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selecting the best advisors and directors
playing the board game
page two of three | previous page


art marks: the investor’s point of view

Hi. I'm Art Marks. I've been in the venture business for about 20 years. Prior to that, I had about 15 years of operating experience. The firms I've been involved with have funded some 350 or 400 entrepreneurial companies, of which about 140 or 150 have gone public. I have been involved in 40 or 50 of those companies myself, and I've been on the boards of 12 to 15 public companies.

          This is a very rich topic. I think there is some redundancy, but there are a lot of different points of view. I'm going to try to glean a few things from my experience that might be useful to you. I come from the narrow investor point of view, but with some significant empathy for the challenges and issues of a CEO. I'm going to talk about the legal framework of why we have boards and what I think they do. Then I'm going to talk about what you can do to make them effective, as well as the typical mistakes I've seen, and a couple of comments about how you attract good advisors or board members.

          When you are working in an entrepreneurial company, you go through a term sheet negotiation and you end up with a shareholders' agreement. You try to envision everything involved in setting up the right structure to prepare and to protect everyone's interests. This is true in the regulatory environment, and the legal environment. What everybody has decided is that all of the things that we can't put into the documents and can't figure out in advance, we will give the authority and responsibility to somebody else to make the decisions in the interest of all concerned, and that is the board. Your board is empowered and they're accountable. That is what the Enron situation is all about -- all the stuff that people can't anticipate, and applying good judgment to the decisions you make in the interest of the shareholders. That is something to think about. You want a group that is going to take on this power and be able to deliver good decisions under very unknown environments to help you make the right decisions. Sometimes those people are decided upon through your negotiations about representation during fundraising. 


          You always want to try to build a relationship with those players to get good advice from their diversity, and from the kind of trust relationship you have with them. At the same time, they've got what is often called a fiduciary duty, that is, the financial responsibility to represent the interests of all the shareholders.

          It used to be that people would joke and say that the job of the board is to hire and fire the CEO and declare dividends. That was sort of like saying that we don't really do anything, we just decide whether the CEO is doing a good job or not. That is one element, but I think that, more and more in our society and in our regulatory environment, there is an expectation that the board is going to take its responsibilities seriously.

          When you look at the board, it's a team of people who are all involved in something. Mary talked about the movies. For me, the movie that best exemplifies a board is the Fellowship of the Ring. That is because we're all on an adventure, all kinds of imaginary creatures come into it -- meaning things that you didn't expect -- and it's endless.

          So what can you do? Well, Raul and Bruce talked about it. One of the things you can do is to learn how to run an effective meeting. Nothing takes away from this process more than people who don't know how to do this. Get the information in advance. What do you want to have happen in this meeting? You want to take all the board’s experience and knowledge and get it to work on an issue or to help solve a problem that is hard for you to solve yourself. If you can solve it yourself, then you don't need the board. You want to bring them into the process of making decisions, get them informed -- not just in a board meeting, as Bruce said, but all the time -- and get them to apply their brains to solving the problem.

          Let me say parenthetically that it's not the board meeting. Don't get distracted and say, “Well, I have to run a good board meeting!” It's a board. It's a group of people. Some of the process takes place in the meeting, some of it takes place at coffee, and some of it is a phone call, or an email. It's the group. It's the team that you are trying to bring forward to help you solve problems for the company. That is why open and honest communication is important, as is having an agenda, and finding out from people what they think the issues are that you have to address. That is why you need balance in the board. You want to get input from everybody, and you want to use that input to make decisions. You'll learn that the boards are not monolithic. They're made up of people with different opinions and they won't all think the same way on everything.

          In fact, you'll often find that there are some people who are the leaders of the board, or more influential. Often that will vary based on what the topic is. Everybody may look to one person, maybe the ex-CFO of the company, for the accounting issues. They may look to another for compensation issues, somebody else for financing or strategy or technology. Use those inherent leadership qualities to help you delegate. Move the decisions to different people to help you solve problems. Involve them.

          You can look at a board and say, “I’ve got a problem. I hate this guy, and I'll get rid of him.” You can try to do that, or you can say, “I'm stuck with these people. How am I going to develop a trusting relationship, or at least get their knowledge?” Don't have this passive-aggressive attitude where you schedule the meetings when that person is out of town. Don't do that kind of stuff, just confront the issues. Move forward, just like you're in a family, but don't become a dysfunctional family. Respect different points of view. Confront problems.


