CHAPTER THIRTY-THREE

BUILDING YOUR BOARD

The first step in having a great board of directors is to carefully and deliberately build the board over time. You're never going to have an awesome board without having amazing board members. Your board can be just as important to you as your executive team and you should spend just as much time and energy building one as the other. I've had about a dozen board members over the years, some better than others.

WHAT MAKES A GREAT BOARD MEMBER?

My top five characteristics of a great director are similar to my top five characteristics of a great executive (except for the last one):

1. They are prepared and keep commitments. They show up to all meetings. They show up on time and don't leave early. They do their homework. They are fully present and don't email during meetings.
2. They speak their minds. They have no fear of bringing up an uncomfortable topic during a meeting, even if it impacts someone in the room. They do not come up to you after a meeting and tell you what they really think. I had a board member once tell my entire management team that he thought I needed to be better at firing executives more quickly!
3. They build independent relationships. They get to know each other and see each other outside of your meetings. They get to know individuals on your management team and talk to them on occasion as well. None of this communication goes through you.
4. They are resource rich. I've had some directors who are one-trick or two-trick ponies with their advice. After their third or fourth meeting, they have nothing new to add. Board members should be able to pull from years of experience and adapt that experience to your situations on a flexible and dynamic basis.
5. They are strategically engaged but operationally distant. This may vary by stage of company and the needs of your own team but I find that even board members who are talented operators have a hard time parachuting into any given situation and being effective. Getting their operational help requires a lot of regular engagement on a specific issue or area. They must be strategically engaged and understand the fundamental dynamics and drivers of your business—economics, competition, ecosystem, and the like.

As I said, there's a lot of overlap between great executives and great board members but there are important distinctions as well. You need everybody on your team to keep commitments, but you shouldn't care particularly about your CFO's industry connections and you absolutely don't want your CTO to be operationally distant. The most crucial similarity between the two lists, though, is that they exist: with the exception of certain investor appointments, you should select board members as rigorously as you would any other senior hire.

RECRUITING A BOARD MEMBER

Likewise, my recruiting process for directors is just as rigorous as what we go through when hiring a new senior executive.

1. Take the process seriously. Devote as much focus to building your board as to building your executive team—both in terms of your time and in terms of how you think about the overall composition of the board, not just a given board member.
2. Source broadly. Get a lot of referrals from disparate sources. Reach really high. Remember that asking someone to join your board is a pretty big honor for them, so that ask becomes a good calling card for you. I've had meetings with some amazing CEOs over the years when I've initiated a cold call around the person being a potential board member. Not all have worked out but almost all of them took the meeting.
3. Interview many people. Conduct interviews face to face and conduct multiple interviews with finalists. Also, for finalists, have a few other board members conduct interviews as well.
4. Check references. As with hiring, check references thoroughly and from multiple sources in different contexts.
5. Have finalists attend a board meeting. Give the prospective board member extra time to read materials and offer your time to answer questions before the meeting or even do a one-on-one meeting in person to prep the candidate. You will get a good firsthand sense of a lot of the preceding top five items this way. You want to see a prospective board member dive into the flow of a conversation in a meeting, even if he or she doesn't know a ton about the material. Someone who is deferential or afraid of saying something dumb or making waves, even during an audition like this, is likely to behave that way once on the board as well.
6. Have no fear of rejecting potential board members. Even if you like them, even if they are a stretch and someone you consider to be a business hero or mentor and even after you have already put them on the board—and, yes, even if they're a VC. This is your inner circle. Getting this group right is one of the most important things you can do for your company.

As I mentioned earlier, CEOs should go through the same process vetting a future venture investor who will have a board seat.

COMPENSATING YOUR BOARD

What about compensating your board members? These are your bosses, so deciding what to pay them might feel awkward. Nonetheless, this is an issue that will inevitably come up, so it's useful to keep a few guidelines in mind:

• Venture directors. This one is easy: venture directors should receive no additional compensation. This is part of their job. If a VC insists on separate option grants or cash compensation, resist. In fact, this is a red flag: high-quality VCs would never ask for additional payment.
• Management directors. This one is even simpler: nothing.
• Independent directors. This is the one case in which board compensation is appropriate. Until you're a big, public company, independent directors should be compensated exclusively via equity. (The rule of thumb is “less than a senior hire but not a ton less.”) That equity should vest over their term as a director (usually four years), with “single-trigger” acceleration in the event of an acquisition.

