I won’t serve on a board without D&O insurance!

I’ve been sued as a board member too many times over the past twenty-five years of board service.  Five times. Does that shock you?  It does me.  Entrepreneurs blaming their board for failures of a fragile, early stage company.  Shareholders unhappy over the same loss, reaching out to sue every name available. Employees reaching out to anyone above to redress grievances.  In one case, an aggressive lawyer finding all the members of an LLC, and suing every member found.  Whew!

Whenever there are outside shareholders or note holders, or unhappy employees, and when there is a product in release, there is a chance, no matter how slight, of a lawsuit against members of the board as well as against the corporation itself.  Even if such a suit is completely without merit, the cost of defense and the risk of a negative outcome both hang over the company and the director.

Directors and Officers insurance (D&O) is meant to reduce that risk and provide for the legal defense of any such suit at the expense of the insurance company.  In that regard, even the lowest amount of D&O insurance available, $1 million, provides for legal defense costs to be covered.  The usual cost for such insurance is $4 to $6 thousand a year, with an extra $2 thousand for an additional million dollars of coverage.

[Email readers, continue here…]  Recently, insurance companies have added employment practice liability insurance (EPLI) to the package to address specifically the recently-increasing risk of employees suing for redress.  Given the increasing number of suits for sexual, racial, gender and other discrimination, this now seems logical and necessary.  So, add another $3 to $4 thousand to the policy cost.  Ouch!

More important than the cost is the provision of investment documents from sophisticated investors like VC’s and sophisticated angels requiring D&O insurance for the company at the time of funding.

Additionally, I have always insisted that a company CEO sign an indemnification agreement, which indemnifies the director in any event of a lawsuit using the full financial resources and staff capabilities of the company.  This may sound harsh, but in reality, the insurance obtained does this.  However if a policy lapses and is not renewed, and if the directors are not informed, this agreement forms an underlying defense backed by the corporation.  Unfortunately, there are times when early stage companies just run out of money and cannot renew their policies and therefore have little resources to pay lawyers for defense of claims.  And unfortunately, it is often during these stressful times that shareholders are angered by perceived or actual under-performance by founders and boards.

Over the many years of board service, before insisting upon this insurance requirement before service, I had been sued as a director several times, in no case covered under the umbrella of a D&O policy.  Although I won each of these rather spurious suits, the cost of defense in some of the cases was not reimbursed, and the time spent in helping the attorney prepare for the defense and in one case through to a several-day adjudication event, was not small.  As a result, I now insist upon D&O insurance for every board upon which I sit.  The backgrounds of these suits make for good stories – for another time.

Posted in Protecting the business | 6 Comments

How about your board members’ time commitments?

Expect a board member to give a meeting a month, emails and phone calls between.  Urgent issues require more of all.

Board members are usually busy people, often running other companies or serving on multiple boards.  Early stage boards usually meet once a month for two to a maximum of four hours, enough to ruin the rest of a day for those who travel even short distances.  In addition, most all board members freely receive phone calls and emails from the CEO during the month, all considered part of service.

There are times when board members are called upon to give extra-ordinary time to the corporation, such as interviewing candidates, strategic planning, recovery from a cash flow crisis or other urgent issues.  Most often these are freely given by board members.

You would probably cross a line if you ask a member of the board to consult to the company, spending considerable time with other employees regarding issues that might be handled by others than from a board.  Depending upon the board member, it is appropriate for you to offer a consulting fee for this time spent above the call of board duty.  Any such informal contracting of service should always be preceded with an agreement between the CEO and board member as to the amount to charge and estimate of time to be spent before further agreement is necessary.

[Email readers, continue here…] Do you expect your board members to be more involved that this?  Have you discussed this during a board meeting?  And would you want more from your chairperson?   How about asking a board member to spend time with one of your VP’s or directors?  All of these are great questions to clarify with your board.

So, now we’ve discussed the expectations that are the norms.  It’s your turn to make expectations clear and be sure there is agreement about these expectations.  Good luck!


Posted in Surrounding yourself with talent | Leave a comment

How do you pay an early stage board?

Give one percent equity to each outside board member vesting over four years of service.

Many early stage CEOs and board members have asked for some guidance regarding pay and time commitments for board members.  Here is my best advice, based upon many boards and many years.  Pay early stage board members of companies that are not lifestyle businesses one percent of the fully diluted equity in the form of an option that vests over four years of service.  You do not pay professional investors who are serving on behalf of an investment company or VC and paid by that company.

