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Building exceptional boards of directors in growth stage technology businesses litwiller - june 2012

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  • 1. Building Exceptional Boards of Directors in Growth Stage Technology Businesses Dave Litwiller June, 2012Keywords: Board of Directors; Supervisory Board; Governance; Leadership; Growth Stage; Technology; High-Tech;Venture Capital; Angel Investor; Management Oversight; CEO Performance Management; Risk Management;Chairmanship; Financial OversightIntroductionHigh performing companies have even higher performing boards of directors. A great board vastlyoutperforms a good one in a growth stage technology enterprise. There are several reasons foramplification of the board’s workings.One is the largely self-regulating nature of the directorate. Second is the strong positive feedback withinthe board and in its relationship with executive management. Third is the velocity of change intechnology and competitive ecology. These dynamics combine to make the composition, operation andleadership of the board of directors a principal lever for building and sustaining value.Growth stage technology companies face distinctive governance challenges as they work to optimizevalue creation and competitive strength. Risk tolerance and risk management has to suitable to thecompany’s stage of development.The pace of change in a growth stage technology business requires agility even when the directors areuniformly strong, group dynamics efficient, and interaction with management effective.Building an outperforming board starts with choosing the right people, training them well, and ongoingrenewal to achieve peak output. Next comes establishing a culture of excellence, both within the boardand in the directorate’s interaction with management. And, finally, superior results come frommaintaining a coherent set of interacting practices which evolve at the speed of the business and itsenvironment.PeopleThere is no bigger driving force in the performance of the board than the quality and commitment of itsdirectors. Directors should be:• Voracious readers, who keep current, and take in enough data to be able to develop an informed, independent point of view about the company’s circumstances. They need this basis to form their © David J. Litwiller, 2012 1
  • 2. own expectations about what constitutes strong decision processes and results, and to develop ideas which can augment those of management;• Prepared, for discussions and deliberations. Consistent preparation delivers a direct benefit by maximizing productivity. It also sends a clear signal to management about the expected standard of performance;• Have time and give it priority. Each director needs to dedicate a minimum of 250 hours per year to the company. Audit committee members and the chairman can require as much as 450 hours per year. The hours spent outside of the boardroom in preparation should match at least two to one the hours spent in full board and committee meetings. A director’s board responsibilities have to be a personal priority;• Strongly competitive in expectations for the business, but balanced with integrity. The best directors have a powerful desire to be associated with a winner, and want to push themselves, each other, and executive management to deliver the full potential of the enterprise. At the same time, they have internal governors so that aggressive, considered pursuit of the highest output does not tip over into underhandedness or willful blindness that becomes corrosive to the long term capacity of the business;• Optimistic, tempered with relentless skepticism, a dash of paranoia, and unwavering belief that the business can always be improved. These individual and group characteristics expunge complacency. They keep up a culture of spirited inquiry and open debate in the boardroom;• Tolerant to risk, matching the business’ stage of development and competitive environment. There can be no liability paralysis. The directorate has to constructively and rapidly move forth in the face of the uncertainty inherent to the stage of development and the environment of a rapidly growing technology-based business;• Collectively knowledgeable, so the board in aggregate knows enough about the key drivers of the business in all of its most impactful respects to be able to provide constructive input to the executive on the most substantial issues. Aggregate breadth and depth is also necessary to be intolerant of weak facts and arguments that may be presented by management, auditors or consultants in error, let alone to justify omissions, specious actions or overly expedient thinking.These traits set the foundation for superior leadership from the boardroom. From this basis, rapidadaptability is most easily achieved as the board keeps its composition and operation at the fore of adynamic business. © David J. Litwiller, 2012 2
  • 3. Advancing and Renewing the BoardThere are several contributing facets to helping provide the right skills at the right time and with low riskto keep the board evolving to fully support the needs of a growing business:• Develop an ongoing pipeline of director talent. There needs to be continual identification of the skills that the board should be looking to add or augment, not last minute heroics responding to a trigger event. A rolling effort to assess current and forward looking skill gaps forms the basis for routinely developing a short list of candidate directors. Better candidate directors will be interested in joining when they see an orderly, ongoing effort to attract talent.• Balance candidate origination. Candidates should be nominated by all board members, including the CEO. There has to be balance of origination between CEO’s choices and those of outside directors. Doing so avoids the all too common case where the CEO’s nominees are acclaimed when times are good, whereas outside directors’ choices are when the business isn’t executing as well. Particularly with the self-interest of the CEO’s assessment and remuneration being decided by the board, consideration of the CEO’s nominees needs to be evenly considered with candidates from other board members.• Resist path dependency. Directors can be inclined to bring on new directors just like themselves, creating path dependency where the future resembles the past. A counteracting measure in director assessments and skill gap profiling is to require directors to identify gaps and shortcomings of the current directorate. It can be helpful too to periodically gain outsider perspective on changing skill needs. Doing so helps ensure different kinds of people are recruited as new board members to keep the board evolving with the company.• Reference-check candidate directors in person, not through a headhunter and not by electronic correspondence. Past associates of candidates will often hold back through headhunters or electronic inquiry because of litigation risk. Reference discussions need to take place face to face between current directors and collaborators of nominees to gain the most unfiltered feedback possible.• Be wary of narcissists as candidate directors. This personality type can be very successful in an operating role through a complex mix of charm, bullying, single-mindedness and self-aggrandizing. Such people often attract a lot of media attention. A significant portion of successful entrepreneurs and business leaders in technology are of this personality type. As such, these peoples’ names often come up as prospective directors. But in general, they neither criticize themselves well nor accept criticism from others. A board member has to be able to capable of self-criticism because of the self-regulating nature of the body. Moreover, narcissists are frequently unable to consistently exert the kind of influence on management or the board to activate the complex alchemy of how this personality type leads well in hands-on situations. There are rare circumstances where several narcissists on a board push each other competitively to positive effect, especially to help advance © David J. Litwiller, 2012 3
