Building a Great Startup Board , Part 2

Last week, we explored the topic of startup boards of directors. We covered what a board of directors does, why it’s so important, and how the role of the board changes as the company grows.

The primary goal of this conversation was to explain how and why a great startup board can be a powerful tool to help the CEO make the company successful. If you haven’t yet read Part 1 of this essay, you can do so here.

This week, we return to the topic to cover how to choose your board members, why startup boards will be more diverse in the future, and discuss some of the great board members I’ve worked with in my career.

This essay is based on Part 2 of a two-part episode of the Greymatter Podcast. You can listen to the podcast here, or search for Greymatter Podcast in your podcatcher.

How Should You Select Your Board Members?

In many cases, the CEO is the only member of management who serves on the board. But every so often another founder also sits on the board.

If that’s the case, it’s essential that that founder and the CEO have a very tight relationship and coordinate closely to avoid allowing members of the organization to use that alternate channel to the board to get around the CEO’s decisions.

Selecting your investor board members should be a careful and thoughtful process, even if that means it requires more work. One common mistake is for entrepreneurs to simply select whichever venture capital firm is offering the highest valuation. That approach can actually destroy the long-term value of the company if it results in selecting the wrong board members.

As an entrepreneur, the basic question you must ask yourself is whether the prospective board member can help you achieve the upside – and also manage the downside. Too often, entrepreneurs (who are inveterate optimists) focus too much on the upside when picking investor board members.

There’s a few things to keep in mind as you consider possible candidates:

• Know who you want in the trenches. Nearly all startups go through a “valley of the shadow death” moment when founders and investors realize that the company is facing major, even existential challenges. Maybe it’s an economic challenge. But it could also be a non-financial challenge, like being a social media company and facing attacks from multiple points of the political spectrum.You want your board members, both VCs and independents, to be people whom you want with you in that valley. You want board members who will help you address the emergency, rather than panicking and focusing on preserving their own brands.
• Look out for passive members. Another mistake that many entrepreneurs make is to pick passive, do-nothing board members as a way to minimize the hassle of dealing with the board. At least that approach doesn’t destroy value, but it is a huge missed opportunity.One of the things a financing round brings is an opportunity to strengthen the startup’s overall network. This is one of the reasons why the best practice for a startup is to raise investment rounds from different lead investors rather than simply doing internal rounds, even if an internal round requires less work. It’s worth the additional effort to add more people – and their network – to the team.
• Know the pros and cons of independent board members. The final category of board members are the independent board members. Unlike management or investors, independents do not have a major financial interest in the company.They tend to be more helpful with capturing the upside versus managing the downside, since they are better positioned to help a startup connect to new opportunities, rather than cutting costs (management) or injecting millions of dollars of need funding (investors).

INDEPENDENT BOARD MEMBERS

One of the really important roles for independents is to serve as a catalyst and bridge between management and investors.

For example, a classic example of the conflicting interests of management and investors, which an independent board member can help mediate, is the approval of equity grants to management and employees.

Management typically argues for larger grants (which is in their self interest), while investors argue for smaller ones (which is in their self-interest).

For example, one of the speeches I’ve heard most often, and from many different VCs is, “Founders should never receive additional equity grants. They already have their founder’s shares.” I disagree with this, and when I am an independent board member, my ability to see the merits of both arguments helps me build a compromise.

Founders should receive additional equity grants, but not to the extent that an incoming CEO or executive would. The purpose of the equity grants are not to motivate the founders (the investors are correct, that the overwhelming majority of the founders’ stake comes from their founder’s shares) but rather to acknowledge their work. Anyone who is on an equity incentive plan should be able to earn equity for performance, including the founders.

It’s the independent director’s job to provide this kind of balanced perspective on conflicts. I’m reminded of the parable of the blind men and the elephant. One feels the trunk and concludes that elephants are like snakes. Another feels a leg and concludes that elephants are like trees. The independent board member can see the entire elephant, and while acknowledging the perspectives of both management and investors, can help them see the whole picture as well.

Another role for independent board members is to provide flexibility in board composition.

SETTING TERM LIMITS

One of the questions that people don’t ask often enough is: When should a board member naturally time out? Or when should a board member be fired?

