I often get asked about the role of a board of directors by both entrepreneurs and angels. I believe good boards can significantly and positively impact the growth of an early stage company.
The responsibility for that growth falls not just on the CEO and management team but the board as well. In addition, the board ensures accountability and transparency and helps establish appropriate procedures, set milestones and assess performance among other things.
Before a company has outside investors, the role of the board is often more advisory than one of governance. Many times these early boards are made up of the entrepreneur plus friends and family. The entrepreneur often hasn’t thought about needing people from the outside.
Things change a bit when angel or other investors come in. The investment documents typically require investor rights which usually include providing at least one, if not more, investor board members. But more than that, some legal duties crop up when money comes in such as fiduciary duty and the duties of care and loyalty. These are important duties that entrepreneurs, investors and prospective board members need to understand, and they should not be taken lightly.
But the responsibilities don’t stop there. Board members are often called upon to uphold other more informal duties in the course of their service, like keeping the company afloat, or making sure all voices (and all shareholders) are represented.
If you consider each duty on this list as you select your board, and take care to ensure that each member performs all of these to the best of their ability, you’ll be a taking an important step to set your company up for success.
The first four duties listed below are legal duties—board members are legally bound to perform them, but the last three “informal duties” are just as important:
A fiduciary duty is an obligation of a board member to act in the best interest of another party. This requires the highest standard of care and a board member must not put his/her personal interests before those of the company.
The duty of care
To meet the duty of care, a board member must conduct all actions in a manner where there is no forseeable harm. This means the board member needs to be attentive and prudent in making decisions – he/she must act in good faith and conduct sufficient due diligence to provide a logical basis for decisions that are made. A board member breaches the duty of care when acting in a negligent manner or when knowing the consequences of an action could be harmful to the company.
The duty of loyalty
To meet the duty of loyalty, a board member should ensure the interests of the company are always first and foremost and that loyalty to the company supersedes any other vested interests of the board member. The duty of loyalty is to the company not to the shareholders, employees, vendors or others. The duty of loyalty is breached when a board member puts personal interests ahead of the company or conducts inappropriate/self-dealing transactions. This is an important one for investor board representatives to clearly understand.
The duty of keeping your mouth shut (or opening it)
Other board member legal duties include the duties of confidentiality and disclosure. The duty of confidentiality requires a board member to maintain the confidentiality of non-public information about the company while the duty of disclosure requires the board member take reasonable steps to ensure the company provides its stockholders with all material information relating to any matter that requires stockholder action.
The duty of survival
One of the most important but informal duties of a board is to ensure the survival of the company – said another way, the board should try to make sure the company never runs out of cash. As we’ve all heard, “Cash is king.” Obviously, this can’t be guaranteed, but the board should always be focused on the amount of runway the company has remaining and the time required to raise additional capital.
The duty of oversight
The board is also responsible for establishing financial controls (e.g., dual signatories on checks, board approval of major expenses, etc.), developing reporting guidelines (e.g., keeping shareholders up-to-date on the status of the business, providing shareholders with any financial reporting requirements, annual operating budgets, etc.) and conducting CEO performance assessments. Functionally, the CEO works for the board, and many entrepreneurs don’t realize or understand the board can both hire and fire the CEO. The board also often plays a conflict resolution role if issues crop up between the CEO, founders and management team.
The duty of stewardship
One of the primary roles of a board, albeit an informal one, is to ensure the interests of all (not just some) of the shareholders are considered. This need to act as a representative, and sometimes, as a devil’s advocate is essential to ensuring every decision is made with all shareholders in mind.
Entrepreneurs and angels wanting to know more about the role of boards should check out Brad Feld’s excellent book called Startup Boards, which I’ve drawn on for this post. Brad’s book is one of the best resources I’ve found on this topic.
Rick Vaughn is the Managing Director of the Mid-America Angels investment network and the VP of Business Development at the Enterprise Center in Johnson County. An entrepreneur himself, Rick also has extensive experience in mergers and acquisitions, which he gained from positions he held at Hallmark.com and Hallmark Cards.