  • 4. the company with networking and introductions. But, the path of stability is very narrow where these kinds of motivations and contributions are productive. Narcissists are usually best avoided as directors.• Get beyond the skills matrix, to find directors who can be independent thinkers and can disagree constructively. Directors need to be cohesive most of the time, but still able to be contrarian without going so far as to routinely become lone wolves.These techniques and orientation give the board the best opportunity to renew and adapt at the speedof the company and its environment. A related challenge can sometimes be how to handle lowperforming directors.Identifying Weak DirectorsIn boards of established companies, the drive for high performing individuals and group interactionoften comes down in part to knowing who the weak directors are and doing something about them.Identifying the weakest or highly conflicted directors is usually straightforward. Typically they’resycophants who always parrot the prevailing opinion or a stronger personality on the board, narrow inviewpoint to the extreme of taking energy away from others, or those who are visibly in over theirheads, unprepared, unwilling or unable to engage directly in difficult issues. Or, they may just expresssuch strong bias or have outside relationships to promote detrimental courses of action. These traitsmake other directors highly apprehensive of bias and thus tentative about adopting offered viewpoints.Strong directors advance the collective discussion at each turn; weak directors take it sideways,backwards, in oblique directions, or simply contribute little to the dialog.More complex weaknesses to identify in directors are those which only become clear when summing upthe individual’s impact over a significant number of meetings, issues, and time. There is no substitutebut for attuned chairmanship to identify these shortcomings as quickly as practicable.Below are frequent archetypes of weak directors from my experience which people can be slow toidentify, unless they know early what to look for. First are some general personality types of concern,then common background personas which often cause issues.Problematic Personality TraitsOver-Generalizing: One who generalizes an overreaching amount. “This must be like that”, can be oneof the strongest primitives in the human brain. Such a person’s experience may not be sufficientlytypical. This situation often arises from an investor, founder or observer of a past business in a relatedspace which achieved particularly notable success or failure. He is overly drawn to anecdotal examplesfrom those experiences. This person is then powerfully attracted to make the new emulate the past, or © David J. Litwiller, 2012 4
  • 5. repelled to keep the new away from any such resemblance at all cost, when such strong polarizationeither way is unsuitable for the business at hand.Would-Be Clairvoyant: Someone who assumes too early how complex situations are likely to play out,and then shuts out relevant information which limits thinking prematurely.High Pass Filter: The individual who is overly influenced by the last thing he heard or that happened.Happy Eared: One who suffers from selective hearing, usually with an affinity for good news, restrictingability to synthesize, question or comment in a balanced fashion.Scattered: The director whose input is fragmented, inconsistent or otherwise not actionable.Other challenges with director quality take the following common pattern forms of background andreputation:Frozen in Time Legend: The highly respected, retired founder or CEO of another company for whom thegame has passed by, or who exhibits a strategic blindness or overreaching leap of faith. Thiscircumstance is difficult to deal with because much of what the person says and does makes terrificsense. He often is charismatic, persuasive and highly regarded. But, there is an area of insufficientlyfounded confidence in present circumstances which he carries forward from the past. The mismatchdistorts strategic thinking and decision making. Often, the sheer force of effort when the person was aworking executive was enough to overcome this liability, or the competitive circumstances of hisbusiness were such that the leap of faith was sufficiently true. But, at a different time and in a differentsetting where the person isn’t working ninety hours per week steering and cajoling the business forwardto adapt at necessary speed, the blind spot ends up being debilitating. As a director in a changedcontext, the ability to assess and correctly decide the most pressing and generative issues iscompromised. This individual weakness can infect larger portions of the board if there is strongdeference among other directors because of his past success.Political Animal: One who achieved high station in his career more through sharp elbows thanexcellence in what he does. These people tend to politically charge the boardroom over time, making itharder to have the right discussions the right way. Defensiveness often grows. Dialog then gravitates tojustifying past decisions and actions, rather than ongoing renewal of objectivity and circumspectdeliberation with sufficient view to the future.Superficial Salesperson: This is often someone who has been successful in sales, but in situations wherethe success formula had already been substantially worked out by the time he arrived. Despite pastachievement, he struggles to make the cognitive leap to the more nuanced world of selling andotherwise building a market presence in a young technology company or in different functionaldomains. These people tend to be very good speakers, working a room very well and cheerleading.They can be equally harmful for moving sentiment off the mark for revenue growth and marketexpansion models that will position the business to perform best. © David J. Litwiller, 2012 5
