Dr. Earl R. Smith II
Managing Partner, The Federal Circle
DrSmith@Dr-Smith.com
Dr-Smith.com
More companies have been damaged or flat out destroyed by lack of governance than by poor governance. Why any board of directors would ignore its fiduciary obligations to the shareholders and leave the management team unsupervised is far beyond me.
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Most angel investors, when funding a start-up, ignore the structure and operation of the board of directors. Most early-stage companies that I work with have only a casually structured board that seems to exist to satisfy legal requirements. Accumulated experience has shown me that this is a very risky approach. A board has defined obligations that are important to the future of any company. Boards unable to fulfill these obligations severely limit possibilities. Here are some of the guidelines that I offer when working with these start-ups:
Composition: A well functioning board is independent of the management team. Friends and family do not meet that test. A board, which is simply a rubber stamp or doormat, creates an imbalance within the organizations culture – key functions are untended or receive short shrift. A functioning board should have a majority of independent members. In my view, the term independent excludes both members of the senior team and investors.
Balance: All the rhetoric aside, the tendencies of management are inherently tactical and self-serving. The CEO is – or should be – focused on implementing the strategic and tactical plans. All implementation is inherently tactical. The team’s compensation – if it is correctly structured – should depend heavily on meeting those metrics and delivering on the plans. Even the most experienced CEO work this way. That implies an unbalanced emphasis on the tactical. An independent board acts as a counterbalance to this tendency.
Professional Members: Board members need to have the accumulated experience and refined judgment that will allow them to help formulate an effective strategic plan. Their vision needs to be long-term. They fulfill their fiduciary responsibility to the shareholders by balancing short-term tactical issues with longer-term ones. One of the changes that I have seen in recent years is a tendency among angel investors to seek out professional board members to take the seats that their investment entitles them to. Angel investors can draw on two pools of talent. The first is successful serial entrepreneurs and the second is professionally trained directors. Both bring important knowledge and experience to the board – both add significantly to the corporate culture.
The Business of Business: As I have written elsewhere, most start-ups fail (one in ten makes it to their fifth anniversary) because the team fails at the business of business. Most start-up teams have a good grasp of the business of the business. A well-functioning board will help make sure that the ‘non-technology’ aspects of the start-up are not the ones that bring it down. One of the most important of these is oversight – both strategic and tactical. Professional board members have the experience to tell when a management team is blowing smoke or missing the point. They also have the ‘stiffness’ to confront the CEO and force the necessary changes.
Standards and Metrics: One of the biggest dangers in a start-up is constantly moving goalposts. The double diversions of constantly evolving Power Point slide stacks and constantly reworked Excel spreadsheets can eliminate the possibility of holding the management team to any metrics at all. A functioning board will insist that performance meet projections and aggressively oppose the proposition that projections should be adjusted to match performance. The later is one of the most serious diseases that can infect any start-up. A management team that constantly lowers expectations to match failure is an amateurish gaggle.
Holding to Account: In most simple terms, if you cannot say what you are going to do and then do it, what is your word really worth? If you say you are a CEO, make statements about what your team is going to accomplish which induce investors to risk wealth based on those statements and them fail to deliver on those statements, you are not a CEO – you are a highwayman. A well functioning board will detect these bandits and take steps to replace them with people that are more professional and productive.
There is a tendency to overlook the impact of governance on the fortunes of start-up companies. My view is that this is a mistake. A well-structured and focused board significantly improves the prospects of any start-up. The cost of such a board is incidental when compared to the risks that it helps control and overcome. ‘Adult supervision’ alone is worth the investment. However, the other benefits – such as a wider range of contacts, introductions to important decision-makers, support in implementing effective control systems, professional evaluation of performance and more, make a well functioning board one of the most valuable assets any start-up can have.
© Dr. Earl R. Smith II
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Related Articles:
- Angel’s Sins
- Red-Teaming: Improve Your Chances of Getting Funded
- Gap Analysis
- Recruiting Successful Board Members
- Board Governance – Searching for Leadership
- Boards, Leadership, Governance and Risk
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7 Responses to “Angel Investing – Governance”
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First rate comment, Michael. I agree with you that a sharply defined and shared vision is essential. I also agree that management has to realize that they are working for the shareholders and are accountable to the shareholders representatives – the board.
Michael Winwood wrote;
The starting point for excellent governance is, in my view, a clear and consise statement of shared destiny, together with clarity about the rights of investors enshrined in investment agreements, articles and other legal documents. It is imperative that management understands from the outset what the financial covenants mean and the undertakings, together with the conditions that will trigger step-in rights. A policy towards strategic management, risk assessment and operational performance measurement will all help but alignment has to centre upon the amplification of purpose. Everything mangement do and everything the Board considers must be judged by the direct contribution to the pursuit of purpose, optimisation of impact in the market and efficiency of flow within the organisation.
Vaus, Thanks for the comment – good stuff. I would suggest that you could say much the same thing about many entrepreneurs – linear thinking, self-promotion, ego-driven actions – all can contribute to business disaster. So, i would suggest that your investors in handcuffs should have another group of cellmates. Earl
Vaus Aslaun wrote:
Investors who lack vision and that are linear thinkers? Step out of the way and just count the beans…don’t step in front of your own shoes, if you want the company to succeed. A 3rd party as mediator is necessary to facilitate that fine balance with the right questions, markers, and metrics. Question I have is, if VCs or investors are so into the bottom-line, revenues, and profits, why do they invest in the most futile ventures? burn rate worse than my chimney or cigars?
I hope there is logic to this..because business 101 says, build a product, sell it, make a profit, re-invest. Sell more.
Or : invest, build a product, invest, r&d, same outcome, invest, sell product, lose, invest, bankrupt.
These people should be handcuffed, in a vault and stare at their decreasing bar charts…to eternity.
Rohan Badenhorst wrote:
Dr. Earl,
In 2005 I wrote a conference paper for the 8th International Conference on Corporate Governance and Board Leadership held in Henley-on-Thames at the Henley Management College.
The paper can be downloaded from the first link on the web resources listed below. (See just below the “my LinkedIn profile” button on the web page is a link entitled:
“Published Paper: In search of the Market Soul 2005″
In the paper I argue for more ethical decision making models to be developed.
See if this paper contributes to answering or partly answering your question.
Regards,
Rohan
Links:
http://themarketsoul.googlepages.com/home
http://themarketsoul.blogspot.com/
Susan Shwartz PhD wrote:
VERY carefully. The problem with VC, angel investors and PE is a lack of transparency and a desire for it. The Managing Partner’s reports should be as transparent as possible. The Managing Partner’s records (whether or not the Limited Partners see them) should be subject to internal and, if need be, external audit — on a quarterly basis until the record-keeping is deemed satisfactory. (I’ve worked on this. It’s a whole lot of no fun, but it cleans things up really well.)
A real problem is institutional limited partners that are funded by legislatures. At one point, Sequoia (if I remember correctly) had to terminate its investment relationships with a couple of public Ivies because the level of transparency wasn’t there.
Too bad Wall Street didn’t read this article. Keeping one’s word and actually doing what you say you are going to do is very difficult. It shouldn’t be but it is. I’ve been an entrepreneur now for 20 years and have seen the best and worst in Boards, Advisory Boards, Management teams etc. It all boils down to two things – Agendas and Alignment on the issues. Keeping those two in check while solving a customer problem and growing cash flow is not a trivial exercise.
Cheers,
Peter
5o9 Inc.