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Being an Effective Director

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Guidelines to being an effective director of a private company: "Coach, Confidante, and Killer." Taught at VCI 2008.

Guidelines to being an effective director of a private company: "Coach, Confidante, and Killer." Taught at VCI 2008.

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  • 1. VCI 2008 Being an Effective VC Director: Coach, Confidante, and Killer Stephen Fleming Chief Commercialization Officer <fleming@gatech.edu> Member of Investment Committee The Seraph Group <http://www.seraphgroup.net> © 2008, Georgia Institute of Technology
  • 2. Stephen Fleming • 13+ years venture capital investment experience. –General Partner, Alliance Technology Ventures. –18 investments as lead investor, 15 exits to date. • BS, Physics, Ga. Tech (Highest Honors). • 15 years operational experience at AT&T Bell Labs, Nortel, LICOM (venture-backed startup). –Supervised startups developing first ADSL modem and one of the first cablemodems in early 1990s. • Multiple advisory boards at Georgia Tech; endowed chair in telecommunications; occasional instructor in MBA entrepreneurship program. • Strong regional technology leader. 9/17/2008 Being an Effective VC Director 2
  • 3. • The Fundamentals • Board Responsibilities • CEO Relationship • Other Board Relationships • The Mechanics • Difficult Times 9/17/2008 Being an Effective VC Director 3
  • 4. “All happy families are alike; each unhappy family is unhappy in its own way.” –Leo Tolstoy, Anna Karenina 9/17/2008 Being an Effective VC Director 4
  • 5. Board Composition • By the time a company has attracted venture capital, the board will consist of: –Usually one or more VCs –Usually one or more founders/C-level execs –Ideally, one or more outsiders • Potential problems: –Family members of founders –Well-meaning but irrelevant angel investors –Founders who are no longer C-level execs • May still be employed in technical capacity • May have left the company 9/17/2008 Being an Effective VC Director 5
  • 6. Board Size • Each round of financing will involve new lead investor(s), each of whom will want at least one board seat. • Other syndicate partners may want observer seats. • Mechanics of scheduling and maintaining open communication break down when you exceed 7 members • 16-member boards are fine for GE, but not for a startup! 9/17/2008 Being an Effective VC Director 6
  • 7. Odd or Even? • Conventional wisdom: You want to have an odd number of directors so you can never have a tie vote. • Reality: It doesn’t matter. –In “happy family” boards, all votes will be unanimous. If you’re down to counting noses to get a majority, you’re already in trouble. –Who’s to say that one member won’t be absent, or sick, or recuse himself/herself, or...? • Get the right people around the table. Don’t worry about odd or even. 9/17/2008 Being an Effective VC Director 7
  • 8. How Do You Get Paid? • You don’t. –This is your job. • Neither do the management team members. –It’s their job, too. • True outside board members (not investors, not management, not strategic partners) should be compensated: –Cash (usually limited to expense reimbursement) –Stock –Options –Company-paid D&O insurance 9/17/2008 Being an Effective VC Director 8
  • 9. • The Fundamentals • Board Responsibilities • CEO Relationship • Other Board Relationships • The Mechanics • Difficult Times 9/17/2008 Being an Effective VC Director 9
  • 10. Your Responsibilities • Very definite hierarchy: –All shareholders — Fiduciary responsibility –Your class(es) of shareholder –Your Limited Partners –Your partnership –Yourself • If you ever find two roles in conflict, the higher responsibility wins! • “Fiduciary responsibility” is a magic phrase... use it cautiously and with great restraint 9/17/2008 Being an Effective VC Director 10 10
  • 11. List of Responsibilities • Loyalty • Candor • Good Faith • Disclosure • Transparency • Confidentiality • Best Effort • Above all: Act ethically and honestly 9/17/2008 Being an Effective VC Director 11 11
  • 12. Board Committees • At a minimum, your board will have: –Audit Committee –Compensation Committee • May also have Executive Committee (especially as board size grows). • Various ad hoc committees will be established as needed to help the company. –May give you an opportunity to work with management team members who are not on the board. This is a Good Thing™. 9/17/2008 Being an Effective VC Director 12 12
  • 13. D&O Insurance • Directors and Officers Insurance used to be rare for private companies. –Purchased only in the run-up to an IPO. • Becoming more common in earlier-stage companies. –Usually just handled by the CFO... a mistake. –Policies vary widely. Alternatives should be explored by a committee of the board, and ratified by the entire board. –If the D&O doesn’t cover you for a stockholder or employee lawsuit, you may be personally liable. Ouch! 9/17/2008 Being an Effective VC Director 13 13
  • 14. • The Fundamentals • Board Responsibilities • CEO Relationship • Other Board Relationships • The Mechanics • Difficult Times 9/17/2008 Being an Effective VC Director 14 14
  • 15. Two Key Questions • When you walk into a board meeting, you should only have two questions: –Are we going to fire the CEO today? –If not, how can we help? –Al Paladino, Advanced Technology Ventures 9/17/2008 Being an Effective VC Director 15 15
