building an entire investable team

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Building Boards: Directors and Advisors Robert M. Gervis, CFA Managing Member and President, Epilogue, LLC July 10, 2013 © 2013 Robert M. Gervis, CFA

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Building an Entire Investable Team - Boards vs Advisory Boards It is an oft repeated truism that angels and venture capital firms invest in teams more than they invest in ideas and technologies. The team, Board, and Advisory Board are extremely valuable. This roundtable will provide investors’ perspectives on this dilemma, along with a discussion of other team-related topics, Board and Advisory Board building strategies and management. www.thecapitalnetwork.org

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Page 1: Building an Entire Investable Team

Building Boards: Directors and Advisors!Robert M. Gervis, CFA!Managing Member and President,!Epilogue, LLC!

July 10, 2013!

© 2013 Robert M. Gervis, CFA

Page 2: Building an Entire Investable Team

How to Build a Board of Directors:Overview & Agenda!

§ Introduction – RMG Bio!§ Background – Compare and Contrast Governing vs Advisory Boards:!

–  Purpose, Role and Authority of Boards!–  Activity, Liability, Accountability of Boards!–  Size and Cost of Boards!–  Frequency/Format of Meetings, Preparation and Time Commitments !–  Conflicts, Contractual Arrangements!–  Summary!

§ Building Effective Boards!§ Bonus Topic: Getting the Most Out of Your Board!§ Questions!

Important Note: This entire presentation represents my personal views on a number of complex issues. None of this should be taken as legal advice for any purposes. Please consult your counsel for specific advice on any and all of these issues as your particular

situation could differ materially.

1 © 2013 Robert M. Gervis, CFA

Page 3: Building an Entire Investable Team

Purpose, Role and Authority of Boards (continued)!

§ Source of Authority, Origination:!– Boards of Directors:!

§ Required by state law for C Corporations;!– Elected by Shareholders!– Strongly recommended for LLC’s;!

§  Initially can consist entirely of founders/insiders;!– Once investor capital is accepted, investors likely will insist on Board

representations by investors, and possibly outside, independent directors.!§  Primary roles:!

– Hiring, reviewing and compensating CEO (and senior management?); and!– Oversee management’s handling of business and affairs of company,

strategic planning, capital structure and financing, financial reporting, and material transactions, looking out for shareholder interests.!

– Day-to-day operation is, of course, left to management.!§ Board’s responsibility is oversight: “Nose in, fingers out” (Steve Kaufman, Harvard)!

2 © 2013 Robert M. Gervis , CFA

Page 4: Building an Entire Investable Team

Purpose, Role and Authority of Boards (continued)!

– Board of Advisors:!§ Has NO source of legal or other authority.!

– Not required by law; and often not even required by investors.!– Only should be assembled if it will be accretive to value.!

§  Advisory Boards were common primarily in technologically-complex companies, ex. Biotech, Energy;!

– Advisory Boards spread to other businesses as experts began to shy away from governing Boards for liability reasons.!

§  Primary Role:!– Serve as specialized consultants with deep technical knowledge, adding

credibility (ie “star power”), or networking capability to the business;!– However, governing Boards can do the same thing if properly constructed.!

§  Advisors are, in some respects, inexpensive consultants; sort of group of “Friends of” the company who derive satisfaction and benefit by being associated with successful ventures, and whose background and skills “fill in the gaps” on the Board of Directors and senior management team.!

3 © 2013 Robert M. Gervis , CFA

Page 5: Building an Entire Investable Team

Activity, Liability and Accountability of Boards (continued)!

§ Board of Directors: Acts as a Board, makes decisions, and has liability for those decisions.!–  Acts as a Board:!

§  Decisions are based upon a vote of the Board (and in some cases, subsets of directors elected by certain classes of shareholders);!

§  In general though, the Board acts as a governing body.!–  Directors have no individual power or authority.!–  For a Board to be effective, careful consideration must be given to personal

relationships, investment objectives and group dynamics.!–  Makes Decisions: Board of Directors is required to:!

§  Hire, review and compensate CEO, provide input on compensation for other executives;!§  Approve hiring of auditors, review financial statements and other disclosure;!§  Oversee the Company’s establishment of policies and procedures intended to ensure that

business is conducted in accordance with law;!§  Approve material corporate transactions (financings, potential exits, acquisitions,

divestitures, key contracts with customers or suppliers);!§  Supervise management’s establishment of strategic direction and priorities, review

performance versus strategy.!