  • 6. Uni-dimensional Technology Guru: He is enamored with the potential of the technology to theexclusion of providing reasonable judgment and governance in other functional areas. The most difficultform of this phenomenon is the technologist who shows balanced business wherewithal on routinematters, where his technology enthusiasm is held in check. But, his overreaching belief in technologybecomes overpowering at the time of deliberating the higher risk, higher consequence commitmentsthe business is making. Technology passion and optimism occludes other functional forces necessary forbalanced business judgment, when breadth of thinking is needed most.Later Stage Company Executive: One who is unable to transpose her experience to match the stage ofdevelopment issues the younger company faces. A common scenario is someone who leaned,restructured, or outsourced parts of a mature business at the apex of his career to great effect. Such aperson is usually very strong on dealing with incremental operating issues. But, she may struggle tocarry over the drivers or insights of that experience to a growth stage enterprise. At an earlier stage, keysuccess factors over the short- and medium-term are often much different.Another common form of the later stage executive shortcoming as director is someone who built muchof his career in a single functional area, and then assumed general management later on. In this caseusually much of the operating infrastructure of the business over which she presided was already put inplace by others. People from such backgrounds often lack the direct experience across a breadth offunctions at a sufficiently tactical level to be able to best help identify risks or opportunities for thegoverned business.Social Media Zealot: Someone who spends much of his time pushing himself out to his online presence,as well as keeping up with others’. He has little time or reflection capacity for larger matters. Whenpeople distribute themselves entirely out to the periphery, there can be very little left at the core forwhat really matters.On the whole, these kinds of shortfalls of personality types and background can be subtle to detect.Knowing in advance what to look for can help to pick-up on these weaknesses quickly. This helps whenlooking at new director candidates, evaluating directors, renewing the board, and deciding what targetskill profiles to seek with new director nominations. The chairman needs to be able to assess all of eachdirector’s contributions and actions over time to develop a total picture as rapidly as possible of who thestrongest contributors really are, to counterbalance any problematic effects of reputation orpersonality.See Appendix 1 for suggested approaches to deal with weak or conflicted directors.With the right directors, the capacity for the board to perform well is geometrically higher than withlesser raw material. Having the right people on the board allows matters to lastingly turn to doing themost constructive things in the best way possible. © David J. Litwiller, 2012 6
  • 7. Management Talent DevelopmentIn my experience, more than any other single area of board operation, the ability to develop executivetalent in a high growth technology business reflects most informatively upon the real quality of theboard as a force for excellence and resiliency.CEO performance feedback needs to be routine. CEO performance should be discussed at everyexecutive session accompanying regular board meetings, as well as more formal semi-annual reviews.All too often, CEO evaluation is the item that gets pinched for time. In addition to regularity, feedbackto the CEO best occurs right after each executive session. It should be delivered by two directors so thatcriticism is less likely to be received as an axe being ground by one delivering director in case the CEOwould presume that such sentiment not be more broadly shared by the rest of the board. Thecautionary motivation for regular feedback is that in situations where the board is unwilling or unable toprovide enough of it, what tends to happen over time is the board comes to harbor apprehensionsabout the CEO that it is not voicing and managing. When that occurs, a loss of confidence can take holdleading to inefficient divides among the governance and leadership. Methodical performance feedbackto the CEO helps the board achieve the right balance to provide constructive feedback and positivetension routinely, while not usurping the authority of the CEO. Lapses in CEO performance feedbackoften sow second guessing or back channel manoeuvers to develop counteracting measures or evenshadow contingency plans.There are several techniques to help CEO performance feedback take place, in the most productive way:• Designate a director who is responsible for the process, even though the whole board contributes;• Perform semi-annual formal evaluation, starting with self-assessment by the CEO for the past half year delivered to the board in writing, and plan for both the six months ahead and full year;• Have the board evaluation start with a survey of open ended questions to be responded by each director qualitatively, as well as each question having a quantitative rating scale. This helps compare board members responses and quickly pick up on where differences lay which can be the most revealing areas for further discussion;• Evaluate not just financial results, but also organizational agility and adaptability, morale, R&D effectiveness, customer satisfaction and preference, and the company’s outward image;• Resist retroactive lobbying by the CEO for softer targets when the past period has been tough;• Use executive discussions in part to talk about how performance criticism will be delivered to the CEO.CEO succession planning, covering both emergency situations and planned transitions. The half-life ofthe CEO of a growth stage technology company is about three years. As such, CEO selection and © David J. Litwiller, 2012 7
  • 8. management is one of the cardinal responsibilities of the board of directors. The credibility and capacityof the directors to manage enterprise risk can be significantly measured by their ability to plan CEOsuccession, and related matters of broader executive management development.The board has to have an ongoing dialog about succession planning. Directors should collaborate onwho would take the reins in a sudden crisis, and who the promising senior managers are to potentiallyassume the leadership under a planned transition. Even when the business is performing well, thevelocity of change can require rapid CEO change, let alone unexpected debilitating health changes orintegrity breaches.The board should redouble its succession planning efforts when there is evidence of character issueswith the CEO. The main ones indicating trouble are if the CEO sticks with trying the same solutions thathave been of limited effectiveness in the past, always thinks he has the answer to problems, issuperficial, or where he exhibits seeing himself as smarter or better than others. Such characterdeficiencies are difficult to correct through performance appraisal and feedback. Change may beneeded. Other areas which signal a growing likelihood of renewal is if the CEO is distracted, hurtlingwithout control, caught up in excessive hype, unable to focus on the most important things, committingprematurely to major investments, or inclined to make matters overly complex.Succession planning for the CEO position tests the mettle of