Evolution of the startup board

When you first start a company, governance is generally straightforward because the few co-founders usually make up the sole stockholder base, the management and the board. But as the company matures, so will the size and nature of the governance dynamic and its relationship with stockholders and management. Here we discuss some common scenarios and scaling considerations with respect to startup boards and overall governance.

In the second part in a new series together with Elke Trilla from WSGR, we sat down with her to discuss possible shifts and evolutions of the startup board and how to manage governance as you scale.

From founders-only board to your first investor director

When you form a company, you'll often have all the same people serving as its management, the board, and being the majority stockholders. There is no hard and fast rule about board size, however a good rule of them is for the number of board seats to initially be small, often with an odd number of directors to reduce the risk of a deadlocked vote.

Given the overlap of founders as managers, stockholders and board members, the duties and responsibilities are directed by and owed to the same limited set of individuals,  whose interests are often largely aligned. This structure reduced the need for complicated or staggered board structures. 

Even with this seeming simplicity, directors and managers are still distinct roles, with distinct fiduciary duties owed to stockholders. It is critical that founders understand these distinctions even in the earliest days and work carefully to ensure proper documentation and authorizations for material corporate activity. Learning and being consistent with corporate governance structures and hygiene will save you time, legal spend and reputational risk as the company grows.

Inevitably, as you raise and scale, the capital stack and investor dynamics start to change, and with this evolution the board dynamic often shifts. A first priced round will often bring the first meaningful expansion of the board, as a lead investor negotiates for a director seat and a larger role in overseeing management and the direction of the company.

Building the board governance muscles

In the early days of a company, certain technical governance requirements, like documenting minutes when it’s just you and your co-founder, or sending shareholder notices to yourself seem silly or redundant. Some founders even skip over keeping meeting minutes, soliciting board and stockholder consents given the overlap of founder roles. This is a mistake. 

Founders need to build the board governance and hygiene muscle from day 1. Development of good board rules, procedures and best practices is a lot less painful when the board is still largely internal folks and manageable in size. By the time outside directors show up, you’ll be prepared for greater scrutiny and able to demonstrate a level of attention to detail and sophistication that is desired and required. 

Building out the board governance procedures and documentation processes also creates a paper trail of material activities and approvals an investor will expect to see. If you license your technology to a third party, amend your charter, make significant hires, or issue equity, an outside party may want to see that those decisions were properly approved and documented. Without these required corporate records, founders open themselves up to a variety of validity and reputational risks. 

Lastly, but importantly, it is always more expensive to pay your legal team to fix poorly documented board actions, than doing it right the first time.

Your position as a CEO/founder on the board

It's important to recognize that there is a clear governance hierarchy at play, namely, stockholders elect the individuals that serve on the board, and the board oversees the CEO, and the CEO serves at the pleasure of the board. This distinction may not feel important in the beginning, but becomes much more relevant as the company matures and outside parties with their outside interests join in on the decision making at the board level. 

With each financing, founders will want to understand their rights to representation on the board, both by virtue of their stock ownership (i.e. voting power to elect individuals to the board) as well as their individual designation as a board member by virtue of their role as CEO or otherwise. 

As the board expands

The first increase in board size will often come with a negotiated investor director seat. From there, subsequent rounds may bring additional investor directors, independent directors, or investors with observer rights rather than a formal seat.

Think of every board seat as a premium and limited commodity. Each additional director changes the dynamics of the room, so boards are generally kept relatively small and, where possible, at an odd number.

Independent Directors

As the board size and dynamic matures, an independent director can bring a perspective outside both management and your investor directors, while adding expertise and credibility to the company.

You can actively seek out industry or technical experts who can give insight into sector-specific problems, strengthen decision-making, or lend credibility to the business.

Consider negotiating an independent seat into the contract when you do your first priced round and get your first investor director at the table, even if you don’t fill it yet. It’s a good idea to fill it once you have more than three people on your board, and add more independent seats as it grows to preserve balance.

Finding an independent director

Finding someone with the right expertise who also understands the dynamics of the role – because they have prior board experience or are a former founder – can be difficult.

 If your investors are pushing for an independent, make sure you’re deeply involved in selecting someone both management and investors trust.This person will have meaningful influence over important company decisions, so do as much homework as possible.

Build a relationship

An independent director may be independent structurally, but relationships still matter. Investing in that relationship will help build trust and make the board more effective when difficult decisions come up.

Factor in the cost

Independent directors are usually compensated, in cash as well as equity, so prepare for that cost – and expect it to grow as the company does.

Get the structure right

Make sure the documentation creating the independent director’s seat clearly sets out how that person can be appointed and removed, so the role continues to serve its intended purpose as the board evolves.

Observers

Observer rights are often granted to investors or other parties who want deeper visibility than typical information rights provide, but who don’t have a formal board seat.

Observers receive board decks and attend meetings. While they don’t have a vote, they can still shape the dynamic of the board room.

Importantly, observers generally don’t have the fiduciary duties that apply automatically to directors. Further, without a written agreement, the observers are not bound to confidentiality. For these reasons, observers are often excused from board discussions where sensitive or proprietary topics are discussed. 

More broadly, observer rights should be granted thoughtfully. They may feel like an easier concession than a board seat, but they still add another person and perspective to manage and can be difficult to unwind later.

Thinking about board control as the company grows

As a company grows, decision-making and influence naturally become more distributed.

You might raise more money and become diluted over time, issue equity to employees, or see the board change as new investors and independent directors join.

But it’s worth thinking about control holistically rather than as something you either have or don’t have. It depends on the composition of the board, your ownership as a founding team, and the rights and voting power you hold as a stockholder and, where applicable, a director.

Your role as CEO, your board position, and your stockholder rights are separate sources of influence. A board may have the authority to replace a CEO, for example, while that founder remains a significant stockholder with meaningful voting rights.

Understand the rights you're negotiating

Fundraising is one of the moments when these governance rights get negotiated. You may push for continued founder representation on the board, or a common seat with common votes attached.

The broader point is not to lock the company into a rigid governance structure or preserve control at all costs. It’s to understand what you’re negotiating each time the board or capital structure changes.

At the end of the day, companies are meant to evolve and bring new people to the table. The goal is to build a governance structure that brings the right expertise and perspectives into the room, creates appropriate checks and balances, and continues to serve the company as it scales.

Elke Trilla is a corporate attorney in the Boston office of Wilson Sonsini Goodrich & Rosati, where she advises high-growth technology companies on formation, venture financings, and mergers and acquisitions. Her practice has a particular depth in capital-intensive climate and energy businesses, including structuring blended capital stacks that integrate venture equity with non-dilutive funding sources. Elke is recognized for her work with underrepresented and emerging founders navigating early-stage capital formation, and has been named to the Boston Business Journal's 40 Under 40, Boston's 50 Most Influential Attorneys of Color, and the Hispanic National Bar Association's Top 40 Lawyers Under 40, among other honors.