Do you really need a board of directors?

First, the short answer

No matter what your size, if you intend to grow your business into more than just a lifestyle workplace, you should create a board of directors.  If you take money from knowledgeable investors, you will be required to create a board as a part of the investment process.

So, why go through the effort?

Boards perform two important types of task.  They protect the company by overseeing the expenditure of company money for expansion, acquisitions, purchases of large assets, hiring of senior management and more.  A board is usually composed of a mixture of the senior executives or the CEO, at least one representative of the investors, and at least one industry expert from outside the company.

Well, how many should be on my board?

The usual size of a board is five, but legally the number in most states is equal to the number of shareholders up to a maximum of three board members required by law. With three or more shareholders, you must have a three-person board of directors in most states.  The average board for a company taking outside investment money is five.  Beyond seven members, a board is often too cumbersome to be at the most effective value to the CEO.

What are the legal responsibilities of board members?

[Email readers, continue here…]   Each board member is legally tasked with two duties: the duty of care, and the duty of loyalty: care for the living entity that is the corporation itself, and loyalty not to the board member’s constituency, but to the corporation itself.  Sometimes, these duties conflict with the best interests of the board member personally or his or her co-investors. This could happen when a board votes to take in new money at terms that would be unfavorable to the class of investor represented by the board member. It could happen if some early investors and board members want to sell the company at a price below the objective of the later board member, where the relative returns are excellent for the early investors and marginal for the later ones.

Surprise! Board members are legally to protect, not to grow.

There is no legally mandated requirement that members of the board help a corporation to grow.  But it is certainly the goal of the investors, the CEO and even the board members individually, when assuming the position of board member.  Often, a board meeting is entirely devoted to issues of growth, with members chiming in to help the CEO with marketing issues or customer acquisition.

How about legal requirements for board meetings?

It is important to make time for the required duties at board meetings.  Approving the budget and watching over it during the year and approving any actions that would dilute ownership including stock option grants, are two examples.  Much less understood are issues that address the management of risk, such as review of corporate insurance policies, adherence to OSHA or HIPAA safety regulations, and oversight of the terms of real estate and large equipment leases that could affect a company’s ability to maneuver in times of crisis or extreme growth.

But what if you just don’t want a board and have no investors?

Many entrepreneurs would rather not have to answer to a board, and resist creating an entity that could have the power to check management actions, and even to fire the CEO in extreme cases.  Yet, the establishment of a proactive board is the first step toward professionalizing the company and its management.  Properly handled by the CEO with adequate time allocation for individual and group board member updates, the proper use of the board will help control risk and provide resources to management that will pay back in better overall management of the company and more efficient use of its resources.  More importantly, no entrepreneur or CEO can do it all alone, especially in a rapid growth scenario.  Too many things can go wrong, many of which are things that one or more board members have already dealt with in their business lives.

And the conclusion…

Take the establishment and nurture of a board of directors seriously. It is much more than a legal requirement to be resolved.  It is the creation of a vital part of the organization, one that could be of great help in both protection and growth of the enterprise.  Great boards create value for shareholders while protecting them at the same time.

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4 Responses to Do you really need a board of directors?

  1. Arthur Lipper says:

    The need for a Board of Directors depends on the financing of the company. Privately-owned companies, which have not sold stock to investors, should consider a board of Advisors, instead of Directors. The Board of Advisors can fill many of the functions of a Board of Directors, but without the personal liability associated with being a Director. Advisors are also less directly concerned with executive compensation and retirement issues than Directors should be.

    As the Directors of a company are responsibile for judging the performance of the CEO, should the CEO be on the Board of Directors? The question is the same regardless of the amount of shares held. The CEO can nominate an individual to serve as a Director, but the obligation of a Director is to serve, without preference, all of the shareholders of the company. The CEO and other senior executives may be invited to attend all but executive session of the Board.

    From an investor protection perspective, Boards of Directors are weakened if company executives are members.

  2. Dave Berkus says:

    Arthur,

    All good points. Not having the CEO on the Board is a non-starter for most companies. CEO’s often represent or hold a significant number and percentage of common shares. A nominee who is not directly in the senior management team would be unacceptable too. Far too much knowledge of operations and strategic plans would be lost without that voice. But balance on the board is of utmost importance. Investors must never control the board, no matter how many rounds. Outside experts who are neutral are importance to keep balance. For earlier stage companies a board of five seems right, with two from common including the CEO, two at maximum from the investor classes and one selected by unanimous consent by the other four.

    Dave

  3. Rick says:

    What is board member’s pay relative NOI of company?

  4. Dave Berkus says:

    First, management, major holder of stock and major investors are not paid for board service. Outside board members and small investors (angels) in small companies are paid in options not cash, usually 1% of the fully-diluted shares, at the current option price vesting over 2-3 years and only increased if at the end of that time there has been significant dilution. Larger companies – still private – often pay $1,000 a month or $3,000 a meeting plus options. Public companies carry much more obligation and risk and pay anywhere up to $60,000 a year to a board member plus more for committee chairmanships. But usually those spots are recruited by professional recruiters and very competitive. Hope this helps.
    -Dave

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