the board to exert the right kind ofinfluence, as much as any of its other responsibilities. Selection and continuation of a CEO is a verypersonal and emotional one for the directorate. The board needs to collaborate with this manager on arange of matters. There is often a dual board chairman and CEO. The CEO may be a founder, and theCEO is often a major shareholder and a persuasive leader, as well as influential person in theenterprise’s industry. Nevertheless, loss of momentum from poor succession contingency planning canbe disastrous, yet all too common for more weakly governed companies. The board delivers outsizedimpact through a disciplined and multi-faceted CEO succession dialog.A further derived benefit of regular CEO succession planning is that it reminds the senior executive thathe is not above reproach, as no one should be with fiduciary responsibilities. Explicit evaluationprompts better behavior, adaptability, and humility. Done well, preparation for CEO succession servesto lower not just the negative impact of succession events, but also in an anti-fulfilling way, to reducerate at which they need to occur.Get to know the managerial up and comers, taking an active role with the rest of the executive and highpotential management. Interacting with the CEO’s reports and high potential managers provides mutualfeedback and awareness, complementing the board’s more regular interaction with the CEO and CFO.Directors can then contribute to mapping out and shaping those who can grow into significantly broaderroles. Typically a two year planning horizon is the appropriate time frame in a high growth technologybusiness – long enough to do planning for key management personnel, but still short enough for currentcircumstances and people have predictive value. The board should provide guidance and input on theassignments the high potential individuals receive, and keep up with follow-on performance evaluation.In the normal course of activity, it is good to have executives other than the CEO and CFO deliver © David J. Litwiller, 2012 8
  • 9. presentations during a minority portion of each board meeting, so that the directors get to know them,and get a more detailed view of parts of the business. More important though is that directors have theopportunity to interact with other management outside of the formal board proceedings, such as atscheduled dinners afterwards. More social settings foster a freer form discussion to get to know thesepeople and exchange ideas about operations, culture and competitive standing for mutual benefit.Boardroom DynamicsSeveral techniques, practices and protocols help boost board productivity:• Education and rapid onboarding of new directors in a structured process so that they contribute quickly and well, helping set the tone early about the standard of performance to which the board holds itself, the executive team, and the rest of the company;• Regular executive sessions. These meetings of directors, without those in management or observers present, are one of the most significant and lasting practices to improve board governance. There should be an executive session adjacent to every regular board meeting. Regularity prevents their occurrence causing the CEO or other executives to take issue or raise acute apprehensions about why one is occurring. Sometimes it is best to have two briefer executive sessions with each regular board meeting. With two, one takes place right before to identify issues that have come up in the course of reviewing reading packages or other late breaking developments which need to be raised at the board meeting. The other occurs right after the board meeting while recollections are freshest to gain feedback about the quality of the meeting, improvements for the next, or concerns to be raised with management about performance or risk management. The agenda for these sessions should always include management performance along with whether the board is spending its time on the right things and with the right information. To keep executive sessions at top vibrancy, it is often helpful to change or at least rotate the format to allow different perspectives on major issues to come out. If these sessions are always run the same way, they can tend to fall into a routine pattern which can develop blind spots and miss important signals. Executive sessions with some variation help the board to detect, question, and act most suitably.• Advance distribution of reading packages. Reading packages need to be delivered to board members well before each meeting. At a minimum they should be received three days ahead of each, and more appropriately one week. Directors need time to consider the materials, issues, and central questions to be most productive at the meeting. The reading package should include all of the presentation materials to be delivered at the meeting, so that the time in session can be dedicated at least 50% to discussion.• Prior identification of the main issues to discuss. The reading package should have a cover memo from the chairman, developed collaboratively with the CEO, indicating which items will be discussed in depth at the upcoming meeting, and which items are informational only. As well, there should be © David J. Litwiller, 2012 9
  • 10. companion cover memos from the CEO and CFO indicating the most pressing opportunities, issues and worries they face to guide directors’ preparation, as well as management’s recommendations on major issues to be decided. Potential changes in strategic goals and objectives should also be indicated.• Minutes showing fiduciary duty of care. All board members are responsible for and entitled to minutes which convey not just decisions, but fiduciary duty of care. The mere existence of meeting minutes is insufficient to show duty of care. Minutes need to reflect enough diversity of opinion to substantiate that directors carried out their fiduciary responsibilities. Vanilla, decision-only minutes do not. There is though a larger reason for having minutes showing ranges of options which were considered on major issues. It is that minutes showing diversity of consideration serve as a kind of time capsule chronicling board conduct which can be observed by others, now or in the future. Almost always bodies under study, or under prospect of future study, behave better than if they are not. Vanilla minutes that portray simplistic unanimity or overreaching brevity fail in this essential regard. They show a lack of confidence, and signal fiduciary and strategic weakness. At the same time, minutes need not be written so that everything sounds like a contested decision. But, they do need to show variation of consideration. Nevertheless, simplistic minutes that mostly show only decisions are often advocated by directors hoping for a quick flip of the business or who envision idealized downstream financings so there be little in the board minutes to slow down transaction due diligence. This line of reasoning only holds up in situations of intense deal heat, which is exceptionally rare. Good buyers and future investors will do thorough due diligence. If there are underreported issues, they will usually surface in the course of the acquisition or investment research. Furthermore, vanilla minutes themselves serve as a warning sign to prospective financiers or buyers. Overall, the self-regulating benefit of board meeting minutes showing fiduciary care far outweigh their cost for the way they contribute to the right behaviors and responsibilities and signal the same to others to enhance value.