Evaluating independent board director candidates and determining compensation

Above Board is back. Today we’re talking about the attributes and qualities a founder/CEO or existing board should be looking for in an independent director. Mike Baker – a successful founder, General Counsel, Chairman of the Board, and independent investor – joins us to discuss this topic. For our new subscribers, the last two Above Board interviews with an overview of independent board directors and how independent board seats get filled may be helpful primers before you read this one.

AB: Thank you for being with us again, Mike. Let's say you’re evaluating two candidates for an independent board seat. One has deep industry experience and the other is someone who has experience in the process of company building, whether from an investment lens or from more of a founder lens. Which one should be chosen as an independent board member?

MB: It’s a great question and the answer depends on what the company has in place already.

The person with company-building experience will be more helpful over the long haul in my experience. People with very specific connections and industry expertise may be more useful in the short term, but less useful or adaptable in the long term.

This brings up the topic of board composition in general: the best boards, like the best management teams, are highly complementary. My advice for a CEO would be to ask the question: who do you currently have around the table? What are their attributes and skills, and what are you missing?

Generally speaking, the best board members have a super power, for example identifying, evaluating and helping to land top talent. Another key power is financing – some people can find and recruit new investors in the toughest of circumstances. Another power is helping to set strategy: helping the CEO connect strategy to execution. These people usually have an operating background and understand how hard it is to consistently execute well.

AB: How do you think about the amount of time an independent board member should be putting forth?

MB: It’s very important. Many board members put in very little effort and time. In my experience, the more wired and connected and famous a board member, the less time he or she has to put into the company.

If you as a CEO are choosing between a director candidate who has depth and time to dig in and work closely with the company vs. a candidate with a big name or power in your industry, I recommend giving the “celebrity” some stock and making them an advisor to help with industry insights and their network connections. The celebrity is not typically going to be interested in the boring work of company building and governance. It took me a while to figure that out.

You always have sort of unlimited slots for advisors with regard to these type of people. Your board seats are precious and you want these to be people who will actually get their hands dirty while bringing outside perspectives.

Board work – done right - is time consuming. From the perspective of an independent board candidate, if you're only getting stock options as compensation, you may ask yourself if it is really worth spending a lot of time on it because your time is hugely valuable, right? So, as a CEO it’s smart to think critically about commitment levels of potential board members.

It’s almost always true that people with a sound process and good behavioral habits in building a company are more valuable than people with connections. I’m not saying networks are not important. I'm just saying there's other ways to get the network and you shouldn't waste board seats on that.

AB: How can a management team figure out when they're evaluating independent board member candidates whether they are actually going to want to roll up their sleeves and get their hands dirty and put in the time?

MB: It’s a direct, adult conversation with a question as simple and as plain as that. Ask them: How many boards are you on? What are your other commitments? How much time do you have in a day, week, month available for this kind of board work with us?

This is a productive conversation because it should be tied to compensation. Maybe there's a great board member that really makes a lot of sense for your company. They can be quite helpful. But they just don't have a lot of time. As an example, a company/board may say to this person: ‘We'd love to have you on the board. You can be really useful. We'll have a relatively lightweight draw on your time and compensate you accordingly.’

I was a board member of other companies while I was a CEO. A CEO who is a board member of another company is going to always be time pressed. But that can be reflected in compensation.

AB: How do independent board directors usually get compensated?

MB: Early stage, it's almost always stock-based compensation of some sort, like stock options that vest on a monthly schedule. The amount of options will vary based on the seniority and track record of the board member. I see anything from one tenth to one half of a point of the company’s fully-diluted equity vesting per year, typically over a three or four year period.

As companies are approaching profitability and reach profitability solidly, it’s more typical to use cash compensation as a significant part of the overall compensation. This is a difference with the US and non-US: companies outside the US tend to cash compensate independent directors at all stages, even if it's relatively trivial.

If you're at the stage in your company where you're putting together a real audit committee, a real compensation committee, etc., you will oftentimes see a committee chair be compensated in cash. The cash compensation will make the chair a little less inclined to just rubber stamp things like a 409A valuation of stock, for example, as compared to if they were being compensated just with stock and may have conflicting interests.

AB: You have some thoughts about corporate VC’s taking a seat on a board. Can you share more?

MB: I see entrepreneurs making this mistake: they take corporate venture (a topic we will look to cover in a future edition of Above Board) which is okay, but then they give a board seat to a corporate, like they do a traditional VC. That's a big mistake to take a corporate VC on your board; if you must, make them a board observer. But making them a board member is a rookie mistake — do not do it. Too often, there’s a misalignment of interests that can impede board collaboration.

And don't take corporate money early; take it later when you need more investment or to facilitate a big deal. But if you take a corporate investor and make them a board member, you will for sure be steered by that corporate investor in a way that's good for them and not necessarily good for all of your shareholders.

AB: I hear there’s a very uncomfortable question you think founders should ask potential VC’s— are you willing to share?

MB: Sure, I learned this one the hard way – as a VC. This is a question entrepreneurs raising capital might ask an institutional investor who requests a board seat as a term of their investment: Ask him or her whether they were one of the people who helped raise the fund. Are they a key person named in the fund formation documents? Did they have a hand in raising the fund?

If they didn't, they're an employee and you don't want them on your board. If they did, they're a true partner or principal. And they're good to have on your board.

The reason I give this advice is because there's going to come a time when you as an entrepreneur need the support of your investor and maybe it's a 50-50 proposition as to whether they should support you on something, whether it be subsequent investment in the company, the valuation or terms of an investment, selling the company or buying another company.

Someone who didn’t raise the fund is going to have to say: “I have to check with my partners.” I learned over the years building three companies that you want the person on your board who doesn't really need to check with their partners; they can just do it because they own the decision.

While VC firms are partnerships, the partners are decidedly not equal. When I was a young partner at a VC firm, I routinely lost internal debates about supporting a company I believed in because the person who founded the firm said: “Hey, Mike, who raised the fund, you or me?” And that was the end of the argument. He made the critical decisions not me.

If you are lucky enough to have capital partner choices as an entrepreneur, you want to focus on the standing of your VC contact at their firm. It’s a factor routinely overlooked by entrepreneurs. This will help you ensure you’re putting a real decision maker on your board. And this act creates more benefits: once you get a person of this standing on your board, other firms will tend to put their most senior person on the board too. And suddenly you've got this great, experienced, high-powered board. Why? Because talented and powerful people like to hang out around other talented and powerful people.

Thank you for reading. Please feel free to send over any feedback and share with anyone who you think may find this newsletter interesting.