          The other piece of advice I would go along with is to keep it small. My definition of small is smaller than Bruce's. My definition of small is five to seven people. An entrepreneurial company doesn't have the bandwidth to deal with much more than that. You don't have the time for more than that for people to have the discussions and feel a part of it, so that would be my advice.

          In terms of the easiest mistakes to make, I'm going to go through three. One is the mistake of control versus trust. People say, “Well, the board is empowered to make these decisions. I don't want anybody to have the ability to make decisions that I don't agree with, so I want to bring in my mother and my father and my brother-in-law.” The job of the board is not to be your best friend. If that is what you're looking for, then you're not trying to build a large, entrepreneurial company. The board’s job is to be the shareholder's best friend, and that calls for independence and variety, not control.

          The second problem is that while the board represents the shareholders, some members of the board sometimes represent shareholders with special interests. In the venture business, we'll often set up a special security which has privileges beyond those of the common shareholders, something like a liquidation preference that gives us the right to the first cash. Sometimes this is perceived as a conflict. Sometimes it is a conflict. You have to recognize that your venture shareholder is both a representative of all the shareholders -- they have a fiduciary responsibility to do that -- but they also represent their shareholders. I'm feeling a little protective of the poor venture capitalist these days, but they may feel like, “Well, gee, they have this liquidation preference. Is that fair?” You have to recognize that if you cut a deal, that is the deal you have, and you have to work with it. Politics can't overcome when you have them by the contract.

          The third terrible thing is this: I recommend that you keep the “ugly sisters” out of the board meeting. I often call them the ugly sisters in the investment business, but they're the ugly sisters of business in general. Those are the three sisters of woulduh, shoulduh, and coulduh. It's, “You shoulduh done this. We coulduh done that.” The board has to be focused on what you do next. If you have the wrong CEO, you have to make a change. If you have the wrong strategy, you have to make a change, but you can't focus all of your energy on woulduh, shoulduh, coulduh. Your whole board process ought to be on what is next.

          How do you attract good board advisors? I think the number one thing is that you need to know what you want. You can't just say, “Well, he made a good comment, so I like him,” or “She's smart.” You have to say, “What I need is somebody who can help me with the audit committee. What I need is somebody who is really great at strategy.” It is not as if you want them to come in and do a project for a month. This is four to eight years worth of touching that person's talent and having them reflect on the issues in your business. You need to know what that is, whether you're looking for technology or business expertise. When Raul described his board-building, you notice that he talked about the kinds of expertise he could tap in each case.

          The second thing to attract board members is that you need an interesting company, one that is changing the world, bringing new technology to bear, or growing in an unusual segment. Also, if you bring someone in, they're going to do it because they expect you to listen to their advice. If you want them for window decoration, they're not going to be very effective and they're not going to be very happy. If they do this, people are looking for an interesting role, for a way to give back in an interesting way. And they're looking for some kind of incentives. The incentives are very difficult, but I would guess that you give a board member something between a quarter and three-eighths of a percent of the company for their lifetime role, that is, their four or five year role. That is for an early stage company.

          That is the end of my set of bullets. Back to you.


the audience: q&a

Mr. Shames: We're going to start by taking a couple of questions from the email, then we'll open it up to the audience. I want to start by talking about a board of advisors. Everyone talked about boards in general, but mostly related to board of directors. For a lot of companies, there is the issue of whether or not they should have a board of advisors. Why would you have a separate board of advisors, and, if so, who is on that board?

Mr. Fernandez: We put together a board of advisors later in our life cycle. I think it's useful for a couple of reasons. First, if you're in a business where you've got a lot of repeat business and customers that have the flexibility, compensation issue aside, a board of advisors is a great structure to bring in individuals who are large buyers. We had representatives from General Motors, General Electric, AOL, many of our large partners over the year. It was useful in that it gave us a structured feedback loop with those individuals. It was diverse. They tended to be operating heads of a particular business unit, mostly eBusiness initiatives across a particular division or across a whole company. One of the things they got value out of was coming together with peers, and, in some cases, competitors, either direct or indirect competitors. Those who could accept were allowed to get options and some level of meeting compensation, as well as expenses. I think that boards of advisors are good to give you feedback, if they're structured, and, at least in our case, we used it 90% from a client base standpoint.