• In person meetings. Telephone or online meetings are ok for final votes, where the facts and arguments have been worked through in person, and all that remains the decision. Telephone meetings are poor when issues are at a less developed state, when reading emotions and gestures is important to maximize communication and collective intelligence.• Antidote groupthink. Management teams often fall into groupthink. It is thus crucial that the board not become tone deaf to new ideas or interpretations. The directorate has to preserve ongoing capacity to play devil’s advocate in fundamental strategic dilemmas, particularly those that go on for extended periods of time. The board should be willing and able to ask anew about past decisions and current escalations of commitments, and not fall victim to herd dynamics. The board © David J. Litwiller, 2012 10
  • 11. should constantly seek better, actionable information and knowledge and be willing to change course when the data is persuasive.• Sharing the load of criticism and taking hard stands on controversial issues. Group dynamics within a board can lead to an overreliance on one or a few individuals to ask the hard questions, which changes the self-expectations of other directors to be as energetic and catalytic. When this dichotomy persists, it impairs the functioning of the board. It is far better to keep the full directorate on their toes and moving forward by distributing the leadership of the individual who will press on sensitive or controversial issues. Task leadership is usually worked out during executive sessions or pre-meeting discussions between the chair or lead independent director and other directors.• Collegial, but stopping short of being so cozy on a personal level as to be impeded from speaking up with alternate viewpoints. Within collegiality as it applies to a board is the capacity for individuals to disagree, without being disagreeable. This characteristic in all directors is essential to being able to work together well yet still bring out enough range of viewpoints to sufficiently mentor, support, and challenge management over time and changing circumstances.• Asking good questions, rather than telling management what to do. Didacticism eviscerates management and should be reserved for crisis circumstances which require directors to dictate actions to carry out their fiduciary responsibilities.• Fast and agile. In addition to the smallest board size reasonably possible, minimizing the number of board observers helps speed up cycles of action. While board observers are not entitled to vote or participate in executive sessions, they are free to participate in the regular discussion. As the number of voices in the boardroom increases, especially from those who do not share the same breadth of responsibilities as voting directors, it becomes more challenging to get all perspectives out in a timely fashion, and to reach consensus.• Periodically hold board meetings at significant remote sites of operation if those sites are distant from headquarters. There is no substitute for seeing in person what goes on in a core operation to get a sense for how things are going. The way to help the board members see for themselves is to periodically hold meetings at those sites. This also allows management at remote sites to more easily interact with the board for mutual edification.Risk ManagementUsually, the most important aspect of risk management is the board regularly and honestly confrontingwhether the company is pursuing the right strategy, and in the right way. This is about more than howthe business is performing with executing the current strategy. It comes down to periodically retesting © David J. Litwiller, 2012 11
  • 12. whether the strategy is the right one. High performing growth stage boards spend about 80% of timegauging and improving current strategy, and 20% looking more fundamentally at the assumptions,dependencies and adjacent possibilities underpinning the selection of the best strategy. This way, thecompany can best keep up with the fitness required to stay ahead of the competitive landscape in whichit operates.The board needs to be the force for periodically articulating and rearticulating the biggest assumptionsand dependencies upon which the business is based. This applies to financial, strategic, technological,and personnel dimensions. It further extends to understanding the next best alternatives for each majorcourse of action. To detail embedded assumptions and dependencies with sufficient care usuallyrequires some scenario planning about what kinds of conditions would signal for alternate paths, and inthose cases, what information would be needed and actions taken.Such an understanding of the underlying structure of reliance allows the board has to maintain a clearand up-to-date view about which activities are longer shots, toss-ups, and nearly sure things. Beingobjective like this about risk, reward, and probability is a discipline. So is the related matter ofconstantly seeking how to quickly and most cheaply get better data and better odds. Part of the skill ofbeing data-driven for best impact is the art of selecting the right data by which to be most influenced. Afurther part of the craft is insisting on reference class analysis for the most significant risks, and notmerely internal estimates. In particular, objectivity in strategy and execution requires circumventingthe trap of letting anecdotes or superficial arguments overly influence directors. With more statisticallysignificant data, the board can then better establish the risk level and appropriate localized strategy forpivotal endeavors.A frequent form of risk management is having defined stop thresholds. They help prevent themomentum of history from being overly influential. Commitment limits require defined, quantitativeand written success criteria for major investments. Thresholds help prevent people from drifting awayfrom more rigorous criteria. People can otherwise overly revise their goals, even to the extreme ofcontinual variation along the lines of “we’ll know success when we see it”, rather than making awholesome effort to define success beforehand. Of course, the board needs to adapt the measures ofsuccess as significant information comes in, and be willing to alter course. But in total, the directoratehas to be objective about not adapting the measurement standard without a sufficiently valid basis.There are a few other areas which are most impactful for maximizing the success profile of growth stagetechnology businesses from the boardroom:• Provide vigorous scrutiny about whether significant investments are premature. If they are, it signals overconfidence in the company’s business plan. Such commitments represent unnecessary execution which typically slows and otherwise harms the business with reduced flexibility. Premature scaling is the leading cause of preventable difficulty for growth stage technology businesses. The board’s influence to govern scaling is of outsized benefit to lift the likelihood of such investments being appropriate to the risk and stage of development. © David J. Litwiller, 2012 12
