Reaching back for an important lesson

As one illustration among many I can recall, let me tell you the story of the first investment made by a newly organized formal group of angel investors. Some of you can guess that name of the group. It was thrilling for these angels to find a young entrepreneur with an idea for a business that seemed so destined for greatness that the angels invested over $1 million on the condition that the group receive two board seats and one observer seat on the start-up’s board.  The young, eager entrepreneur immediately agreed, and the business was launched, well- funded and anticipating great profits.

Good intentions sometimes lead to…

As the business expanded into a second city and then planned expansion into a third, there was a rift that became evident between these angel board members, played out in front of the CEO.  The angels argued about whether the expansion was too quick, requiring additional money, or should be slower and bootstrapped with profits from the first city’s success.  Finally agreeing upon expansion at speed, the angels raised more money and encouraged the CEO to accelerate the expansion, which the CEO did with enthusiasm.  It did not take long for the company to again run out of money, and for the board to split over the next moves (since the first city continued to be profitable).

The consequences of not thinking ahead:

[Email readers, continue here…]    The angel investors could not raise the next, larger round to finance the shortfall and further expansion, putting the fragile young company at risk for following the advice of its board.  In the end, the company had to turn to a wealthy individual investor who took control of the corporation as his price for saving the company.  Look ahead only a short time, and the new major shareholder ran into trouble overleveraged with his real estate investments and defaulted on his funding promises.  But I digress.  Painfully.

What went wrong?

Had the angel board members been able to agree upon a financeable strategy for growth, the company might have been immensely successful.   To put an ending to this story, the entrepreneur followed the suggestions of the new investor just as he had followed the angels, and accelerated quickly into more cities, again running out of cash.  And now you know that the wealthy investor in the meantime, could not make good on his promise to further fund the company, which found itself unable to meet its obligations and ultimately was shut down, causing a complete loss for all.  Bad advice taken by an enthusiastic and compliant young CEO was the root of the cause, compounded by circumstance.

And the result for the entrepreneur for taking this advice?

By not putting up any argument and being completely compliant, the CEO ceded control of the company to outsiders who gave bad advice.

The lesson for any CEO or for any of us for that matter is to filter all advice through the strainer of good reason, taking that which seems reasonable and rejecting that which is wrong for ourselves or for the immediate time.  And, as I have learned from experience, if you perceive advice to be in error or against better judgement, form your arguments after a little thought and make your case with information to back it up if necessary.  Most of the time, the person on the other side of the table will see your side, feel your passion, and either agree or withdraw any objection.  Remember, passion and reason almost always win the day in these cases, even when facing a superior in the food chain.

Now you can tell your story…

Images for this block created using DALL-e, Microsoft Designer, with prompt: A group of diverse standing adults surrounding a single young businessman, all casually dressed, with all staking at once. Photo-realistic image with ragged edges and transparent background.

The CEO position can be a lonely place, especially when you find yourself in a position of not being able to bring an issue directly to the board and not wanting to explore solutions with associates within the company.

Sign of weakness?

This sometimes happens when a person is unwilling to admit a weakness in an area that is critical, such as analysis of financial statements, or when unhappy with the actions of your board or with pay offers by the board’s compensation committee that cannot be resolved amicably.  Having an experienced coach, usually acting informally and not for any kind of pay, is a safety valve that cannot be understated when in times of great stress.

Some possible coaches in your present sphere…

[Email readers, continue here…]     Sometimes that coach is a member of the board willing to listen and make suggestions off the record.  And often that is good enough.  In my experience, there are times when a CEO needs a completely neutral third party or a roundtable of fellow CEO’s to help guide him through a difficult maze.

Here’s a suggestion:

Develop relationships with fellow CEO’s in non-competing businesses for a start. Perhaps even formalize the relationship with regular lunch meetings or meetings in groups of CEO’s to discuss personal issues without fear of the discussion leaking outside closed doors.

Image created with Microsoft Designer (OpenAI) using prompt: A photorealistic image of a male CEO sitting at an office desk, looking lonely and alone. Image should have soft edges. Desk should be loaded high with papers in the inbox tray.

Of course this is a tricky question. You might expect the answer to be “as much as necessary” or “more during emergencies” or “usually just at scheduled meetings.”

But 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 board members freely receive phone calls and emails from the CEO during the month, all considered part of board service.  And with the advent of Teams and Zoom, board members travel far less frequently to meetings.