– Has Liability For Those Decisions!!

4 © 2013 Robert M. Gervis, CFA

Page 6: Building an Entire Investable Team

Activity, Liability and Accountability of Boards (continued)!

§ Directors’ Liability: As a matter of state law, directors have fiduciary duties to shareholders: In general these are duties of:!

–  Care – requires directors to be adequately informed and to act in a deliberate manner when making business decisions; and!

–  Loyalty – put shareholder and company interests first. !–  Other duties: Directors sometimes are sometimes described as having other duties, although

they really are derived from the original two. Examples are:!§  Good Faith – act in good faith, with an honesty of purpose and in the best interests of the company and its

shareholders.!

§  Candor / Disclosure – disclose all information in their possession when seeking shareholder action, particularly where directors have a personal interest.!

§  Oversight – assure that reasonable information and reporting systems exist.!

§  Duties in a Particular Transactional Context – maximize price in a sale of control; act reasonably in response to threat in adoption of takeover defenses.!

– Failure to properly discharge these duties could result in directors’ personal liability!!

– Directors also can be held personally liable for Company’s failure to pay over to the state amounts withheld from employees (so called “Trust Fund” liabilities), for certain back wages, as well as dividends if not paid out of corporate “surplus.”!

5 © 2013 Robert M. Gervis, CFA

Page 7: Building an Entire Investable Team

Activity, Liability and Accountability of Boards (continued)!

§ Mitigators to Directors’ Personal Liability:!

– Business Judgment Rule: Courts will not second-guess decisions made by directors in good faith, using the care that an ordinary person in a like position would exercise under similar circumstances, and in a manner the directors reasonably believe to be in the best interests of the corporation and its shareholders. !

§  Protects directors and officers from liability for losses incurred in approving corporate transactions within their authority, so long as the transactions are made in good faith and with reasonable care and skill.!

§ mistakes or errors in the exercise of honest business judgment will not subject directors to liability for negligence in the discharge of their duties.!

§  Summary: Directors are allowed to be wrong, even stupid; but are not allowed to be careless, thoughtless, unprepared, self-motivated or duplicitous.!

– Delaware law allows directors to rely upon records, information, opinions, reports and statements presented by officers, employees or experts.!

–  Indemnification and Directors’ & Officers’ liability insurance.!

6 © 2013 Robert M. Gervis, CFA

Page 8: Building an Entire Investable Team

Activity, Liability and Accountability of Boards (continued)!

§ Advisory Boards:!

– Have no liability whatsoever (except perhaps for fraud);!

– Are not required to make decisions; merely provide advice, guidance and counsel;!

– Have no responsibility to put the interests of the company or its shareholder first.!

– Advisors typically deal more with:!

§  technology and product development;!

§  industry trends;!

§  strategic planning;!

§ Networking; and!

§  sales and business development.!

– Since advisors do NOT make DECISIONS on financial reporting, capital structure, compensation or shareholder rights, perhaps the absence of liability is acceptable.!

7 © 2013 Robert M. Gervis, CFA

Page 9: Building an Entire Investable Team

Frequency/Format of Meetings, Preparation & Time Commitments (continued) !

§ Board of Directors meet regularly. Meetings typically:!– Occur at least quarterly for public companies, and often monthly or bi-monthly for start-

ups.!–  Last anywhere from one to three hours for startups, to a day or two for public companies.!

– Boards typically form committees, like audit, compensation, nominating and governance, finance, environmental, health and safety, technology, etc. Committees meet separately and provide reports to the full Board on their deliberations and decisions.!§  Some committees are required for public companies; but!

§  Even start-ups usually have audit and compensation committees.!

– Minutes (ie a complete record) of all Board and committee meetings is maintained, reviewed and approved, and part of the legal record of the Company.!

– Preparations typically involves management’s distribution prior to the meeting of financial results, updated forecasts, business developments, updated market dynamics and competitive developments, and other detailed analyses and reports.!

– My personal view is that a director should plan to commit an average of at least six to eight hours per week for every Board on which they serve; although the actual weekly time commitment will be a highly volatile number. Some weeks may involve little-to-no effort; however other weeks will require several days.!