  If a director candidate insists on cash compensation, find another candidate. (In some cases they will ask for a consulting deal. Tell them that you'd be happy to consider them as a consultant but that is independent as their role on your board.)

One other item to note: vesting terms for director equity isn't a formality. You can fire an underperforming board member and that may very well happen before their term is up. I've seen multiple instances of CEOs or boards firing underperforming VC directors, sometimes by leaning on other partners in that director's firm to take over the board seat, sometimes as part of a broader overhaul of a board at the time of a financing.

You don't always have the ability to fire an underperforming director but even if you don't, you owe it to your board and to your company to give open and honest feedback and strive for continuous improvement of your board. By adding this element of rigor to your board process, you are further driving a culture of accountability, transparency and rigorous debate to the board culture. You'd be surprised how even the most callous or arrogant board members respond to peer feedback saying they're not getting the job done, as long as they respect their peers.

BOARDS AS TEAMS

Having great individuals on your board is only the first step toward having a great board. As with building any team, you want to make sure you field a collection of superb individuals who complement each other nicely in terms of experience and personality. Among the three VCs currently on our board, two have operating experience, one as a founder and one in product management. Among the two industry CEOs, one has more of a business development focus and the other has deep technical expertise. We have a world-class CFO with significant corporate development experience as well. Some directors are excitable and quick to react, others are more reflective; some are aggressive and others are more conservative; some have extremely colorful metaphors, while others are a bit more steeped in traditional pattern recognition. That diversity makes for great conversations.

Fred Wilson has regularly written that “the success of an investment is in inverse proportion to the number of VCs on the board.” Though it hasn't been my experience, I see Fred's point. I'd argue that the same statement is true of founders or management as well. Boards help govern the company and watch out for shareholder interests. Boards give outside perspectives and strategic advice to the company's leadership. Boards hire and fire the CEO. More and more every day with large public companies, boards keep management honest. How can these critical functions occur when a board has too many members of the management team on it? They can't. We have had outside directors only, other than me, from Day 1. I'm not advocating that boards meet 100 percent apart from senior management; just that other members of the management team aren't officially directors.

STRUCTURING YOUR BOARD

I regularly get asked the following questions about board structure:

• How big should my board be?
• Do I need any committees and how do those work?
• Should I be chairman or should someone else or what happens if someone else wants to be?

New CEOs especially will often get pressure to handle these issues one way or the other, either by including far too many people on the board of directors or overcomplicating it with multiple committees. The reality is that things can and should be much simpler.

Board Size

The size of your board is directly related to how large and complex your company and shareholder base are. If you are pre–Series A financing, then a board of three is plenty. Once you have raised a Series A, have a five-person board for a long time, until you are starting to think about going public. At that point, increase it to seven people. I'm not sure it matters all that much, as long as you have great directors and a manageable conversation. There are unruly boards of three and high-octane boards of seven. The main thing I'd suggest around your board's size is to:

• Never have more than one representative of management on the board (you).
• Have as many independent (nonmanagement, noninvestor) directors as possible, preferably industry CEOs or large strategic partners/customers.

The value is in the balance and diversity of opinion and experience, not the size.

Note: Although it's not permitted in a handful of states and countries, it's okay to have an even number of directors if you have a good and high-functioning board. We have had long stretches of time over the years with four or six directors. As I always said at those times to our board, “If it comes down to a tie vote about something big and contentious, we have bigger problems.”

Board Committees

The topic of board committees is also a relatively easy one for private companies in early stages. Most companies have two: a compensation committee and an audit committee.

• Compensation committee. You need a group of directors to figure out how much the company should be paying you and overseeing your decisions on what the company is paying other senior executives.
• Audit committee. You need a group of directors to speak directly to your outside auditors to make sure that your income statement and balance sheet are accurate and follow generally accepted accounting principles (GAAP).

Neither committee really needs to meet more than one or two times a year until you get much larger (i.e., approaching $100 million in revenue or about to go public). At that point, you might need a third committee on nominations and governance as well—but that's something I haven't gotten to yet at Return Path.

Note: All committees can be “committees of the whole” in smaller companies.