Special circumstances often appear by surprise.

There are times when board members are called upon to give extraordinary 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.

Crossing that line…

[Email readers, continue here…]   CEOs: You will 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.

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!

Images created with DALL-e from prompts for this blog post.

Where did this statement come from?

I first heard this in a governance seminar for a non-profit higher educational board upon which I sit, over 25 years ago.  It made an impact and stuck with me through the years.  I have repeated it often to boards deliberating action and to individual board members seeking to get their hands dirty inside the corporation by giving advice and helping at levels beneath the CEO.  (And it is interesting to hear it returned from various unrelated sources, even quoted as “Noses in; hands out.”)

The problem cannot be overstated.

Once a board member reaches beyond the CEO into the corporation, especially without the approval of the CEO, incurable damage has been done to the CEO’s ability to govern.  Even if not the intent, there is an instant change in dynamic once this line has been crossed.

There is even a gray area that illustrates this effectively.

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.  The meeting was 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.

My lesson learned about this mantra:

[Email readers, continue here…]   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.  The chairmanship carries 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.

So, what is the proper behavior?

Therefore, it is appropriate to ask tough questions, request help in understanding issues, seek permission from the CEO to interview others.  But a board member or advisor should never react to statements heard by issuing directions or hints of action in return.  It is appropriate to state that the advisor or board member understands much more after the briefing and will be able to address the problem with the board and CEO.  It is not appropriate particularly for a board member to promise any action to anyone beneath the level of CEO.  Noses in; fingers OUT.

While the CEO and management offer the vision, strategies, and tactics as well as the proposed budget, it is the board that controls with its votes the execution of strategy, the expenditure of cash, the taking on of debt or new equity, the very direction of the company as well as its ultimate health. Surprised?

Then who is most important?

The most important person in a corporation usually is and should be the CEO. This person, often the founder in early-stage companies and beyond, is the originator and keeper of the vision, leading all others below and the board above as willing believers in the vision advanced.  But the board is responsible for providing resources to fulfill that vision, which may include new cash infusion or assumption of new debt.  

Does this ever happen?

Yes, but… In extreme situations, it is the board that must step up and replace the CEO, assuming the responsibility for finding and integrating a new leader quickly and efficiently.  Sometimes this means having a board member step in for a short time as CEO for continuity.

A true story…

[Email readers, continue here…]    One of the CEOs in a round-table who had been active and vibrant for years in both his company and the round-table, died suddenly of a heart attack.  His board met in emergency session and managed a smooth transition to a new leader within a month, during the most traumatic of times for all employees and the board itself.

Remember the most important duties of a board member?

For non-profit boards, the two most important duties under the duty of loyalty and care are the oversight and eventual replacement of the CEO, and maintenance of the entity over its infinitely long lifetime.  I have been a member and even chair of presidential search committees and can attest that board members (and other designated stakeholders) spend hundreds of hours in the recruiting process, all without pay.

It’s all about continuity of the organization.

It is because the continuity provided by the board is the one thing shareholders must count on above all else to protect investment, that the board rises in importance to at least equal stature as the executive cohort.

Practically speaking, this is an impossible goal.  We have investigated the restrictions imposed by investment documents and the obvious need to keep continuity on the board with the retention of the CEO position at the very least.  But it would be the best of form to require in the bylaws of a corporation that all seats are re-elected annually.

How about loss of institutional knowledge?

Well, here’s a problem that needs a bit of thought.  If you elect your board members annually and for some reason aggressively change members, you will experience the steep learning curve required to get the newest board members up to speed to contribute with deep knowledge of the company and of your management style.  And that’s not good.  Re-electing board members again and again is not a problem – if those re-elected members contribute effectively as they fill their seats.  But annual re-elections signal to all that a board seat is not permanent or even long-term.

How about non-profit boards?

There are three types of members on non-profit boards, and the balance is critical.  There are those with money to give or get, necessary for all non-profits.  There are those with great community and industry contacts for finding honorees for events or bringing onto the board.  And there are those with deep knowledge of the non-profit itself, always able to help when members without that experience make suggestions that may be impractical or tried before.

How about staggered four-year terms?

[Email readers, continue here…]   That’s appropriate for non-profits for the reasons listed above. But I’d revert to the annual re-election habit for all but non-profit boards.

Why the difference?

