agency problem where managers may overlook the goal of maximizing shareholder wealth and instead decide to take private benefits. I believe that the board of directors is one of the mechanisms in place to protect shareholder interests and their duty foremost is to their shareholders and equity owners. However as far as I am aware, the board also has significant power and has the authority to replace senior management if they deem it necessary.
Many of the other students argued with me and were under the impression that the board is simply there as an observer. I guess they lacked an understanding of the role and power that a board of directors have. I even went so far as to cite to them the case of Apple in 1985, when the board decided to replace Steve Jobs with Scully but I still could not get them to understand.
I am glad that an experienced person such as yourself has similar views to mine and I look forward to now reading your blog more often and hopefully improving my own education along the way by benefiting from your experience.
Thanks for the lesson,
Cheweyyy
I wish I had read this ten years ago. This is very good advice.
Hi Steve, great article as usual…I have a question for you, if you have the time to look at it i will be glad. The questions is about your sentence….”While you traditionally compensate advisors by giving them stock, I suggest you ask them to match any grant with an equal investment in the company – so they have “skin in the game”…Is there any “standard” amount (%) of stock to compensate a advisor before a seed stage? I’m working on a start-up, the bootstraper way, and because of my need for networking i recently bring on board an advisor. Can you give me an idea of a fair % for this kind of role?
Thank you.
Hi Steve,
Great article as usual 🙂 I have a question for you, if you have the time to get back to me i will be glad. In the article you refer that advisers normally get stock as compensation. Is there a “standard” % of stock for this kind of role? I ask this because i’m building a product with a lot of potential and i felt the need for networking to be able to advance for next steps, namely showing the prototype and try to close some deals (not investment) so i brought an adviser on board and i don’t have a clue about how much i should share with him…
Thank you for your time and the great work you have been doing.
Ricardo.
Ricardo,
Take a look at my Startup Tools page on this blog.
There’s a section on advisor and executive compensation.
steve
Thank you Steve, i will do that.
Cheers.
Like much advice received, it is not so simple. Here are some reasons a founder and a start-up need (or might want) Board members:
A. Affiliate Transactions: Who will approve your salary and employment agreement and have it be solidly set and not subject to second guessing or even a lawsuit for self-dealing? You need someone other than you (the founder) to vote for your compensation to pass muster without leaving these decisions open to attack. Same with stock options. Same with the rent you pay to yourself or your family for your start-up office space or for your car if it is not company property.
B. You Need a Bad Cop. Founders often have “friends” as their number 2. Guess what? You/the company may need to fire your friend, or cut his/her salary or change his/her title.
C. Statutory Requirement. In Delaware you need only 1 Director, but in California (for example) you need at least 3 directors if you have 3 shareholders, and at least 2 directors if you have 2 shareholders. The founder can appoint all 3 and that can work, but those other 2 Board members have fiduciary duties and are likely to take them seriously once on board (no pun intended).
D. Smart Business. Sure, you could hire advisors, but you are unlikely to get them all in the same place at once to consider and share ideas and solutions. Board meetings, and the preparation for those meetings (your Board members should insist on a real Board package, up to date information, etc.), are a way to force you to stop and sharpen your saw, and measure what you have done.
E. Investors. Your investors and potential investors will want you to have a Board, even if they are not on the Board or appointing a Board member. You are likely to have 2 classes of securities if you have investors, and those investors need someone on the Board to watch over their interests, even if it is via a fiduciary responsibility to the whole company.
[…] and control (investor rights). It just turned out that we believed strongly (as the famous Steve Blank does) that an early seed round should not be about control but enabling and supporting the founders […]