Angel Investing – Start-up Governance

By Dr. Earl R. Smith II
DrSmith@Dr-Smith.com
www.Dr-Smith.com

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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Dr. Smith is a proven senior executive, successful entrepreneur, published author and public speaker. He serves on boards of directors and advisory boards or as a strategic adviser to CEOs. Dr. Smith specializes in turnaround management, strategic planning, leadership development and executive coaching. He also works as an executive and/or life coach in the areas of personal growth and spirituality. He is the author of Amazing Pace: Turbo-charged Business Development – a book that shows how Advisory Boards can dramatically increase revenue. Dr. Smith is also the author of Dream Walk: Parables for the Living – a book of Raven Tales and exploration.

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  • Neil
    I just want to thank Earl for allowing us to publish his advice here. It is extremely wise and is a great reminder to us business angels or entrepreneurs that we simply mustn’t rush the hard work and get so excited about the opportunity that we don’t put the structure in place.

    I think we all know what Earl is saying is true – and some of us may be tempted to say that our venture is too small to bother with a board.

    Well, here is the question we need to ask ourselves, if the business is going to be a great success it won’t be small, so why would you not do this now?

    Equally, if you don’t think it is going to be a great success, then perhaps you shouldn’t invest after all.

    Either way, we can’t get away from doing what Earl advises.

  • Putting together a good board is, unfortunately, easier said than done. I worked hard to put together a board which included a couple of marquee names in our industry. Unfortunately, it takes a long time to get to know board members and some of the advice I got from mine was downright destructive to the business. In the early stages, the CEO/entrepreneur knows the business best and has the most passion for it. If the CEO is held hostage by a board that is not on board, so to speak, the business can fail before it has a chance to even hit its stride. I guess the point is, a bad board is worse than no board. So, take your time and make sure the company is far enough along to warrant the risk and overhead — definitely not pre-funding.
  • Hi Lisa

    Yes, you are right! In my time I’ve tried outside consultants sitting as quasi-board members – just to hold us to account, I’ve tried no board, and I’ve tried a board where all the members were also shareholders and directors.

    None of it worked particularly well.

    I guess where Earl’s advice works is when you begin to seperate the business leadership from the ownership.

    I know that Stelios Haji-Ioannou – the founder of Easy Jet – began as an entrepreneur but as his business grew he stepped back from the management and became a shareholder using the board to hold the directors to account.

    I think that a board needs a clear mandate to function well – and that needs to come from the shareholders – and that usually comes when there is a clear seperation between the business leaders and the shareholders.

    Hope this helps
    Neil

  • I also think that most CEO’s naively think that their board cannot or will not fire them. Many have learned the hard way that all it takes is a majority vote, that can occur at any time, and without good reason. It doesn’t matter if the CEO has the majority of the common stock. The voting rights of that class rarely come in to play. Food for thought.
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