  • 16. CEO Relationship • Critical that this relationship works well. –Significant part of CEO’s job. –Too many of them neglect it... thinking it only is relevant during the actual board meeting. Wrong! • Responsibility goes both ways –Coach –Confidante –Killer 9/17/2008 Being an Effective VC Director 16 16
  • 17. Coach • You’re not the CEO. –If you want to run a company, go get one funded. Until then, you’re there to advise and encourage, not run the show. –Especially difficult for VCs who have been CEOs in prior companies! • Make useful connections using your industry contacts. • Provide a different perspective. • Don’t hesitate to suggest professional development activities for the CEO. 9/17/2008 Being an Effective VC Director 17 17
  • 18. Coach: Perspective • Your key asset: –You’ve (hopefully) seen many more deals than the CEO, and you’re currently involved in half a dozen others. –You have a perspective that’s impossible for the CEO—who is 100% committed to this business. • What worked in other cases? What didn’t work? Why? • Other experiences: –How long can you take to make a decision? When does this become a critical problem? Who should you call? Where should you look? 9/17/2008 Being an Effective VC Director 18 18
  • 19. Confidante • Even happy families hit rough patches. • CEO cannot share all fears/concerns with employees... since the good ones may quit! • You have to be available as a sounding board. –On a moment’s notice. –In person, if humanly possible. –Preferably over coffee/alcohol/whatever. • Much of your value as a board member will be exercised at informal meetings like this, not at the actual board meeting! 9/17/2008 Being an Effective VC Director 19 19
  • 20. Confidante or Friend? • The obvious reality: We invest in people we like, and we don’t invest in people we don’t like. • It’s easy to become friends with the CEO. • That’s fine, but: “When the need arises—and it does— you must be able to shoot your own dog.” –Robert A. Heinlein 9/17/2008 Being an Effective VC Director 20 20
  • 21. Killer • Sometimes, the CEO has to go. –Very common in early-stage investments... the required skill set changes dramatically as company grows. It always becomes tangled with emotions. • Three paths: –Friendly: CEO says “I can see where I’m going to be out of my depth soon. Can you help me recruit a successor to take the company to the next level?” –Not-so-friendly: Board tells CEO it’s time for a change, start a transition period, launch a search. –Hostile: CEO has to be removed from office by hired security. 9/17/2008 Being an Effective VC Director 21 21
  • 22. Killer: Guarantees • When you change out the CEO: –Everyone in the company will know it’s time for a change before the board does. –Once you make the change, you’ll say “We should have done this 6 (or 9, or 12) months ago.” • To ensure a happy family, you should have regular “Executive Board” meetings... –Consisting of investors and outsiders, but not the CEO or other company representatives. –If you have them regularly, then scheduling one isn’t sudden evidence of an impending coup! 9/17/2008 Being an Effective VC Director 22 22
  • 23. • The Fundamentals • Board Responsibilities • CEO Relationship • Other Board Relationships • The Mechanics • Difficult Times 9/17/2008 Being an Effective VC Director 23 23
  • 24. Other Board Relationships • Management Team • Key Customers • Key Suppliers • Legal counsel • Auditors • External CFO (if applicable) • External HR (if applicable) • Other Investors on the Board • Your Partners (in your VC Firm) 9/17/2008 Being an Effective VC Director 24 24
  • 25. Other Investors • In an ideal world, all investors would have identical objectives: –Obscene capital gains for their stock. • In the real world, other factors intrude: –Serie(s) of Preferred Stock owned by each firm. –Size of VC fund. –Age of VC fund entity owning stock (still investing, or ready for harvest?) –Other investments: • Overlapping board memberships. • Time commitments. 9/17/2008 Being an Effective VC Director 25 25
  • 26. Series Mismatch • As multiple series of Preferred are issued, incentives begin to diverge: –Liquidation preferences begin to pile up. –Series A (and Common!) shareholders may want to hold out for an IPO, where all stock converts to Common. –Series D (or E, or J!) shareholders may settle for a quick M&A exit to double their money in a year. • This is when the “unhappy family” dynamic kicks in... every troubled company is unhappy in its own way. 9/17/2008 Being an Effective VC Director 26 26
  • 27. Your Partners • At some point, you’re going to ask your partners for more money to support this deal. –That’s the wrong time to start telling them about how well (or how poorly) it’s doing. • Frequent updates... if your Monday meetings are too crowded, write monthly emails. • Bring a partner as a board observer to a meeting. –He or she can build relationships with CEO, other board members; form an independent opinion. • Don’t be afraid to swap deals sometimes. 9/17/2008 Being an Effective VC Director 27 27
  • 28. • The Fundamentals • Board Responsibilities • CEO Relationship • Other Board Relationships • The Mechanics • Difficult Times 9/17/2008 Being an Effective VC Director 28 28
  • 29. Before the Meeting • Ideally, board meetings should never contain surprises... good or bad. –Surprises should have been communicated instantly, by email/phone calls. –You may choose to defer the discussion of possible courses of action to the board meeting, since that works best with everyone in the room. –But everyone should enter with a rough idea of the company’s situation, good or bad. • CEO responsible for reaching out to board. • Board members are responsible for doing their homework! 9/17/2008 Being an Effective VC Director 29 29
