Truth 31. Board of directors
The need for a board of directors depends on the type of business you start. If your business starts as a corporation, it is legally required to have a board of directors. A board of directors is a panel of individuals elected by a corporation’s shareholders to oversee the management of the firm. In an early-stage firm or a small firm, the board may be restricted to the principles running the firm. In these instances, the board serves little more than a legal function. In other instances, however, the board plays an active role in the management and oversight of the business.
Technically, a board of directors has three responsibilities: (1) appoint the firm’s officers, (2) declare dividends, and (3) oversee the affairs of the corporation. The optimal size of a board of directors for a start-up is three to five people.[1] A board is typically made up of both inside directors and outside directors. An inside director is also an officer of the firm. An outside director is someone who is not employed by the firm. A five-member board of directors usually consists of two inside directors and three outside directors. Most boards meet formally three or four times a year. Large firms pay their directors for their service. New businesses are more likely to pay their directors in company stock or ask them to serve without direct compensation—at least until the company is profitable.
If handled properly, a business’s board of directors can be a central part of its new business team. An active board provides guidance and lends legitimacy to a firm.
If handled properly, a business’s board of directors can be a central part of its new business team.
Provide guidance
Although a board of directors has formal oversight responsibility, its most useful role is to provide guidance and support to the managers of the firm. Many well-intended business founders and managers simply “don’t know what they don’t know,” which often results in missteps early in the life of a start-up. Experienced board members often see these potential missteps before they occur and help new business teams avoid them. Many business owners interact with their board members frequently and obtain vital input. The key to making this happen is to select board members with needed skills and useful experience who are willing to give advice and ask insightful and probing questions.
Although a board of directors has formal oversight responsibility, its most useful role is to provide guidance and support to the managers of the firm.
Individual members of a board of directors can also help fill competency gaps when a company is started, as mentioned in Truth 28, “How to approach the task of building a ‘new business’ team.” If a firm gets investment capital, the investor normally occupies a seat on its board of directors. Investors do this not only to protect their investment but also to assume a formal role in lending advice and assistance to the business.
Lend legitimacy
Providing legitimacy for a firm is another main function of a board of directors. Well-known and respected board members bring instant credibility to the firm. For example, just imagine the positive buzz a firm could generate if it could say that a well-known entrepreneur, investor, or banker had agreed to serve on its board of directors. This phenomenon is referred to a signaling. Presumably, a high-quality individual would be reluctant to serve on the board of a low-quality start-up because that would put his or her reputation at risk. So when a high-quality individual does agree to serve on the board of a new firm, the individual is in essence “signaling” that the company has the potential to be successful.[2]
Achieving legitimacy through high-quality board members can result in other positive outcomes. Well-known board members can often help companies get their foot in the door with potential suppliers and customers. Board members are also often instrumental in helping young firms arrange financing or funding.