The option price should be set by appraisal under IRS rule 409a, and certainly should be low enough to recognize that common stock options are not worth as much as preferred stock, given the many preferences of the latter.  Further, the option should contain a special clause that accelerates vesting to 100% upon a change of control in the corporation, which aligns the board member with the best interests of the corporation itself. Otherwise, you might picture an event in which the sale of a company to be consummated a few months before full vesting could cause a board member to find ways to vote for delays or even against a sale of the company, awaiting full vesting of his or her options.

[Email readers, continue here…]  For lifestyle companies or later stage companies, board members should be paid on a per-meeting basis in cash. Typically, this payment amounts to $1,000 per meeting of the board, adjusted upward for public corporations to $3,000 per meeting on average, with special pay for committee chairs and special meetings.  These payments recognize that board members are not working for equity but for the equivalent of consulting fees plus the attendant risks of board membership.

To be clear, venture investors with investments from their funds are not typically ever offered pay for board service, which is expected as part of the investment.  Inside board members, CEO and any other paid employees are not paid for board service in either stock options or cash.

Expenses for travel are often reimbursed by the corporation.  VC board members sometimes request this, other times do not. It should not be offered to the VC members unless requested.

Next week, we’ll cover what should be expected of a board member in the way of time allocated to the company.

Posted in Depending upon others, Surrounding yourself with talent | 3 Comments

Please learn this: “Noses in; fingers out!”

Many of us have someone who reports directly to us and who supervises others in return. If that fits, well then, this one is for you. And it is one of the most important lessons you can learn as a manager or board member of a company or a non-profit enterprise.

I first heard this expression in a governance seminar for a non-profit higher educational board upon which I sit, years ago.  It made an impact and stuck with me through the years.  I have repeated it often to boards deliberating action, to individual board members seeking to get their hands dirty inside the corporation by giving advice and helping at levels beneath the CEO, and to senior executives or managers as well.

The problem this addresses cannot be overstated. Once a person of higher authority reaches beyond their direct report in an organization, especially without the approval of that direct report, incurable damage will have been done to that person’s ability to manage.  Even if not the intent, there is an instant change in dynamic once this line has been crossed.  Sound overstated? It is not, and that is the lesson here.

[Email readers, continue here…]  Here is an example, even where your presence without speaking can do harm.  Once again, it is a personal story where I had to relearn this mantra first hand. As chairman of a company in an industry where I have extensive experience, I elected to attend a regular meeting of the management team with its middle managers on a Monday morning, a practice I had not done in the past.

I found the meeting to be unusually quiet and tame to say the least. The CEO spoke, shared metrics, spoke of issues to be addressed during the coming week, and did a fine job of pointing the assembled troops in the right direction. I could not have been more pleased.  After returning to my office, I received a call from the CEO. ‘Would I please (oh, don’t take this wrong, Dave) not attend these meetings anymore?’

What I took for unusual silence was a complete disruption of the normal give and take of the management group because of my presence.  My chairmanship carried unstated power even if not overtly demonstrated, since the CEO reports to and is accountable to the board, and of course its chair.

I learned from this that there are times when members of the board are appropriately brought into an operating group, and certainly times when the board should hear from vice presidents presenting their issues in a board meeting.  But the position of CEO is absolutely to be reinforced at all costs, never to be undermined by any member or by the board as an entity.

Now insert your position, no matter how low or high in the organization.  How would you feel if a more senior person stepped into your meeting, instructed your direct reports without your permission, or generally took over a process you controlled?  Yup. I thought so.

Sure, it is appropriate for the senior person present to ask the tough questions, request help in understanding issues, seek permission from you interview others.  But that senior person should never react to statements heard by issuing directions or hints of action in return.  It is appropriate to state that you understand much more after the briefing and will better be able to address the problem with others.  It is not appropriate for you to promise any action to anyone beneath that person at the next level.

So, let’s repeat the lesson. Noses in; fingers OUT.

Posted in Depending upon others, Surrounding yourself with talent | 3 Comments

Hire a consultant; ignore the advice.

At one time or another, most all businesses use consultants to fill the gaps in knowledge or to provide guidance for management.  Consultants are good in that you can sample their work with short projects, change to other consultants quickly, and stop using them when a project is completed.