The challenge is that it’s very difficult to fire an investor board member, because a venture round’s legal paperwork typically entitles a lead investor to a board seat. Maybe you can exchange the general partner who sits on your board with another general partner from the same firm, but doing so tends to be very difficult.

So if you don’t want to remove management board members, and you can’t remove investor board members, that leaves the independent board seats as the only source of board composition flexibility. This is one of the reasons why independent board members should be on an explicit tour of duty, with a specific term, which makes it easier to make changes without having to “fire” a board member.

Finally, the independent board member slot can be a way to “hire” an essential skillset into the company that wouldn’t otherwise be possible. This could be an industry luminary, or it could be someone who is the perfect person to complement or strengthen the CEO and executive team.

A final piece of key advice is to remember to reference check your board members. I’m a firm believer in the power of reference checks–after all, the references are basing their evaluations on hundreds or even thousands of hours of interaction, not a handful of interviews. But reference checking a potential board member is different than reference checking a job candidate.

The questions I like to ask are:

• Was the potential director your best board member?
• What were the strengths and weaknesses of the board member?
• What was the greatest benefit of having them on the board?
• What was their greatest weakness (as a board member)?

How Can I Build A More Diverse Board?

In the state of California, SB979 is requiring every public company with a principal executive office in the state to have at least one board member from an underrepresented group by the end of 2021.
And companies with five to eight board members will have to have at least two diverse board members by the end of 2022. Companies with nine or more board members will be required to have at least three such board members then.

But in addition to the legal requirements, there are also good business reasons for increasing board diversity.

• It changes the status quo. The first reason is to break up the old white man network. Boards often select their members based on homophily, so if current board members are overwhelmingly older white men, and they tend to select new board members who resemble them, without some kind of intentional change, the status quo will perpetuate itself. Requiring diversity is one of the only ways to break this feedback loop.
• It brings new perspectives. But the reason diversity matters, beyond equity and fairness, is that diverse board membership provides additional perspectives that help the company navigate a fast-changing world. Diverse board members are more likely to be aware of the changing currents in the world, and will be sensitive to different potential landmines and different breakthrough opportunities. Thus board diversity helps startups capture more upside and avoid downside.

Even relatively early stage boards should be thinking about diversity, because they face particular challenges on this issue. If the only board members your startup is adding are investors, then investor selection is the only way that you can add diversity to the board.

And because white, East Asian, and South Asian men are so overrepresented in the VC community right now, your investor board members might be limited in how much they contribute to diversity.

I’m glad to report that the industry is changing; Part of the reason why Greylock works with All Raise, and other such initiatives, is that we believe that if you aren’t part of the solution, you’re part of the problem.

And even if you can’t achieve board diversity during the early stages, you should be planning how to achieve it with your independent board members.

ADDITIONAL THINGS TO CONSIDER

Even though SB979’s requirements only apply to publicly-traded companies, it’s obvious it’s going to have upstream effects. If you’re a privately held company and you’re getting ready to go public, it’s probably not ideal to say, “Let’s add a diverse board member right before we go public.”

First of all, you are putting it off until the last possible moment. It’s much better to have people on board all throughout where you’ve been building that relationship. The other benefit is that the first question a public company asks when considering a potential board member is, “Well what other boards have they served on?”

Serving on a board is like getting one’s passport stamped. And the more people with diverse backgrounds who are getting that stamp, the easier it will be in the future to fulfill these requirements.

Finally, whether for the board or for your company, it’s not enough to hire one diverse person. This isn’t fair to the person, and won’t accomplish the goal of making the organization welcoming to diverse people.

You need to hire N diverse employees or add N diverse board members, where N is greater than one! You may not be an exact reflection of society, but you’ll show that you are trying.

As with any hire, culture fit is essential. Why would a diverse board prospect want to serve at a company that didn’t share his or her values?

What do you think is more appealing to a great candidate: “Come help us respond to our critics even though we’re not a good fit for your professional plans,” or, “Bring your talents, vision, and perspective to this company because when you add those to what’s already here, we’ll have a championship-level team”?

What Are Common Board Mistakes You Should Avoid?

