For a corporation, there is a legal requirement that a board of directors be formed. How the board are formed and practically utilized can vary across companies. For instance, many years ago the Weinert Center worked with a small family business that built custom cases for a variety of different business customers. Originally, the board of directors (BOD) consisted of eight family members who used the board meetings more as family reunions than important business meetings. After many years the company president noted that company finally added two outside directors who were noted as tremendous additions to the firm providing a valuable outside perspective.
When small business owners decide to form and utilize a board, especially a working board, the usually can’t contain their enthusiasm. A working BOD is formally constituted council who members have valuable expertise; a board which involves itself in serious discussions and decisions about the role and operations of a corporation.
A “non-working board”, on the other hand, is simply a legal entity not taken very seriously (similar to the example above when only the family members were involved). These boards provide little value except for meeting the legal requirements of a corporation.
Most information on Board of Directors is related to large corporations with the National Association of Corporate Directors (NACD) conducting surveys and holding seminars for board members. Much of the information referred to here is based on information from the NACD.
What do Working Boards do?
A working BOD has both legal and fiduciary duties when serving for a corporation. A board of directors are elected or appointed members who jointly oversee the activities of a company. In an organization with voting members, the board acts on behalf of, and is subordinate to, the organization’s full group, which usually chooses the members of the board. In a stock corporation, the board is elected by the shareholders and is the highest authority in the management of the corporation.
Typical duties of boards of directors include selecting, appointing, supporting and reviewing the performance of the chief executive; approving annual budgets; accounting to the stakeholders for the organization’s performance; and setting the salaries and compensation of company management.
Choosing a Board of Directors
The first question in formation of the board of directors is how many directors and the composition of outsiders vs. insiders. The number of directors is typically in the five or seven range in early stage company. As the firm grows, so may the board of directors in size. The most important aspect to the number is that it be an odd number for voting purposes and that thought be put into a staggered board composition where terms expire at differing times so there is not an exit of too many board members at one time. At the same time, the firm’s governance has the means to have a constant renewal of board members (if desired) to ensure constant renewal of perspective and experiences in the board of directors.
Using outsiders for the board of directors has been an ongoing trend for several decades with public corporations. For private firms, the trend has moved towards outsiders but is largely driven by the demands of lenders and investors for most small businesses. Critical, as with the Board of Advisors, is that management identify which skills and experience are needed by the company based on its current and near term needs.
A question always comes up about whether to have investors on the board. In many cases where an investor has a significant stake in the company, there may be no choice. If an investor (can be a banker or equity investor) doesn’t have a significant stake, management should truly evaluate the expertise of the investor and what they can offer the firm in the form of guidance in operations and strategy.
What to pay a Board of Director?
Similar to a Board of Advisors, most directors should be compensated for their time and advice. How much to pay is always dependent on the size of the company and what the expectations of the board members are. Brad Feld, co-founder of Techstars accelerator, suggests to his portfolio companies that they do provide any direct cash compensation to board members instead allocating equity at up to 1% ownership vesting over time.
As a rule of thumb, I attempt to estimate what such a board member would earn as a consultant to a company based on an hourly rate. Then, I attempt to determine what the hours of commitment will be to determine what an annual expense might be. If the company is smaller or having major cash flow issues, then that rate should be discounted and possibly enhanced with equity in the form of common stock or stock options. As with any transaction, the management team should consult with other local companies and consultants to gather info on compensation for boards in their area.