Chairing the Board

Should you be chairman of your own board? Up until the Enron scandal and the ensuing Sarbanes-Oxley legislation in the early 2000s, almost all CEOs were also chairman of the board. My latest read is that 75 percent of public companies are still that way, although there is a growing movement to separate out the CEO and chairman roles. There may well be good reasons for that with larger, public companies and companies with long and potentially checkered pasts that are rife with governance issues—and it's a very common practice for nonprofits and associations with different stakeholder structures. In closely held, private companies, it probably doesn't matter much either way.

If you're a typical, VC-backed company, you probably have directors who explicitly represent at least 50 percent of your shareholder base on your board, so you're unlikely to run afoul of your largest stakeholders. If your board or a major investor insists on someone else being chairman, you could always push back and suggest appointing a “lead independent director” instead. Either way, not being chairman or having another lead director only means two things:

• You still run the meetings and write all the materials, since you run the business.
• You have one person to consult with on the meeting agenda and possibly the materials ahead of time.

In other words: no big deal either way.

RUNNING A BOARD FEEDBACK PROCESS

Do you evaluate the performance of your board? If not, you should! A lot of CEOs think it's pointless to give board members any feedback, but failure to do so is just as big a miss as failure to give your staff feedback. How else are they going to understand where they're serving you and the company well and where they're not?

Running a board feedback process need not be lengthy or cumbersome. If a board is healthy, it doesn't even have to be run all that often. (There's nothing magic about an annual process. It could easily be every 6 or 8 or even 12 quarters). I developed a simple survey that I run anonymously through Survey Monkey. There are about two dozen questions in these broad areas:

• Issues—is the board working on the right things?
• Culture—does the board work openly and in a rigorous way?
• Structure—does the board have the right number of directors and committees?
• Process—does the board have the right number of meetings, good agendas, good clarity of role?
• Information and resources—are meeting materials good?
• Committee structure and performance.
• Board member evaluations—each board member ranks each board member against a number of criteria.
• Management evaluations—each board member ranks all regularly attending members of the management team against a number of criteria specific to their performance in board meetings

The exact survey we run is available at www.startuprev.com.

The one thing I've never done is ask members of my staff to evaluate the board. That would be more of a 360. Quite frankly, it's a good idea that I'll incorporate in the future.

The report-out and ensuing discussion also don't have to be particularly formal or difficult. I just include our survey's results, with my commentary, as part of our executive session materials for the following board meeting and I moderate a discussion of the results and commentary at the meeting's executive session. If I had a major problem or disconnect in the survey results, I might handle it differently. (For example, I might have the conversation facilitated by another director or by an outside facilitator or coach.) So far, that hasn't been necessary for us.

BUILDING AN ADVISORY BOARD

Many companies have some form of an advisory board. As I mentioned earlier, an advisory board isn't a great substitute for a true board of directors but it can be a useful addition to the company's brain trust.

If you are building an advisory board, the first thing you have to do is figure out what kind of advisory board you want to build. One type of advisory board actually functions as a group. You call regular meetings. You have a single agenda. You want the group to help you problem solve together and you appreciate the dynamic of the conversation among the advisors. A second type of advisory board is a board in name only. In reality, it's just a collection of individual advisers.

Regardless of which type of advisory board you construct, there are a few simple guidelines for running an effective one. These are similar to the guidelines for running a board of directors:

• Clarify the mission, role and expected time required from advisers on paper, both for yourself and for people you ask.
• Figure out the types of people you want on your advisory board up front, as well as a couple candidates for each slot. For example, you may want one financial adviser, one industry adviser, one seasoned CEO to act as a mentor or coach and one technical adviser.
• Aim high. Ask the absolute best person you can get introduced to for each slot. People will be flattered to be asked. Many will say yes. The worst they will do is say no and refer you to others who might be similarly helpful (if you ask for it).
• Be prepared to pay for people's time somehow, likely in small stock option grants.
• Work your advisory board up to the expectation you set for them. Make sure you include them enough in company communications and documents so they are up to speed and can be helpful when you need them. Treat them as much like a board of directors as you can.

At Return Path, we never had a true advisory board but we have had about a dozen advisers over the years, all of whom have received small stock option grants (one or two have even received multiple grants). The people on our advisory board have always taken my calls and been helpful as needed—and more than that have offered proactive advice and information flow regularly.