The most common mistake is to believe that the CEO works for the board. The logic seems to be that because companies are hierarchical, and individual contributors work for managers, managers work for executives, and executives work for the CEO, then presumably the CEO works for the board, and is the equivalent of their employee.

This doesn’t mean that the board is subservient to the CEO either – being a good partner doesn’t mean being a pushover. The objective should be to be clear, concrete, and helpful–not submissive.

One of the metaphors that I use when I’m training people to be board members is that the relationship between the board and the CEO is like a traffic light. The light can be green, yellow, or red. Your responsibility as a board is to be super clear on which color currently applies.

• When the light is green, the relationship is good. The CEO makes the decisions, and if the board gets involved beyond the crucial “below the waterline” decisions that could make or break the company, it’s probably a value-reducing distraction.
• But, if you’re not comfortable with the way the CEO makes decisions, that is a clear sign that the light has turned yellow. The yellow caution light is a signal that something is wrong, and needs to be resolved quickly.As a board, you should explicitly discuss the concerns that triggered the yellow light, and decide on what you need to learn to move back to green or on to red within a fixed timeframe. As with a traffic light, the yellow light is purely transitional and time-limited. When a board stays on yellow indefinitely, it destroys value.
• Of course, the board should hope to return to green. But if it proceeds to red, then there are only two things to do: Replace the CEO or sell the company.Notice that even under red light conditions, the board isn’t running the company or telling the CEO what to do. The CEO is the leader and decision maker; if you believe that CEO’s decisions will lead to the failure of the company, the board must either change leadership or look for an exit.

Whatever the color of the light, the language that board members use matters. When I’m on a board, you will rarely hear me say, “You should do X,” unless it is a very specific legal issue.

For a business issue, I’ll say something like, “Here are three reasons why advertising might be this company’s most important business model. This is why advertising is a really good business model. This is why it applies to this company. And this is why it’s worth considering a change. I’d like to hear your reasoning on this topic.”

When the CEO listens to you, does the CEO hear, “You work for me; I get to hire and fire you, so do what I say.” Or does the CEO hear, “You’re the leader. Take the lead, and I’ll try to help as much as possible.”

NOTE: As a practical matter, early-stage companies likely lack the ability to attract a good outside CEO candidate anyway. I feel like laughing (and crying) when I hear board members say things like, “We should hire a CEO like Jeff Weiner, Satya Nadella, or Reed Hastings.”

Yes, if our early-stage startup that has zero revenues can convince one of the iconic CEOs of the entire industry to leave their job running a multi-billion dollar enterprise, we should do it. But get real. Most companies won’t get within 1,000 miles of being able to recruit such a person.

When you consider the talent the company can actually attract, the current founder/CEO is nearly always the best bet. If they fail, the company is probably doomed anyway.

How Much Control Do Entrepreneurs Have Over Who Joins Their Board?

Part of being an entrepreneur is understanding that there are many things beyond your control. You always have choices, but the results may depend on external factors like competition or market. Financing can be one of these things.

For example, let’s say you’re an entrepreneur and you get one financing offer from one venture capitalist. That’s a no-brainer, right? You have to take the deal…right? Wrong. I remember one time when an entrepreneur asked for my advice on this very situation.

My response was probably the harshest reference I’ve ever given a venture capitalist. I told the entrepreneur, “You might want to consider shutting your company down rather than accepting money from that person.”

The reason you’d rather shut down your business than accept an investment offer is that if an investor is so incompetent and malicious that they’ll eventually destroy the value of your company, you’re better off failing now rather than slogging through another couple of years. At least you’ll be free to try something that might actually succeed. Fortunately, I haven’t had to give this advice very often.

But let’s say that for whatever reason, you end up taking money from a VC who turns out to be a bad board member. As we’ve previously discussed, it’s very difficult to fire a VC board member.

Given this fact, the best way to improve the situation is to recruit another board member–whether investor or independent–that can serve as a counterweight to the problem board member. It’s a lot easier for a CEO to stand up to a board member if another board member has your back.

To pull off this technique, you need to recruit a board member who has the character, board experience, and “throw weight” based on reputation and previous accomplishments to get the bad board member to back down.

Real-Life Examples Of Great Board Members

I’d like to take a look now at a few great board members I’ve worked with over the years and what made them so exemplary.