Mr. Crockett: I think you have to be careful that they don't become honorific. You've got to manage the process. If you don't manage it, it's a little bit like kissing frogs. Hopefully, you are getting something for the cost, but it could easily get out of control, and, in a sense, be a second class citizen below the board itself.

Mr. Shames: Raul, you mentioned that you picked a board of advisors later on in your cycle. Was there any reason why you didn't pick one initially?

Mr. Fernandez: We were just focused on the board of directors and on trying to get the most out of it. If you have a small management team, you'll find that there are only so many sets of outside advisors that you can concentrate on to get the type of value Art was talking about. It all depends on whether you have a structure within your company to take advantage of it.

Mr. Shames: Art, what do you see when you get involved at that early stage?

Mr. Marks: I think Bruce and Raul are right. If you don't have a board of directors and you're experimenting, maybe a board of advisors is sort of a half step. Most entrepreneurial companies can't afford the bandwidth to do both. The board of directors has a clear mission, and people understand how to deal with that. Boards of advisors are typically experiments about technology, customer access, etc. They don't usually have the same duration. That is partly because you don't have the time to deal with it. I'm always a little cool on boards of advisors because I've never seen them last; whereas, boards of directors endure. They have a role, particularly with new technologies, which is when they can become critical.

Mr. Shames: What do you typically compensate a board of advisors for their role? How did you do it at Proxicom?

Mr. Fernandez: I think the number of shares was somewhere around 10,000 options and some token meeting fee.

          One thing that none of us has talked about that is very important in attracting your board is the appropriate amount of insurance. It's a very risky proposition to be on a board, and those people that commit are not only committing their time, in some cases they are risking their personal wealth if you don't have the proper amount of protection. A high level of Directors and Officers (D&O) insurance, especially in the post-Enron days, is going to be absolutely key to getting anybody of any value.


Mr. Crockett: I agree with that. Insurance is really important.

Mr. Shames: From my perspective, we've seen a lot of companies that think about board of advisors, but I haven't seen that many that have properly executed. Once you raise professional money and get a real board of directors, you get to the issue of what is the role of the board of advisors? You don't want to have a conflict between what you're hearing from the advisors and the directors. What I typically see is that the board of advisors kind of fades out as the board of directors takes over. The goal would be to focus on the board of directors as early as possible, but especially when you start to get interested parties who have money in your company.

          I want to pick up on D&O insurance, which we have several questions on. Ben Martin went to a lawyer and someone from the insurance industry to give a description of what it is. The following explanation comes from Andrew Pagalis, who is a lawyer at Armfield, Harrison and Thomas. “D&O insurance is Directors and Officers insurance. Directors and officers are exposed to personal liability in their capacity as “Ds” and “Os.” Types of claims have varied widely and are brought by shareholders, employees, customers, competitors, vendors, and others. Within the insurance industry they use the term "management liability" to refer to these types of exposures, and there are three main forms of management liability insurance coverage which may be procured individually, or combined into one form. Those are: directors and officers liability insurance, employment practices liability insurance, and fiduciary liability insurance.”

          That is a very important facet. Any board of director would expect a company to have it in place. We typically advise our clients at a very early stage to start talking to insurance brokers to figure out what makes sense.

          I want to turn it over now to talk a little bit more about compensation. I think everyone here mentioned it, Art especially. Exactly what kind of percentages would you give in equity? What about cash compensation for boards? Do small company boards of directors get cash, or is it typically just in the form of equity?

Mr. Marks: I'd say typically it’s not cash because cash is usually their scarce commodity. How small is small? Once they get to be public, there is typically a cash component.

Mr. Shames: What about paying for expenses, such as coming to meetings?

Mr. Marks: Always pay expenses.

Mr. Crockett: Even where cash is a practice, there is a trend towards incentive-based compensation for directors that aligns the directors' interest with the shareholders. For example, you'll see a decrease in such emoluments as pensions for directors because that tends to be potentially contrary to the interests of shareholders. There is much more of a trend towards alignment of interests.

Mr. Fernandez: In larger companies, even in smaller companies for that matter, although the numbers are lower, there tends to be some level of retainer, some level of per meeting fee, then some level for chairmanship of a committee, which can see some nominal increase. As Bruce said, the compensation committee is a good one to be on. I'm on the compensation committee for Liz Claiborne, so everybody loves me there, but they pay me an extra thousand dollars to be on it. You're not there to make money on the fees; you're there to add value and get value.