I have a partner in a consulting practice that specializes in the travel industry.  Several years ago, we were hired by one of the largest companies in the industry (yet another Fortune 50) to perform a top-to-bottom audit of their processes across 27 facilities, and recommend measures to increase efficiency, increase income, better the customer experience, and of course, decrease costs while also increasing the quality of service.  We were quite confident that our services would yield great, measurable results.  The work continued for about eight weeks between the two of us as we visited the 27 locations and worked with employees in departments across all disciplines within each location and at central offices that performed services for all locations.

Finally, at the end of the project, we had identified nineteen specific issues, each of which would, if implemented, accomplish one or more of the goals outlined at the start of the project. The sum of the savings and increases in revenue were worth multi-millions annually, well worth the implementation of most or all of the recommendations.

[Email readers, continue here…]  On the final day of our assignment, I was responsible for the “reporting out” to the assembled twenty or so executives in the large conference room of this major corporation.  I started my presentation, which had been carefully documented in handouts and PowerPoint, with this story…

“I want you to all imagine that it is tomorrow morning, looking back upon today’s reporting of these past months of work by your consultants.  Imagine that today I build for you a beautiful sand castle exactly at the water line of the ocean nearby.  Tomorrow, we both will visit that beach and look at the water line, and find not a beautiful castle, but just smooth sand, just as it had been the day before building our beautiful sand castle.  In other words, I would not be surprised if you accept our report today with enthusiasm, but then in the overwhelming rush of daily business, fail to implement few if any of these recommendations that you so enthusiastically received.”

The story is true, and the results were as I predicted.  A few of the recommendations were implemented over time, one with great effect and even a national advertising campaign behind it (that you surely saw on TV).  But most were just ignored.  I imagine that our report sits today on someone’s shelf, filed with others from past and from following months and years.

Unfortunately, it is human nature to enthusiastically ignore to act upon recommendations of third party consultants. There are many, many exceptions, but far more instances of this in the business world.  Not all consultants give advice worth taking, of course. But when they do so, it is only as good as that which you implement.

Posted in Depending upon others, Surrounding yourself with talent | 13 Comments

Bankers: love ’em or hate ’em. They may affect your future.

Let’s get right down to it.  Your banking relationship can be like a great marriage or a bad trip to the DMV.  In most cases it is strictly your choice.  But the results of that choice will reverberate for what could be years.  For a start…

How did you open your first bank account?  Did you just walk into a branch, fill out the forms, take your first ten checks from your newly-opened account and leave?  Do you even remember the name of the bank employee who helped you with that transaction?  Well, that would have been your first mistake.  As I’ve found in numerous companies over the years, the initial visit sets the stage for an entire relationship to follow.

But why bother with a relationship if all you want is a checking account?  Well, it’s time to tell a few true stories to illustrate why you should cultivate a relationship with a banker.  And it is never too late, even if you opened that account years ago.

Here’s an example – an unintentional overdraft in your checking account.  Most of us have suffered this at least once if not more often.  Whether caused by sloppy accounting or bad cash control or by a third party taking money from your account for a recurring charge – or even by a PayPal purchase not recorded in the books, people or companies with marginal checking balances will someday be hit with an overdraft.  Today, many banks charge $35 or so for each check paid with insufficient funds.  One of my companies was recently hit with ten such charges in a single day before they realized the error, resulting in $350 in overdraft charges in a single day.  So? Here are two alternative responses.

[Email readers, continue here…]  Relationship banking: If the CEO or CFO had no relationship with the banker in charge of the account, there is little chance of receiving a waiver and reversal of the charges, even if your history with the bank is flawless.  On the other hand, a good relationship and established history could and would usually result in a call to the banker, a short and rational explanation, followed by your banker’s immediate promise to reverse the charges.  Yes, if this habit becomes routine, all bets are off, sometimes including whether the bank will keep your account open for you in the future.

And there are more important issues.  Most business banks will grant a $50,000 line of credit through a bank-issued credit card, often requiring a personal guarantee.  That is an expensive alternative, with costs for amounts carried over even for a few days beyond the due date running between 8% and 24% when annualized.   With a good banking relationship, your banker can help with a line of credit at reasonable rates, fitted to your needs, and established in a way that will not drain cash each month affecting business health and growth.  Yes, most banks will require a personal guarantee for such lines of credit, and even for equipment, receivables or other secured loans.