For non-profits, this allows for the creation of a board development committee to find and recruit outstanding new board members and find ways to unseat those who are no longer contributing or even attending board meetings.  Such a policy further reinforces the duty of care for the corporation by its board.  Unseated board members with longevity and a history of participation can be invited to become “emeriti” members of the board with observation rights but no vote.

The annual shareholder meeting:

Although not required by all corporate bylaws, all companies should hold and document an annual shareholder meeting in which the shareholders are notified at least 10 days in advance and given the right to submit a proxy vote for their choice of officers and for any other issues that will come to a vote, including expansion of the stock option plan to include more available shares.

The bottom line is that good corporate governance calls for a skill set within the board that is not often present, but for the protection of members and the corporation itself, necessary.

In my last insight, I described the CEO who stacked the board with two friends, making a majority for control purposes and relegating the investor representatives to insignificance.  There were no outside board members with industry experience, no members the CEO trusted with governance backgrounds, no scientists to evaluate the technology that is the core asset of the corporation.

A recipe for failure.

If the CEO does not fight for balance of the board, outside board members must fight for this to protect the corporation.  If for no other reason, this protects the members of the board from making decisions without rising to the standard of careful deliberation under the “reasonable care” test.

How about the size of the board?

[Email readers, continue here…]   Some board members find themselves debating whether there should be an expansion from five to seven, from seven to nine or more to allow for such a mixture of protective seats created by the investment documents and balance with outside board members.

What about multiple investor rounds?

Sometimes, as in one board where I sit today, there are so many classes of investors, each with one or more seats, that a seven-person board is not enough.

I am not for large boards.

There are social studies that reinforce the notion that a group of six or seven is far more likely to arrive at reasoned decisions effectively than larger groups.  Look at the example of most non-profit boards, where the number of members often exceeds thirty, requiring the creation of an executive committee to get the work done.

In fact, such a board would seem out of place in a one-person company.  As soon as any outside money is ingested into the corporation, others have a vested and legal interest in the behavior of officers entrusted with the best use of funds.  Money from friends and family usually is offered in a casual manner with much less restriction than professional investors, so that a formal board is a logical step but not often created upon this event.

Then along comes either money or contracts from strategic or financial investors or partners.

The operations of the corporation become more complex. Ownership is spread among

several classes of investors.  The number of employees grows.  Bank loans with restrictive covenants are taken on.  These events, one or all, usually are triggers for the founders to seek to create a board for oversight and guidance.

And then company grows…

Once the company hits high growth or larger size, it is logical to follow the standard practice in the creation of two standing committees composed of outside board members (not employees or executives) – the compensation committee and the audit committee.  Compensation’s charter is to approve stock option grants for any employee, no matter how small the grant, and all salary and benefits for at least the CEO if not the next level down, to avoid conflict of interest with the CEO.  All actions of the committee are in the form of recommendations to the full board for a vote and are not binding until that event.

[Email readers, continue here…]    Second, the audit committee is responsible for hiring an outside auditor as appropriate, reviewing the accounting practices of the corporation and making sure that laws are followed relating to recognition of revenues and expenses.  Good audit committees also review the corporation’s insurance portfolio, risk protection policies such as email and computer use, disaster response and recovery policies and any other area where the corporation’s very life could be at risk from inattention.

Yet another personal story…

Let me tell you the story of a company on whose board I sat for several years.  The CEO insisted that between husband and wife, over half the stock always be in their hands, refusing new offerings or any other form of dilution, and controlling the majority of board seats in the process.  After replacing two board members with two other friends who were a bit less independent, during that first meeting with all of us present including the two new board members, I suggested that the corporation then form the two committees – audit and compensation.

“Never!” was the single word as I recall the CEO’s immediate outburst.  I made a motion to bring it to a vote. The corporate attorney was present, recommending this as a relatively safe move for the CEO.  I called the question after a drifting discussion. You can guess that the three friends voted down the measure, perhaps as a sign of unison, since this was the first vote by the two new members.  It was the final nail for me.  I engineered the extraction of the outside investors, even at a near total loss.  At least the investors could then take the loss against ordinary income under rule 1244 of the IRS code, worth something to each, rather than being locked into what was a slowly failing lifestyle business with no effective oversight.

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.

A personal story of ignorance of good advice.

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.

The result of the consulting project…

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…

A unique description of the “ignore” lesson.

“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 sandcastle 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 sandcastle.  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.

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?

[Email readers, continue here…]    Many early-stage founders and CEOs 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 CEOs 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.