          One of the things we haven't talked about is the value that we have gotten from being on these diverse boards. You get to interact with people who have very, very different backgrounds. The retail business is very different from the business that I'm in, and I've gotten a tremendous amount of value in the last couple of years since I've been on that board, such as understanding what the real value chain is for the clothes that you and I wear every day and what it takes to put that on our back from a manufacturing and delivery standpoint. 


          Back to the fees, there are publicly available benchmarks that can tell you that 60% of all firms pay such-and-such amount of money. If you're looking for specific direction, that information is available.

Mr. Crockett: That information is available on an industry basis, on a company size basis, and you can slice and dice it. There are all kinds of information out there, and you can get most of it off the Internet.

Mr. Fernandez: Let me ask a question. Art, you mentioned a quarter to three eighths of a percent as an average compensation. What is the expectation, in dollars, that a board member should have over a four- or five-year period of time?

Mr. Marks: I tell CEOs that if they are attracting the right person, we'd like to see him make $500K to $1 million over the course of the term for a successful company.

Mr. Fernandez: That is the range that I've heard as well. If you do well, if they do well, if the market does well, over a period of time they can walk away with that range of gain.

Mr. Shames: Questions are pouring in. Should a startup company have an audit committee as does a public corporation? If not, who performs that function?

Mr. Marks: Let's go in reverse order. If there isn't an audit committee, then the board is the audit committee. In fact, even with an audit committee, the board has the responsibility to deal with the auditors and to resolve any issues related to audit regulations and the financial reporting requirements. I generally advise companies that the best way to eventually become a public company is to start acting like one from day one, if that is your expectation. You want to start getting in the habit of having an auditor, having an audit, and for the board to learn how to do all those things way before the point that they actually go public. That way they're not learning when it becomes critical and when they become the target of lawyers.

Mr. Shames: Does a VC prefer an already existing board of directors or board of advisors?

Mr. Marks: I'd say that they’re indifferent. Post-investment, you want to have the kind of board that you think the company should have, which is balanced: the CEO, the venture guys, and independent people. To the extent that the existing board obstructs that, it's a negative. To the extent that it accommodates and helps fulfill it more quickly, it's a positive.


Mr. Shames: Bruce, a follow-up to your comment on retirement age. Has anyone used a term limit for a board?

Mr. Crockett: There are terms with respect to how long you get elected, Sometimes it's annually, sometimes it's for a three year period, whatever. I don't know of any company that has specifically said you can serve two terms, then you must retire, but there are mandatory retirement ages that can vary anywhere from 62 to 65 to 70 to 72, and, in extreme cases, maybe 75. As I said before, in the absence of a truly compelling reason, it's hard to get somebody off the board after you've put them on. I'm not saying it's employment for life, but, from a practical point of view, it's just a difficult thing to accomplish.

Mr. Marks: Just to add to that, I think that the idea of terms, like a three-year term staggered through the board, is a very good way to force the process of thinking about whether that board member is right or not. While it may not be the absolute best way, the fact is the board and the management have to put forward the slate for reelection, and that gives you a perfect opportunity to reconsider without a lot of broken glass.

Mr. Fernandez: I think that the key is to set the expectation up front. “I want you to serve for one term, then, as we evolve, we'll discuss it.”

Mr. Crockett: That’s why having a formal evaluation process in place is good. You just don't want to say that one person is not doing a good job and all of a sudden try to find a way to get that person off the board. If there is a process that repeats itself every year for the directors who are standing for reelection, as an example, then you're going to have a chance to have somebody not stand for reelection. If there is a euphemism for kicking them off the board, I suppose that would be it.

Mr. Fernandez: There are companies that specialize just in facilitating board evaluation processes.

Mr. Shames: That was a great segue, because that was the next question I was going to ask. How do you evaluate a board. Do you go out and hire an outside third party? Do you typically give formal reviews to your board members?

Mr. Crockett: In a couple of cases, I've been on a board where they didn't have a process, so we decided to put one in. The first step was to come up with a process to evaluate the effectiveness of the whole board. Once that was established and it became routine, we began the next step, which I think is a logical one, to do evaluations of individual directors. That is not as easy. As Raul said, if you had set the expectations from the very beginning, it would be a lot easier. If you have a board where it's been business as usual, then it's a little more difficult.


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