There is usually one exception:  Some banks, especially those known as “venture banks,” will recognize the issue of a company with multiple investors, especially with a venture capital company as one of those.  By substituting a small number of warrants to purchase stock in the company at a reasonable price for what would have been a personal guarantee, those banks will eliminate the need for the founder or CEO to sign such a guarantee, trusting instead the relationship with the VC company as of overriding importance.

There are many types of bank loans, including those guaranteed by the Small Business Administration (SBA) in which the bank and SBA share the risk for the loan.  It is worth spending time with your relationship banker to discuss cash management, banking needs, and various opportunities.

But what happens when something goes wrong?  Sometimes you get into a cash bind and cannot make a payment or even need to restructure a loan.  This is the time when your personal relationship with your banker makes or breaks a company.  Sound a bit dramatic?

Ever hear of the “workout” division of your bank?  I hope not. That is the group your banker turns to when your account has shown signs of being too high a risk for the normal banking relationship.  Your banker is removed from the process once that divide is bridged, and you are introduced to a “workout specialist” who dictates your banking future, typically by establishing new rules requiring accelerated repayment, perhaps sale of assets, direct bank collection of receivables to pay down loans, and other mild to draconian efforts to protect the bank and reduce its exposure.

You do not want to be sent to workout.

On the other hand, if you have been communicating your progress both positive and negative to your banker on a regular basis, that person can mitigate the more draconian moves if she or he understands the reasons for a temporary setback, having history and confidence in your abilities to work through the problem.

So, it is all about the relationship you establish when first walking in the door of your bank.  And it is not too late if you failed to do this back then.  You may not know who to call, and a cold call or visit to the local branch is a good start to establish that relationship and begin or reinforce the positive aspects of the banking experience.

It is just one more of the things a good manager does to ensure the ultimate success of an enterprise.

Posted in Depending upon others, Surrounding yourself with talent | 6 Comments

Take only “smart money” investments

This statement could be considered controversial.  We have previously made the case that professional investors demand more in the form of restrictive covenants and lower valuations.  Now we explore the other side of that coin.  Professional investors usually bring “smart money” to the table, defined as money that comes along with good advice and great relationships for corporate growth.  Often, that money is worth more than the cash invested, because the investors who often become members of the board, bring a wealth of experience, insight, relationships and deeper pockets to the table.

I have served on the boards of several companies with just such VC talent at the table,  partners in firms that made subsequent investments in companies where I either made early investments or led a group of fellow investors in early rounds of finance.  Each of these companies needed more cash than professional angel investors were willing or able to provide, and we turned to the venture community for larger investments.

[Email readers, continue here…] Attracting a VC investment means finding a partner in a VC firm who is willing to champion your opportunity before his partnership and then represent his firm with a seat on the board once the investment is made.  In a number of cases, these VC partners have made the difference between success and failure or at least growth vs. stagnation.  These VC partners have relationships with later stage investors further up the food chain, with service providers, with potential “C” level senior managers, and with other CEO’s with great timely advice or partnering opportunities.

In one such recent case, the angels were tapped out at $6 million invested, an amount far above their usual taste, but for a company we thought had a billion dollar potential.  The VC’s subsequently invested $18 million, well beyond what angel investors usually are able to project from their own resources.  Without the VC guidance there would have been little opportunity to even dream of a billion-dollar valuation goal.  There is no question that the company took smart money and leveraged it for maximum growth, using the money, guidance, contacts and more from these large VC investors.

Posted in Raising money, Surrounding yourself with talent | Leave a comment

How to cheat legally on your tax return.

When do you cross the line between honesty and dishonesty in tax planning?  Is it ethical to allocate income between periods to take advantage of tax breaks?  Can expenses be put off until the next period to increase income, or accelerated into this period by prepayment to decrease net income?  Where do you draw the line, assuming no intent to defraud?

First, corporations are usually on an accrual accounting basis, meaning that income and expenses are accounted for as earned, not when the cash is received.  (You, on the other hand, account for your individual income on a cash-accounting bases, counting the cash not the date of your earning or accrued expense.  The difference:  If you earn pay due December 31st and it is paid January second, you pay income tax on those earnings in the following year.  But the corporation that pays you accrues the expense and takes the deduction in the year in which the income was earned or expense actually incurred.)