  • 13. • Keep an eye on customer satisfaction and customer preference ranking. This requires cohort analysis showing how fast the company is really improving relative to its competitive environment. A balanced view of customer sentiment also means getting not just quantitative measures, but also qualitative ones such as periodic reviews of major lost orders, up-sell opportunities, support calls, and renewals to fully see the picture of customer behavior.Other risk management issues are more of a routine checklist nature:• Major prevailing laws, domestic and foreign, and any recent legislative or enforcement changes• Securities rules• Industry-specific laws, domestic and foreign• Better practices for corporate reputation and company brand management, including public- and media-relations• Financial risks• Related party transactions• Fraud• Bribery and corruption, and not just more spectacular possibilities with entities like representatives or affiliates of foreign governments, but closer to home things like purchasing managers getting kickbacks from suppliers, facilities managers receiving compensation from real estate brokers, and sales managers receiving unapproved compensation from channel partners• Export restrictions• Disaster planning• Product and service liability• Health and safety• Environmental protection• Insurance• Information technology systemic risk © David J. Litwiller, 2012 13
  • 14. • Intellectual property management, protection and enforcement• Employment practices and morale• Family members of executives on the payroll• Human rights practices• External stakeholder relations, including investors, relevant government agencies and programs, lobbying groups, industry associations and standards bodies, and, leading academic and research institutions• Defined and widely understood lines of communication from staff to management and the board about risk management• Staff and management training about risk management• Board training about risk managementChairmanshipSimilar to the outsized impact of key playing positions in team sports, board output is greatly enhancedby strong, engaged chairmanship. The demands of chairing well are distinctive because it requiresleadership among peers.Board chairs need to lead by example in terms of preparation for board meetings, communication styleoutside and inside the boardroom, and their contribution to onboarding for new directors to contributequickly.The chair has a disproportionate influence over creating an environment where the CEO regularly andopenly discusses next milestones, and as results come in, what is working, and what isn’t. This line ofdiscussion should then extend to what factors will be most significant going forward which are presentlyweakest, least understood or subject to varied interpretation. From there, the chair moves the focus onto what can be done to improve or gain quickest, high quality data to better inform interpretations anddecisions. This then allows the board to weigh in with input on how to improve or structureexperiments that will best reveal how to rapidly improve.The chairmanship challenge of rapid learning and discussion is often if too much advice comes back fromthe board, especially an overwhelming amount of contradictory advice. Incompatible advice muddiesrather than clarifying priorities and objectives for executive management. The chairman needs toharness the energy of the board’s input to provide a coherent range of ideas to the CEO, in order tokeep up effectiveness of the board. The chairman also has to help the CEO keep the board up to speed © David J. Litwiller, 2012 14
  • 15. on which ideas are being pursued and which ones are not so that misunderstandings do not developwhich tend to harm trust and communication.A corresponding piece of the chair’s communication challenge is that he plays a key role in the methodby which executive management presents to the board for input. Strategic options need to be deliveredas a range of possibilities, along with management’s preferred course. This gives the board room to givemore than yes-no feedback, but not so many choices as to be unwieldy.The chair also influences the contents of the reading package which is distributed before each boardmeeting. He identifies major items for discussion in collaboration with the CEO, to help direct directors’preparation.One of the biggest structural influences of the chair is the agenda for each meeting, as it largely shapesthe discussion. The agenda should be developed collaboratively with the CEO and with input from otherdirectors. Explicit time parameters should be noted. Each agenda item should indicate whether there isclear decision intent at the upcoming meeting, or whether the matter is informational only.During a board meeting, the chairman should have a parking lot list for issues that are important, butwhich need to be followed-up later. This keeps time and discussion on track for the most pressingmatters, without losing sight of important ones to be dealt with subsequently.The chair also plays an outsized role ensuring the flow of information from individual directors andboard committees to the full board, as well as to management.In the board meeting, the way that the chair guides the discussion and solicits the input of individualdirectors is yet another lever for achieving high output from the group. It starts with the chairforeshadowing major points of discussion. Then, the board’s role in a particular issue need to bedefined, as well as work that has come before by the board on that matter. The chair should indicatewhat is needed from the board now. The right steering influence continues with ensuring the input ofall directors, particularly on major issues approaching decision. Furthermore, the ability of the chair totreat board deliberation holistically, by periodically weaving themes together, helps build a sense ofoverall purpose that is greater than any one issue or individual.As well, there is a larger suite of techniques which have been analyzed and recorded which serve aspreferred practice for the chairman to help get the most out of each director and contribute toconstructive group dynamics.These methods are borrowed very directly from the outstanding work of Katharina Pick, as described inthe chapter she authored in the book Boardroom Realities.1• The tension the chairman needs to actively manage is that individual directors are often appointed for their individual talents, and typically recognized by themselves and their director peers as such. This is where they and others expect to make greatest contribution. But, the directorate needs to1 http://www.amazon.com/Boardroom-Realities-Building-Jossey-Bass-Management/dp/0470391782 © David J. Litwiller, 2012 15