LINKEDIN

David Sze was my most effective and helpful and competent board member at LinkedIn. His performance as a board member is the reason I chose to join Greylock when I transitioned from entrepreneur to venture capitalist.

David helped make LinkedIn a better product and company. For example, at one point he said, “I think we’re crossing a line. All viral products are somewhat spammy, but I think we’ve become too spammy in the following ways, and here are some techniques we should be using instead.”

We were one of his star portfolio companies, but he was willing to call a spade a spade because he knew it would make the company stronger.

He also brought a valuable perspective that helped us think more broadly about the environment around us. Part of the reason we raised our Series D in 2008 is because David came to us and said:

“One of the things we do at Greylock as a partnership is we talk about the state of the markets so we can help our portfolio companies make financing decisions. We think that the market’s superheated and heading for a crash. We don’t know exactly when, but we’re telling all our portfolio companies that they should do a preparatory fundraise.”

Based on David’s advice, we raised our Series D in September of 2008. Those with long memories may remember that in October and November, the subprime mortgage crisis caused a stock market crash and destabilized the financial system. And because of our preparatory fundraise, we were comfortably financed and easily rode out the market turbulence.

Notice that David never tried to seize the steering wheel; he stayed in the passenger seat and was an awesome navigator and support.

I could tell that David would be a great partner as a board member from the very start of his involvement with LinkedIn.

When David led our Series B round, he told me that when you’re reference checking for an important role (in this case, my ability to be a good CEO for LinkedIn), you haven’t checked enough until you have found at least one negative reference. Now that’s something I already knew.

But David took things a step further–he walked me through the references, including the negative reference. It was his way of building our partnership. Right up front, his technique established transparency, trust, and the ability to talk about difficult subjects.

In addition to David, I’ve worked with so many great board members, I’m apologizing in advance to any of the amazing board members that I don’t mention next. You know that I love working with you and I’d be a happy reference at any time! But alas, I only have time to discuss one VC director and one independent director.

AURORA

One of the great VC board members I’ve worked with is Michael Volpi of Index Ventures, who serves on the Aurora board with me.

Michael does a really good job of asking the right questions while still being a great passenger side partner. For example, when he makes an assertion, he makes it clear what level of information he has to support it.

Sometimes, this means saying, “You should take this really seriously. I have X, Y, and Z experience in this matter, and here is why it is an important issue.” And then other times he’ll say something like, “I’ve got this question, but I don’t really know the answer.”

And finally, like all great board members, he rolls up his sleeves and gets involved in the detailed work. For example, one of the major deals we made at Aurora is acquiring Uber’s self-driving research unit.

Michael, who built a legendary M&A practice at Cisco Systems, was super important in that process, helping the board and team thinking about questions like, “How will we integrate this acquisition? What are the right ways to think about management? What are the key priorities we should focus on?”

KIVA.ORG

One of the great independent board members I’ve worked with is Julie Hanna, whom I brought in to be the chairperson of Kiva.org. She’s now the second-longest-serving board member at Kiva, and has contributed to the organization’s success in so many ways. Alas, I only have time to discuss two of them.

First, Julie is very rigorous about making sure that the board is managing its own performance, not just the organization’s. She asks us to think about the OKRs of the board as a group, and as individual board members.

All of us have to take the time to ask, “How can we operate better? What’s the way that we can help Kiva more? What’s the way that we can help Neville, the CEO, more?” We’re a learning team, not just a board.

Second, Julie does an amazing job of spending time with the other executives in the organization. She finds out what is really going on in the organization to help the CEO and board make the right connections.

She might say, “This board member should talk with this executive,” or she might say, “We’re having this problem between this founder and this executive, so I’ll have dinner with them, and I might involve this other board member later on.” As a serial founder and CEO herself, she understands how to work with the management team in collaboration with the rest of the board.

Conclusion

I hope that you’ve seen that a great startup board can help your company succeed. It takes hard and thoughtful work to build such a board, and I hope that the advice I’ve shared helps your own effort to do so.

In future essays, we’ll be discussing additional topics, like how to manage your board and board meetings. Be sure to subscribe to the Greymatter Podcast to stay up to date on this, and other topics I’ll discuss.