It’s a successful entrepreneur’s worst nightmare: The company you’ve worked tirelessly to create with your hard work and innovation is usurped by the banal vision of a misguided board of directors.
One of the most notorious conflicts between a company’s founder and the company’s board of directors played out in the mid-’80s, when the board of directors at Apple wrestled control from the iconic tech company’s co-founder and Chairman Steve Jobs after the company’s first iteration of the Macintosh computer was deemed a financial flop. Unable to influence the direction of his company or the products they were developing, Jobs left Apple in 1985.
Jobs, of course, got to live an entrepreneur’s “I told you so” dream when he was brought back to the then-struggling Apple in the mid-’90s and turned the company into the world’s largest technology firm by creating generation-defining electronics like the iPod, iPhone and other gadgets.
It’s an extreme example, but Jobs’ situation illustrates some of the potential quandaries an entrepreneur can be exposed to when taking on an investor or a group of investors. On one hand, a business may have reached its earning potential in its current position with its current resources, and an influx of finances could enable it to expand and grow. However, in exchange for the investment, an entrepreneur is basically introducing an authority – a boss – they will have to answer to who has the final say in decisions the company makes.
The individual owner of a company is referred to as a sole proprietor, or can be considered a sole directorship.
Van Clause, PhD, the chair of the Forcht Center for Entrepreneurship at the University of Louisville College of Business, said when an entrepreneur wants to change the legal status of their company – usually from an LLC to a C corporation – the business owner needs to make sure he or she is comfortable with whom they will be working and the arrangement of that relationship.
“You want something the entrepreneur, the owner of the business, is comfortable with. This is going to be a working relationship, a long-term working relationship with your investors,” Clause said. “It’s very rare that investors will put their money in and then you don’t ever hear from them again. So you need, during this courting relationship of looking for investors, to have a good working relationship with those individuals.”
The nature and makeup of the board of directors the investors and the entrepreneur is creating is something to be considered, as well. Do the investors want two of the three board seats, giving them majority control of the board? Do they want two of the five seats? What sort of process do they want in picking an independent board member?
Clause said a typical board of directors for a young startup is small, especially compared to a large Fortune 500 company. The common combination is three or five people. In each situation the odd number is usually filled by a professional who is independent of the company – isn’t an employee and doesn’t have any money invested.
Along with money, however, investor board members usually bring a set of skills – finance, marketing, sales, management – that are not normally in the entrepreneur’s toolbox and can be a tremendous benefit to help grow the company, guide the organization through a transition such as a succession, and help find other talented members for the management team.
A board of directors can also help give direction to the company and provide a system of governance for the business, as well as for the board itself. And, above all, they have a fiduciary responsibility to be good stewards of their and other investors’ interest in the company.
Given the complicated nature and importance of the contract between investors and founders, Clause always recommends legal counsel.
“In all cases, I always recommend that entrepreneurs retain legal counsel, someone who is familiar with these types of deals – equity investment deals, succession planning deals – because it’s really a negotiation between the investor and the startup business,” Clause said.
But first, an advisory board
But before an entrepreneur is in the position to begin considering if they want to take on an investor’s money – and the oversight of a board of directors – Clause also suggests that they have a formal or informal board of advisors, or an advisory board.
“You are not required to have a board of directors with an LLC. Most of the businesses I’ve worked with, though, do want some sort of an advisory board because they want someone that has an interest in their business that they can use as mentors or experts in a particular area,” he said. “Most businesses starting out, if they are going to have an external group helping them, will want to start out with a board of advisors, and that is an informal advisory group. It doesn’t require any legal relationship with the venture.”
Christopher Clifford, PhD, the Phillip Morris associate professor of finance with the University of Kentucky Gatton College of Business and Economics, agrees that having access to an advisory board is invaluable, especially with a young startup company. The challenge to the entrepreneur, however, is the required legwork to find the people who will be
of real benefit to the company.
“Finding good people who are willing to sit on your board for probably pennies – to justify their time – it’s very difficult to do,” Clifford said. “There’s not thousands and thousands of qualified directors just sitting around retired, waiting to jump on boards. It’s really difficult, in my opinion, to form a good quality board.”
As with a board of directors, an advisory board, even if it’s just a small group of professionals who meet only a few times a year to talk about the company, can be extremely beneficial to a small company when the business goes through any number of transitions, from an acquisition to a succession to a younger family member.
“A board could provide continuity from that one generation to the younger generation,” Clifford said, “and provide guidance drawn from past experiences: ‘This is what’s worked in the past, we ran into this problem four years ago.’ If you’re coming in to take over the business, having that continuity of information from one generation to the next would be valuable.”
Along, of course, with articles of incorporations that are filed with state officials, the typical process includes adoption of corporate bylaws declaring the powers of directors, length of members’ terms, frequency of meeting, appointing and dismissing a chairperson, vacancy protocol and compensation. A board of directors agreement might be appropriate. Meetings should have an agenda and minutes kept. ■
Robbie Clark is a correspondent for The Lane Report. He can be reached at [email protected]