  • 16. operate as a team. Thus, the chairman needs to both harness each director’s special expertise, as well as drawing them out to contribute to a broader set of issues facing the board, and not let input become too narrow. The chairman pulling people to contribute beyond their power zone of expertise liberates directors from negotiating status and ambiguity within the group to comment more broadly, reducing the sense of posturing and frustration that can otherwise take hold.• Separate observations from inferences and assumptions.• Encourage direct proposals, rather than oblique or disguised ones.• Provide enough time for debate, at the same time as keeping digressing directors from taking up inordinate time by indicating when it is time to move on.• For stressful or controversial issues, to keep discussion from spiraling out of control by converging with a summary and defining future board actions in order to move ahead.• To bring everyone into the discussion through polling. Polling reinforces a sense of collective effort rather than individuals jockeying for position. Getting everyone involved also helps ensure that the board’s work is largely done in the boardroom, rather than in sidebar conversations.• Call on particular directors where their domain expertise is much greater than others, alleviating others of that burden.• Ask directors to pose second or even third follow-up questions on the most controversial issues.• Ensure unity in front of management. A significant contributing factor to a coordinated approach with management is by keeping conflict at a task level, rather than at a board or interpersonal level. Board chairs often do this by framing individual directors’ input in the context of their expertise, and summarizing points of disagreement along with areas of consensus. Doing so makes disagreement acceptable, rather than being seen as a sign of failure with expanding tendencies.• Insist upon confidentiality about what goes on within the boardroom. This builds trust, which is the only way to sustain open dialog.• Build bridges between competing points of view, particularly those between the views of the board and those of management. Doing so through providing context helps keep channels of communication with management open. Those communication pathways need to remain strong, since the board relies upon management for so much of its information.• Handle conflicts of interest. Conflicts are not intrinsically bad, within reason. They are often a reflection of having suitably knowledgeable directors. The greater issue on routine conflicts is that they be addressed directly and appropriately by the chair. © David J. Litwiller, 2012 16
  • 17. Midway between meetings, the chairman should have a business update call with the CEO, to keep theCEO and chairman in sync by mutually reducing information asymmetries.SummaryThe impact of the highest performing boards of directors is vastly greater than the merely good. Thedisproportion of positive impact is very high for high growth technology companies in the midst ofconsiderable environmental uncertainty.There is no shortcut to quality. The board can only be as good as the quality of each individual directorand the time he or she dedicates to performing to his full individual and collective potential.There is a large productivity impact from a thorough and balanced process for identifying skill gaps,candidate directors, and then onboarding and training new directors. Keeping the board size as small asis reasonable also boosts efficiency. While prevention is better than cure, the ability to remediate orexcise weaklings is usually part of the real world of achieving and sustaining superior leadership in theboardroom of established businesses.The rapid pace and evolution for a growth stage technology business means the board needs to work asfast and evolve as rapidly as the rest of the enterprise. There is no substitute for hard work, a significanttime investment, and a commitment to frequent dialog to achieve the right dynamics.The board chair plays an outsized role in delivering the full potential of the board through his actions,thinking style, communication skill, ability to discern signal from noise, pace of progress, and structuredapproach for how to conduct different interactions with other board members and senior managementto best effect. © David J. Litwiller, 2012 17
  • 18. Appendix 1Dealing with Weak or Conflicted DirectorsConsistent high performance from all directors is obligatory. At the same time, speed and agility of theboard is best served by keeping it as small as possible while still having enough capacity and diversity ofskills to meet the company’s stage of development needs. For a growth stage technology business, theright size of board is usually five to seven directors. In a board of this size, there is no room for non-performers. Lagging directors need to be dealt with quickly and decisively.More often than they should, people try to dilute the impact of an underperforming director byenlarging the board. This is rarely a good solution, nor is trying to manage around individual liabilities byother directors and the chairman.Where a weak director has skills or attributes of ongoing value to the enterprise, he can be moved to anon-fiduciary, advisory board role to provide select input to the board and executive as needed.Alternatively, he can become a paid consultant to the company, with the scope of activity and form ofengagement tailored to the situation.That said, getting rid of a poor director can be much harder than getting rid of an employee, even asenior executive. If an independent director is weak, unlikely to change ways, or has not improvedenough despite explicit feedback from the chair to do so, then he has to be asked to leave. To move himout in a timely fashion and without further dispute if the director resists resigning often comes down tomoney. A typical settlement to reach an expedient outcome is the outgoing director receives half thecompensation he would have over the upcoming year as a consulting fee to the board, in exchange for avoluntary, prompt resignation.Sometimes, removing a weak director is complicated by his being a significant investor or fiduciary of aninvestment vehicle with rights to one or more board seats. In the case of a significant individualinvestor, he can sometimes be encouraged to step off the board if there is a sufficiently strongdirectorate in place apart from him, or candidate independent director to replace him. If he expects toretain his shareholding substantially as it is, placing his shares in as voting trust so that he rescindsfurther voting influence is often the preferable outcome to achieve a clean break. Where a voting trustis used, care is needed about who acts as the trustee and the way he does so as there can be conflictswhich arise and subsequent risks. The advice of competent legal counsel is needed when contemplatingthe use of a voting trust or any similar structure.In the case of an investment fund representative who needs to be removed, it is usually necessary tonegotiate with his overseers at the investment fund to arrange a stronger alternative appointee. Whenthis delicate conversation needs to occur with investment fund senior management, clear evidence ofpoor performance by the current appointee and a considered short list of prospective replacementdirectors can help move the change dialog forward. © David J. Litwiller, 2012 18
