Evaluating the Role of Board Seats for Startups and Early-Stage Investors
Establishing an effective board can be essential to every young startup’s success. While Delaware requires companies to have at least three directors on their boards, many veteran directors suggest starting small by keeping boards as small as possible at first. The Amazing fact about board management.
Startups typically allot one board seat to each investor who leads the first priced round, while later investors often act more as observers than taking up board seats.
Founders can have an influential voice in an early-stage board if they can effectively prioritize their time and energy. Therefore, when selecting board members, they should carefully assess candidates for these positions and request references from potential board members.
Idealistically, any startup’s initial board of directors will consist of only its founder(s) and an investor who led its seed round. However, as it progresses through subsequent funding rounds, its board usually becomes more significant, with additional seats being granted for new investors and independent directors.
Early on, board members with proven expertise should help your company devise a solid plan to achieve product/market fit and drive revenue growth through traction. In addition to technical knowledge and customer insights, these individuals should also possess networks that can aid them in meeting these goals faster. Successful boards must balance giving young teams space to experiment while learning and ensuring no existential threats arise as part of this process.
Early development stages for startups typically feature limited revenue and sales. When the business finds the product-market fit likely to produce substantial future earnings, investors often seek opportunities to participate proportionately in its future expansion.
Friends and family, angels, or venture capital funds typically compensate their investments with an equity stake in the company they invest in; this equity structure lends itself well to early-stage investing as it creates close alignment between investors and founders as the company pursues its objectives and grows.
After receiving funding through Series A or B rounds, your board may increase to five seats from its previous three. While retaining its initial independent representative is essential for aligning itself with the founders’ vision and strategy, providing observers with observer seats can alter this dynamic by allowing investors to contribute their thoughts on where your company should head next.
Many early-stage investors include an observer seat in their investment agreement. An observer seat allows an investor to attend board meetings as a nonvoting observer and receive copies of all related documents; most observers do not have voting rights and are legally obliged to keep confidential any information they receive as an observer.
As is often the case, board observers become involved in board discussions as if they were full members, which can seriously impact board dynamics and disrupt its functioning. Furthermore, high-profile observers may be seen to use their presence to gain an advantage in front of more powerful counterparts within the room and advance personal agendas.
Care must be taken when considering whether the potential value of an investor attending board meetings exceeds any risks involved, particularly for Series A leads, who must often retain observer rights in subsequent financing rounds if not appointed board members as part of their equity commitment.
Alongside assessing potential investors for board roles, it is also worth taking note of their interactions with other members and their willingness to assist if asked. Some directors can provide connections to essential business sources or investors, while others could offer expertise, such as finance or marketing, that can assist the company in reaching key milestones.
An ideal board for any startup should include experts from different sectors who can bring value to the company. A financial expert could oversee company finances and help connect the startup to potential investors and funding sources. In contrast, marketing experts could offer guidance as the company pursues its growth strategy.
Multiple chairs of boards acknowledged the significance of conducting independent evaluations of their performance, structure, and composition. Such evaluations should be overseen by their nominating/governance committee and undertaken using an interview process that solicits candid responses from directors.