Fit for Purpose: Successful Board Composition
Effective corporate governance is often invisible to the outside world.
Effective corporate governance is often invisible to the outside world until an issue arises. Establishing a well-run board of directors that is a great fit for the company reduces the risk of a PR crisis or worse. Recent examples, like that of OpenAI where the board didn’t synchronize with the mission of the organization; or the disastrous melt down at FTX which did not have a board in place at all and had not maintained financial reporting.
The three fiduciary responsibilities of directors are essentially: Duty of loyalty (the organization comes first); duty of good faith, and to ensure policies and procedures are in place to reduce risk and duty of care. Or in brief - show up - do your best - and be diligent. These responsibilities dovetail with those of the senior executives responsible for execution of daily activities.
Company leadership that resists the addition of a board may not understand the role of the board or they see they may see it as extra work, as perhaps they have had a poor experience in the past.
What is a Board and Why Do We Need One?
Let’s begin with why a company needs a board and what they should expect in terms of how it contributes to the success of the business. In the US, most startups register as corporations as opposed to LLCs or other structures. One of the primary reasons for this structure is it’s the preference of investors; and with this structure they are legally required to have a board of directors. The company board has a fiduciary duty to the company’s shareholders and differs from advisory boards that make recommendations to company leadership but cannot drive strategy or make impactful decisions. A corporate board has legal obligations, an advisory board does not.
A corporate board meets regularly and has an important role in setting the direction of the company, as risk and strategy fall under its mandate. A board needs to be aligned, ensuring the management of the company is performing against plan. The board also has oversight in appointing senior executives and setting their remuneration structures. The board also votes to adopt constitutional changes to the company and its overall direction or mission. A board of an early-stage company may include a mix of the founders and key members of the executive team, non-executive members who may be investors that required a board seat in their funding terms and ideally some independent directors with positions and responsibilities outside of the company. The board approves the strategy of the early-stage company and may receive more detailed updates and be more engaged in these efforts than more mature companies where it has transitioned to a purely governing role. Some private equity firms employ a similar model for their portfolio companies.
Convening a Board
The selection of directors is critical, it sets the tone and direction of the company. As the board and the company grows the appointment of new board members is conducted by the board itself, with appointments ratified by shareholders with voting rights at an AGM. The founding board, and most likely some of the leadership team will create the necessary by-laws and structure for how the board will run including defining director responsibilities, board structures and broader board responsibilities.
Private boards are not tied to the same requirements as public boards as they do not fall under the SEC rules and regulations, or those imposed by listing on a stock exchange. However, there are advantages of making reasonable efforts to align with these regulations as more private boards are being governed as if they were public and having the structure and requirements in place from the beginning means there is less to effort to realign later, and you are following an established path.
Term limits for non-executive directors
One area that frequently comes up is with respect to term limits for non-executive directors. For private companies there are no legal constraints and six to eight years is about average. Directors require time to get up to speed, and the first year is often considered part of the learning curve. Given that CEOs can have a relatively short life span (having gone on to their next startup or effort) and boards are often set to have directors rolling off at different times, having some reasonable amount of time to ensure institutional knowledge is retained by the board should be considered. Another situation may occur that the need for a director may change as a result of a change in strategic direction and the existing board director may not have the right skills and knowledge.
The best fit directors
Board directors should be chosen for the value they bring to the board and company, this value can come in many forms such as executive experience, industry expertise, for early-stage company commercialization expertise would be a tremendous resource to draw on. A board skills matrix is often used to identify desired skills and where gaps might exist. This matrix should be reviewed frequently as needs change over time, such as skills for DE&I, ESG and AI. Boards that look purely at ‘names’ trying to build themselves a marquee brand do themselves no service, think of Theranos that was packed with well-known names but limited business backgrounds so they were unable to ask the right questions or provide the necessary oversight.
What are a Director’s Responsibilities to the Company?
The board is the guardian of the company’s constitution and its founding principles, which may be amended to reflect the evolution of the business. Part of their duties ensures the company is addressing its risks and that includes ensuring that polices, people etc are right for the situation. In recent years that means consideration for instances such as AI in the work place, as part of strategy, and all the ancillary considerations that come with that, such as does the company have the right talent to consider AI, how will AI be handled in the workplace, what are the IP implications, how will data be protected, how will the results be validated. The efforts are ever evolving to keep pace with change.
Board composition, oversight and management are meaty topics and regulatory compliance varies by country and organization type albeit for profit or non-profit. The bottom line is that the function of a board is to ensure that the organization is run effectively to fuel its growth and prosperity.
Canary & Shield takes a holistic view of risk. One of the key stakeholder groups we evaluate with our clients is the health of their governance and the profile of its board of directors. A core part of our offering is ‘looking around corners’ to see where risk could cause crisis, then working with leadership teams to mitigate those risks.