  • 30. The Mechanics • How often? –Monthly, until it’s obvious that it’s overkill. • How long? –It depends, but 90 minutes is a good target. • In person or audio/videoconference? –In person. • Where? –Company offices... unless there’s a particularly relevant trade show or customer event that the board members should attend. 9/17/2008 Being an Effective VC Director 30 30
  • 31. The Mechanics (cont.) • Scheduling? –Schedule a full year in advance, twice a year (January and July are good). • Formal agenda? –Yes. • Detailed minutes? –No. Just what the law requires. • Board package in advance? –Yes. (See next slide.) 9/17/2008 Being an Effective VC Director 31 31
  • 32. Board Package • Insist on a standardized board package to be emailed 3-7 days in advance of the meeting –Agenda –Financials –Dashboard/metrics (varies by deal) –Sales pipeline –Technology roadmap/issues –HR issues –Capitalization table • CEO will complain this is a huge monthly admin burden. He’s right. Do it anyhow. 9/17/2008 Being an Effective VC Director 32 32
  • 33. Who Should Be in Room? • All the board members, obviously. –If two or more can’t make it, reschedule. –If one is a perennial problem, explore replacing with another representative for that class of stock. • CFO: –Yes. (Even if contracted to outside firm.) • Other management team representatives: –For part of the time. Not for HR/financing/etc. • Legal counsel: –It depends. 9/17/2008 Being an Effective VC Director 33 33
  • 34. • The Fundamentals • Board Responsibilities • CEO Relationship • Other Board Relationships • The Mechanics • Difficult Times 9/17/2008 Being an Effective VC Director 34 34
  • 35. Down Rounds • Selling a new series of Preferred at a lower price than the last round. –Can dramatically dilute the stake of earlier investors and of management. –Especially painful for earlier investors who cannot participate in the new round (pay-to-play). • End-of-life for their fund. • Other deals have drained their capital. • Cross-ownership prohibitions. • Down rounds will strain board relationships. • Keep focused on doing what is right for the company, not for your class of stock. 9/17/2008 Being an Effective VC Director 35 35
  • 36. Fire Sale • Selling the company (or its assets) for less than invested capital. –Depending on liquidation preferences, different classes of Preferred may have dramatically different payback percentages. –Common stock (founders, employees, etc.) will be at the back of the line. • Usually means that the existing investor group cannot or will not continue investing in the company. • Guaranteed to strain board relationships! 9/17/2008 Being an Effective VC Director 36 36
  • 37. Firing the CEO • Discussed earlier. –Always an emotional decision, but not an uncommon one. • Employees can see this as a betrayal of founding principles of the company. –Identify the “must keep” employees early. –Need to have retention plans in place. • One or more directors may need to step in as temporary CEO or “Office of the President.” –Meet with key customers and suppliers right away. 9/17/2008 Being an Effective VC Director 37 37
  • 38. Killing the Company • Sometimes it’s not the CEO that has to go... it’s the whole company. –Emotionally painful decision for the entire board. • Frequently, but not always, tied to “zone of insolvency” issues/impending bankruptcy. –Triggers a change in director responsibility. • In rare cases, board decides to pull the plug while there’s still cash in the bank to pay off creditors and then be distributed to shareholders. 9/17/2008 Being an Effective VC Director 38 38
  • 39. Zone of Insolvency • Grey zone where company is nearly or actually insolvent –Fuzzy criteria: Cash flow? Balance sheet? Both? • In private companies in the Zone of Insolvency, responsibility of directors expands to include creditors. • Actions in this zone can, and probably will, lead to lawsuits by aggrieved creditors. –Especially if your actions “deepen insolvency.” • Consult frequently with experienced counsel. 9/17/2008 Being an Effective VC Director 39 39
  • 40. Time to Leave? • When is it time for you to resign from the board? –When conflicts between your roles make it difficult or impossible to fulfill your responsibilities. –When your schedule makes it impossible to devote sufficient time to this investment. –When your financial stake is diluted to the point where your ownership is no longer relevant. • Unless you’re universally perceived as still adding value. –When you don’t think you’re making a difference anymore. 9/17/2008 Being an Effective VC Director 40 40
  • 41. Time to Leave? (cont.) • When is it time for you to resign from the board? –When you reach irreconcilable differences over company strategy and you’re no longer able to invest in future rounds. –When the board grows to an unwieldy size, and you believe other members will add more value. –When the company goes public. • Okay, that’s partially facetious. But in the era of Sarbanes-Oxley, make darned sure you know what you’re doing before participating as a board member during and after an IPO! 9/17/2008 Being an Effective VC Director 41 41
  • 42. For Further Information Stephen Fleming Chief Commercialization Officer Georgia Institute of Technology Personal blog: <http://www.academicvc.com> <fleming@gatech.edu> (404) 385-2360 Download this file at <http://www.gtventurelab.com> 9/17/2008 Being an Effective VC Director 42 42