Can an independent board member help save the company and a founder’s job?

Welcome back to Above Board. To our new subscribers, thanks for joining us. Today’s edition completes a discussion we’ve been having with multi-time successful founder and investor Mike Baker about independent directors on boards. We talk about how the thoughtful, timely appointment of independent board directors can both help the company and potentially save the founder/CEO’s job. You may find it helpful to reference our last three editions that focused on an overview of independents (who, what, why), the process of filling independent board seats, and questions to ask independent candidates.

AB: Mike, thank you for joining us once more. For the CEO’s who are reading this: as it relates to when to appoint an independent director, is the goal to be cognizant of when things might not feel like they're going great on the board? Or is that too little, too late?

MB: The right time to think about this issue is when you first accept institutional capital. In the term sheet, there should be a clear provision for having an independent director. Let's say the board has three to five people; there should be one independent director involved.

I recommend putting that in the term sheet when you are agreeing to give a board seat to a provider of institutional capital; and make clear that it's you, the CEO, who can appoint the independent board director and that the board’s veto right shouldn't be unreasonable; their consent shouldn't be unreasonably withheld.

After raising a Series A, these days you’ve typically found product/market fit, and are starting to scale up somewhat. That’s a good time to appoint the independent director before an issue arises. Once you start to have some conflict or negative patterns of behavior between the management team and the professional investors, then the appointment of an independent director decision will be more divisive; it'll be political and it'll be perceived as a power struggle where it really shouldn't be.

My advice to CEO’s is to tell investors or other board members that appointing a thoughtful independent board director early on is best practice and sound corporate governance. The key is making it a priority and communicating with your board that it is a priority for you because you believe in having a real board with good governance. Establish the principle and take the moral high ground early. You'll be really glad you did later.

AB: A CEO recently was removed from their role by their board. They say: “I should have appointed my independent board seat before the board got rid of me so that someone else was here to stand up for the management side and not just the investor side.” What's your reaction to that statement?

MB: True.

It is not uncommon at all for an institutional investor (on the board) to simply not like the CEO for one reason or another and be out to get them. I've seen that a number of times where there's a personality conflict or the board member just doesn’t trust what the CEO is saying. An independent director can be a useful reality check.

If the independent board member agrees with the investor board members, then it's probably true that there does need to be a change at CEO. But if they don't agree, then that can be a board discussion where there's a useful drag on the line versus bullying by an alpha investor who may be doing something that might not be in the best interest of all the shareholders.

For instance, I'm involved in a current situation where that kind of investor— who by the way is not even supporting the company financially now— is a loud voice on the board and got rid of the founder CEO only to rush replace them with an inexperienced and junior substitute. It’s just resulted in a world of immediate hurt for the company. That is board malpractice; that's a company that has a bad board in my opinion. Unfortunately I'm an investor. I'm not on the board but they have a quite weak independent director who doesn’t have the confidence or experience to try to stop the damaging behavior of the financial investor.

AB: What have you seen an independent board director do really well to establish the right middle ground relationship between management and institutional investors?

MB: It's a great question and I can share two example cases I’ve been involved in.

1. An independent director can help resolve a split opinion on whether to accept an offer of acquisition. I was the deciding vote on a board where control was effectively split between management and PE backers. More typically, an independent would not cast a deciding vote but rather influence the decision (i.e., where the investors have a veto right). But in either case, an independent can help to bridge the gap between management and investors. For example, let’s say there's a situation where the investors want to sell and management doesn't. The board might consider a management incentive plan to make a transaction more acceptable to the management. An independent director can help bridge the gap, ask both sides for their input, and try to work a consensus.

2. A more mundane example is dealing with employee compensation as the company scales. Some boards have a compensation committee, some don't; the formality around this topic varies widely. Oftentimes you'll have a board that doesn't have very generous views around compensation. They may have a CEO who is requesting an increase in the stock option pool for retention of employees. Investors might be reluctant to offer that increase since it dilutes them, but an independent board director can step in and endorse the viewpoint that the board should be giving the CEO the tools to more effectively recruit and retain people whether it's cash or stock-based compensation. I was involved in a situation where I helped get a compensation committee to build trust in and commit to an objective, neutral process to benchmark and get some of what management wanted done, done. Management was happy that somebody stepped up and spent more time on the topic. At the same time, the busy VC’s (editor’s note: we discussed this topic more in this edition) on the board were just glad that somebody did the work and it wasn't them. But it was objectively probably a good idea.

AB: One or two independent board seats?

MB: It depends on the size of the board. One at a board size of three to five and then I would go two at a board size of seven and up. The breakdown of board members (ie: independent vs. not) is usually written into the investment agreement.

AB: You've obviously done a lot of amazing things on both the investing and operating side of things. If you had to choose one, what experience of yours has taught you the most about how to be a great independent board director?

MB: It was being a lawyer and sitting in as a secretary on a bunch of different board meetings. First of all, you see more board meetings than almost anybody else does because you're there taking notes. Second of all, you see all the issues we've talked about brought to light— who's spending a lot of time on their board responsibilities, who's prepared, who is helping to try to bridge gaps and engage in collaborative decision making, who is being divisive and saying unhelpful things, who is being transparent and who is hiding behind their lawyers or partners.

During that experience, I took notes as I saw the different kinds of behavior and different kinds of people. And in my mind, I was like: ‘this is the kind of board member I would want if I were a CEO’ and that's still the way I think about this. I ask myself ‘how can I be really useful to the CEO and make a difference’ and it's not by acting like another VC on the board— most companies have enough of that. But it's also not by just being a reflexive pro-management proxy or trying to avoid conflict. The key is being engaged in the financial and operational decisions with a real opinion, but a small ego. 

Once again, we’d like to thank Mike for all of the incredible insights (and time) he has shared with us. Next week we welcome a new investor to the series. Until then, please consider sharing the series with a colleague/friend/classmate.