8 © 2013 Robert M. Gervis, CFA

Page 10: Building an Entire Investable Team

Frequency/Format of Meetings, Preparation & Time Commitments (continued) !

§ Boards of Advisors may, in fact, never meet as a Board.!

– Sometimes advisors work individually, and sometimes they all gather to meet and share ideas.!

– The Company tends to work with each advisor topically, sporadically and episodically, based upon current and necessary business initiatives.!

– Preparation is dependent upon the objective.!

– No minutes need be recorded.!

– Time commitment is entirely variable and situation dependent, sometimes with no minimum commitment expected (ie when the advisor is really lending his/her name and reputation to the venture).!

9 © 2013 Robert M. Gervis, CFA

Page 11: Building an Entire Investable Team

Size and Cost of Boards!

§ Boards of Directors:

– Size:

§ Public Company Boards generally are in the 7-15 range; some of course are larger but current governance trends seem to favor 9-11 members;

§ Start-up Boards may begin as one founder, often become 3-5 members once investor capital is accepted, and tend to remain around five members at early stages;

§ Odd numbers typically are preferable to avoid deadlocks;

§ Some investors seek Board Observer positions.

10 © 2013 Robert M. Gervis, CFA

Page 12: Building an Entire Investable Team

Size and Cost of Boards (continued)!

– Cost:

§ Directors of young companies are typically compensated with equity (options or restricted shares)

– This helps insure alignment of directors’ interests with shareholder interests; and

– Preserves cash.

§ Directors’ fees for start-ups typically are in the 0.25% to 1.0% range, with average being around 0.5%.

– Directors’ equity typically is subject to vesting, with smaller awards having annual vesting and larger ones vesting over multiple years.

11 © 2013 Robert M. Gervis, CFA

Page 13: Building an Entire Investable Team

Size and Cost of Boards (continued)!

§ Advisory Boards:

– Size: Anywhere from zero to over a dozen, depending upon needs, management style and strategy

– Cost:

§  Typically very small equity awards for joining;

§  Additional compensation (equity) for meaningful contributions.

§  Advisors should have an equity interest; but remember that in many cases, the equity incentive for simply joining is more of a “thank you”.!

– Most advisors are sufficiently successful in their own right that a small option award will be of little financial consequence to them.!

– Advisors often feel aligned with the company, and become interested in seeing the company succeed, by virtue of being identified as an Advisor.!

§ Meaningful compensation for advisors should depend upon demonstrable contributions (converted leads, scientific contributions, etc.) !

12 © 2013 Robert M. Gervis, CFA

Page 14: Building an Entire Investable Team

Conflicts!

§ Conflicts:!

–  Board of Directors:!

§  Because directors are fiduciaries, the existence of actual or even potential conflicts can result in legal liability; so directors and companies need to be acutely aware of any actual or potential conflicts and seek legal advice on the best way to manage these situations.!

–  There are times when a conflict can be managed merely by a director fully disclosing all elements of the conflict;!

–  Other times, the director may need to recuse himself or herself from the deliberations or decisions on the issue; but!

–  There may be times when a conflict is so severe that a director may need to resign to avoid liability. !

–  Advisors:!

§  Because advisors are NOT fiduciaries, except in the extreme cases, conflict issues will likely be more a matter of propriety, competitive sensitivity or good taste.!

–  For example, a public company that might not allow one of its officers or executives to serve as a director of a start-up in a related industry, might allow the same executive to serve on the same company’s advisory board. This avoids any conflicting fiduciary duties between the two.!

13 © 2013 Robert M. Gervis, CFA

Page 15: Building an Entire Investable Team

Contractual Arrangements!

§ Contractual Arrangements:!

–  Board of Directors:!

§  Directors are entitled to indemnification by state law, Charter provision and By-Laws, which have some features of contract.!

§  Current best practices for companies to provide directors with separate indemnification agreements to provide express contractual rights, lock in indemnification terms, protect against changes in law or changes of corporate control and clarify procedures for expense reimbursement.!

–  Advisors!

§  May have agreements which are akin to consulting agreements which also may contain contractual indemnification provisions, but nothing is required.!

§  Advisory agreements should also clarify that ownership of any intellectual property remains with the Company (don’t create a “Winklevoss” problem).!

–  Bottom Line Regarding Contracts: Contracts with directors are almost exclusively about indemnification and typically not about compensation; however contracts with advisors are primarily about compensation and may also have an indemnification provision.!