[Email readers, continue here…]  It is perfectly legal to hold delivery of goods until after the start of the next period and take the income next year rather than this.  It is a bit murky if you accelerate payment for incomplete services or even for products not yet received into this year to take the deduction from income early.  In either an IRS audit or an accounting review or audit, the accelerated costs and payments will show as an accrual – a balance sheet item – that does not change income, just cash and an asset.

In other words, for the usual accrual-based business, there are fewer ways to affect the outcome than for a cash-accounting individual.  There are lots of caveats here and certainly if the issue is critical to you, an accountant (rarely a bookkeeper) should guide you to the action that is both legal and strategic.

Please feel free to comment on this post in the field below. -Dave

Posted in Protecting the business | 2 Comments

Accounting: What kind of bean counter do you need?

Accountants are trained, certified and usually quite experienced in financial analysis, both creating and reviewing data.  Bookkeepers are often trained on the job although sometimes more formally and handle the physical work of accounting for the transactions.  To expect a bookkeeper to provide analytical planning is to ask for something they often cannot provide, except in a cursory way.

We need to repeat this distinction on occasion, because there is a considerable difference between the cost of a bookkeeper and an accountant.

Why bother with this? Many early stage founders and CEO’s believe they can delegate design and creation of metrics, flash reports, analytical reports and more from their bookkeepers.  And at some early stages, a bookkeeper can prepare such information.  It does not take long for a growing business and a knowledgeable CEO to quickly outgrow the lack of depth and sophistication such reporting usually offers, looking instead for deeper analytical tools.

On the other hand, many early stage CEO’s are not trained and ready for such tools even if available.  The lesson here is twofold.  There is a benefit to using a good accountant to help devise critical reports for a corporation; and CEO’s must quickly become financially savvy in the analysis of financial statements and metrics that measure the health of a business.  To fail to have this skill is to reduce the corporation’s capability to discover problems early and take advantage of growth opportunities.

Please feel free to comment on this post in the field below. -Dave

Posted in Depending upon others, Protecting the business, Surrounding yourself with talent | 2 Comments

Can your lawyer destroy a good business deal?

Over the years in business and as a member of over forty boards, I have received good advice from corporate attorneys and on occasion bad advice as well.  There is a line that should be drawn in a relationship between corporate attorney and CEO or board.  Attorneys are paid to protect the corporation, not to give business advice.  Some are experienced enough to provide great business advice.

But the law degree they earned does not assure that, even though most CEO’s respect the advice they receive from their attorney highly enough not to doubt the conclusions or the experience behind the conclusions offered.  And since attorneys are paid to protect, often they will give a litany of warnings about what could go wrong when accepting a contract clause that they have been trained to challenge.

There comes a time when a CEO must decide to reject what may seem like important good advice from the attorney and chance acceptance of terms within a contract that may cause risk, but controllable risk or risk that is so remote as to be worth the acceptance of the business represented by the contract at hand.

[Email readers, continue here…]  I was chairman of a company that had been offered an investment by a Fortune 500 company offering to make a strategic investment in our business, which would be capable of driving new demand to the large company through a series of new web services creating a greater need for the large company’s products.

The business terms had been agreed between the business development officer of the investing company and our board, as both companies turned the details over to their respective attorneys for documentation.  The attorney for the investor was a member of a large, respected law firm in Silicon Valley, and certainly was full of himself as sole legal protector of the rights of his very significant investor.  As drafts of the otherwise standard investment agreements passed from him to our attorney and our management, we immediately spotted a significant number of terms we not only had not agreed to but were contrary to the spirit of the investment.  The attorney held fast defending every challenge, stating that “these terms are standard for our client and cannot be changed.”  We appealed to the business development executive, who deferred to the attorney restating that the terms were unchangeable as far as the big company was concerned.  After conferring between our attorney and board, we walked away from what would have been a fine strategic partnership, killed by an attorney who probably understood the client requirements but was unwilling to offer flexible solutions to problem areas.

That attorney had made what we considered business decisions on behalf of his client.  By the way, we immediately found a willing replacement that had an attorney not quite so full of himself and quickly concluded a similar deal to the acceptance of all.  And to this day, I caution my CEO’s not to deal with that Fortune 500 firm because of the experience we had with its attorney.  You never know how much far reaching an action can be, given the speed and extent of communication between CEO’s today.

Posted in Depending upon others, Protecting the business | 11 Comments