  • 19. Appendix 2Financial Monitoring and ReportingThe quality of governance is largely mirrored by the board’s financial monitoring and oversight. Strongfinancial governance on its own is not sufficient, but it is a necessary contribution for a high performingboard of directors. Durably high performing companies always have attentive audit committees that aremeticulous, challenge, and advocate improvement in specific and actionable ways.The first priority to lift performance is through the quality, credentials, independence and periodicrenewal of the company’s outside auditors. Second is the performance of internal auditors. Third is tobe clear about what accounting regulatory compliance and legal standards are being used, theinterpretation of those standards in the company’s circumstances, and the classification of thecompany’s financial entries into those frameworks. The next ingredient for sound financial governanceis testing the suitability of the assumptions, interrelationships, categorization and major entries duringeach reporting period.The following is not an exhaustive list, but it describes the areas which I find most informative from afinancial governance perspectives:• Revenue recognition, especially where there is an ongoing service stream accompanying product sale, entitlements to future upgrades, or complex vendor-customer arrangements. Contract terms conferring rights of refund, return or discount need to be understood, as does the existence and nature of any side letters furnishing the similar rights. Side letters are common in Germany, Japan and many eastern European nations. Allowances related to accounts receivable, defaults and bad debt are a related area for attention;• Capitalization of expenses, including sales commissions and R&D. Such capitalizations can have significant implications downstream if there are impairments, especially if management or the board becomes reluctant to make competitively necessary changes in order to preserve the appearance of the value of past investments on the balance sheet.At a higher orbit, ongoing oversight and testing needs to occur regarding:• Suitability of the company’s capital structure relative to its risk profile and stage of development, keeping conflicts within the capital structure and fiduciary roles within reason, and maintaining sharp focus on delivering returns above the company’s cost of capital;• Equity documentation and tracking, including stock-based compensation, with a sound process for establishing valuation and expensing, tax treatment for deferred compensation, as well as grants, expirations and cancellations.Growth stage technology companies which gloss over these matters often encounter downstreamdifficulties which can restrict access to capital and talent, or harm valuation. Providing strong oversight © David J. Litwiller, 2012 19
  • 20. in these areas frame much of the audit committee’s and board’s work to provide good oversight andinput in other areas of financial and general management.The following is a more advanced list of financial monitoring and reporting concerns:• Productivity performance and trends, relative to payroll and headcount;• Working capital, efficiency in general and particularly cases where working capital requirements are growing or could grow faster than the business;• Gross margin, showing the impact, significance, competitive differentiation, and scale efficiencies of the company’s products and services.Other areas to keep an eye on:• Hedging transactions, derivative transactions, embedded derivatives and foreign exchange fluctuation exposures, as well as swap and barter transactions;• Depreciation and amortization calculations;• Recorded asset values, especially where there may be a tendency to use higher market than cost values, including property, plant, and equipment. Inventory can be a frequent source of issue, as can testing and impairment of goodwill;• Summary of write-offs;• Accruals and deferrals;• Recognition of government tax incentives and funding programs;• The use of estimates and the way they are established using internal and external benchmarks;• Total reserves, major reserve components, and reserve fluctuations from period to period which are altering the numbers;• Higher risk cash investments, such as corporate bonds rather than government treasuries, money market and bank deposits;• Regulatory compliance, starting with accounting body compliance such as IFRS or GAAP. If an IPO is in the offing, financially related regulatory awareness needs to extend to Sarbanes Oxley compliance or its foreign parallels, and sometimes beyond; © David J. Litwiller, 2012 20
  • 21. • Internal processes and controls, accounting IT system capabilities and limitations, as well as general IT security;• Cost of perks that have grown up since the company was small;• Restructuring charges;• Transactions which individually may not be material, but in aggregate are.To do the best work, the audit committee of the board needs to follow the cash, and not be misled bynet income or any other single measure of financial health. It should always ask if the financials arebased on reasonable assumptions, and if the assumptions are being tested and updated with currentdata. One of its most strategic contributions is to help see that the pace of investment is matched to theattainable growth of revenue and profit, so that the business invests sufficiently to capture the highestquality portion of its growth potential, but not commit too much or too early which puts the business atundue risk of financial and strategic harm as conditions change.This audit committee and board need to strive to have the accounting be crystal clear, with a bareminimum of one-time charges. Unusual accounting can temporarily make a company look better than itis, but it will rarely make the company better than it is and if so done usually achieves just the opposite.Great boards and their audit committees work to keep the company’s financial structure and reportingmost fairly representing the company’s real operating condition as the basis for sound decision makingby management and the board. © David J. Litwiller, 2012 21
  • 22. About the AuthorDavid J. Litwiller is an Executive-in-Residence with Communitech, based in Waterloo, Ontario. Hisbackground is in wireless devices, precision electro-mechanics, semiconductors, electro-optics, MEMS,biotech instrumentation, and enterprise software. His work spans functional and general management,as well as governance of growth stage technology businesses. He serves as an advisor to various privatecorporations in matters of strategy, technology, operations, finance, governance, and businessdevelopment. Mr. Litwiller is the author of the book published in 2008, “Rapid Advance - Mergers &Acquisitions, Partnerships, Restructurings, Turnarounds and Divestitures in High Technology”.Dave can be reached at dave [dot] litwiller [at] communitech [dot] ca. © David J. Litwiller, 2012 22