14 © 2013 Robert M. Gervis, CFA

Page 16: Building an Entire Investable Team

Summary!

§  Boards of Directors:!–  Boards have legal obligations, make substantive decisions, and are legally responsible to shareholders for their actions.!–  As a result, their meetings and actions have much more formality and gravitas.!

–  However, notwithstanding the formalities and potential liability, a properly-functioning, well-constructed and effectively utilized Board of Directors can and should tremendous value to any company, regardless of size stage or public/private status.!

§  Advisory Boards:!

–  While advisors have much less formality and no legal responsibility, effective use of the right advisors can be be a tremendous differentiator for a small company.!

–  Advisors can supplement Board’s and management team’s experience and skill set by adding:!

§  Technical expertise and other experience;!

§  Credibility and validation, or star power and excitement;!

§  Networking and high-level introductions to potential customers, distributors or low-cost suppliers;!§  Insight into industry trends and developments; !

§  Idea generation; and!

§  Objectivity in assessing trends and opportunities (i.e. a “sanity check”).!

–  A carefully-selected Advisory Board can be a time-efficient and economically-effective way to supplement the Board’s and management team’s capabilities and experience, as well as broaden the Company’s reach and increase the inputs available to management.!

§  By carefully planning the construction of both groups and coordinating their activities, management should seek to create one efficient, effective functional team whose experience covers all necessary areas and works cooperatively to support the growth of the business.!

15 © 2013 Robert M. Gervis, CFA

Page 17: Building an Entire Investable Team

Building Effective Boards (continued)!

§ Think of your Board and Advisors together as a single functional team.!

§ How do public companies do it with their Boards?!

– List capabilities they need around the boardroom table in order to be successful;!

– Study the backgrounds, experience and skill sets of their existing directors; and!

– Do a “gap” analysis showing where they have excess capabilities and where they are deficient.!

§ What should start-ups take away from this?!

§ The Board is legally required, so start by developing the most effective Board you can.!

– Do your best to find directors who add the background, skills and experience necessary to help the business grow and prosper.!

§ Then do a “gap” analysis; and fill in any gaps with advisors.!

16 © 2013 Robert M. Gervis, CFA

Page 18: Building an Entire Investable Team

Getting the Most Out of Your Board!

§ Boards are most effective when the CEO and management team has the right relationship with and attitude towards their Directors, and meetings are run effectively and efficiently.!

– Treat your Board as an asset, i.e. a source of competitive advantage.!

– Three most important things to a good CEO/Board relationship:!

§  Communication, communication and communication! !§  Deliver good news fast, and bad news faster!!

– Consider directors and advisors as:!

§  Mentors, coaches and confidants for company executives;!

– Executives must be able to have candid discussions about all difficult issues.!

§  Ambassadors for the business;!

§  Sources of connections, contacts.!

– Do NOT view Board as an obstacle to be overcome in order to advance your agenda.!

§  If a director genuinely acts more like an obstacle than an asset, and all other directors agree, find a replacement.!

– Avoid political or personal intrigue; face issues head-on.!

17 © 2013 Robert M. Gervis, CFA

Page 19: Building an Entire Investable Team

Getting the Most Out of Your Board (continued)!

§ Effective Board meetings:!– Send material in advance, with enough time for directors to review it.!

– Assume that all pre-read material has, in fact, been read.!

§  Allow time for questions on pre-read material, but DO NOT waste valuable meeting time by simply reading the same material that directors already have absorbed.!

– Reporting is a necessary evil at Board meetings; but the more of it that can be done in advance through pre-read material, the more time there will be to devote to discussing and debating issues. This will engage directors, and make meetings much more valuable and enjoyable for everyone.!

– Effective executives approach every Board meeting (whether a Board of Directors or Advisory Board) with a short list (1-5 items) on which the executives would like specific guidance, suggestions or input.!

–  If a CEO walks away from a Board of Directors or Advisory Board meeting and has not gotten any input on the issues facing the business, and only provided directors/advisors with information, it was an opportunity lost and should be viewed as a failure!!

– Every Board meeting should end with an “executive session,” where the independent directors meet separately without the CEO or other members of management.!

18 © 2013 Robert M. Gervis, CFA

Page 20: Building an Entire Investable Team

19 © 2013 Robert M. Gervis, CFA

Thank you for listening.

Any questions?!