Board work is often perceived as “overhead” for many startup CEOs, who basically want to deal as little as possible with investors and “get the work done” quickly. The interesting question here is: What exactly is the work that should be done by the CEO?
Is the CEO’s job only to build products and acquire customers? I think we would all agree that at the end of the day the main role is to build a “company”, and this entails some issues that needs to be taken care that at first might not seem like “core competencies” of a company.
Unfortunately, we have too often seen entrepreneurs that spent years building a great business and then, when faced with their great “exit” opportunity, had to settle for millions of dollars less.
This could be because of historical bad treatment of tax, or employees that couldn’t exercise their ESOP in the right manner because of late filing to authorities, or strategic acquisitions that completely fell apart because of mistreatment of Open Source Code, unsettled legal claims and other issues that have very little to do with the business but become major factors when it comes to major corporate transactions.
The trends in the market that we are seeing in the past few years only accelerate this problem. In the past, startup companies were often acquired before they reached valuation of a few hundreds of millions of dollars. Most tech companies valued at greater than $1B were public and had to adhere a much stricter corporate governance and control.
Nowadays, many of those companies are private, and while they might have raised huge amounts of money and have been running a very large business, are still using methodologies and best practices of early-stage startups. This entails huge risks for the company, its entrepreneurs, its shareholders, and its employees.
There needs to be a delicate balance between dealing with those G&A overheads and growing the business, so not to overlook the above mentioned problems on one hand, while not imposing impossible procedure for an agile culture on the other hand.
One of the best ways to deal with these issues is forming Board Sub Committees pretty early on in the lifecycle of the company. Those committees are usually made of experience board members that can bring fast best practices working together with the executives in the company that are in charge of implementing those practices.
The goal here is not to put an additional burden on the CEO, but rather the contrary, help the CEO take care of those “important but non-core” matters without his/her direct involvement, providing them with peace of mind that the company is ready for its next stage of growth without them needing to be personally involved.
I would like here to discuss the two most important board sub committees, their roles, and the rationale behind them. Obviously, as the company grows it makes sense to add more working groups as needed.
1. Audit Committee
This is a committee that is required by law for public companies, but it is well advised to form such a committee in the initial growth stage of the company. While the official charter of the committee is usually to handle accounting policies and financial statement, in practice it often acts as a “G&A committee” that oversees a lot of the infrastructure building and compliance issues facing the company. The charter of the committee should be pretty broad and encompass the following issues:
• Accounting policies – the past few years have introduced significant changes in accounting policy (e.g. ASC 606 and others) that are once again changing the way revenue is recognized and the need to prorate some S&M expenses. As the issues becomes more complex than people might think, it requires some digging in and constant board oversight.
• Inter-company agreements – most companies in Israel have foreign subsidiaries (usually in the US but not only). The transfer pricing policy and other inter-company agreements may have significant tax and other implications when the company is up for an acquisition or IPO. Determining the right policy is better done at the early stage of the companies as it is harder to change it over time.
• Compliance – meeting certain industry standards (PCI, HIPAA, SOC2, ISO 27001 just to name a few) is quickly becoming not just good governance but more of a prerequisite for selling to large enterprises. Hiring the right consultants and monitoring the process has a direct effect on the ability of companies to go up market as part of their growth strategies.
• Finance team building – at some point in time – most companies are facing the same issue – a growth investor wants to see a 3 year plan when the company hardly knows how the next quarter will look. While CFOs and VPs of Finance deal with the scaling of other departments, they often miss the need to scale the finance department itself – hiring specific people for jobs like FP&A, Accounts Receivable and corporate controller are key to the ability of a company to think ahead and to support the ongoing operations of the company.
• IT and Cyber Security – IT is often viewed as an efficiency process and is therefore in the sole hands of management. But this is often not the case, IT infrastructure scale is mandatory from both an operational governance perspective and is major productivity and risk mitigation tool alike.
• Company procedures – whistle blowers, ESG, Sexual harassment etc.
2. Compensation Committee
We recommend forming this committee as soon as possible after raising the first institutional funding round. This committee should be considered a major tool for management to deal with the most important task of a fast growing company – hiring. Some board members (mainly those who are on several boards) usually have a lot of value add here as they have seen these processes before and most likely have come across a lot of the issues the company is facing.
Two specifically important issues need to be raised here:
• Benchmarks – what is the right compensation package for a VP marketing on the east coast? how much equity should we grant a junior DEVOPS engineer? Should the exercise price of US and IL employees be the same? What is 409a study and how often it should be conducted (and how much should it cost)? There hasn’t been a single company that doesn’t face these questions very early on in their hyper growth stage. Setting a clear policy based on industry benchmarks and wide industry experience is key to providing management with the right set of tools to hire at scale, and also provide a “consulting forum” when dealing with specific issues (usually around executive hiring).
• Secondary transactions – this is becoming a very important tool for retention and compensation of founders and senior executives. We estimate that approximately 1/6 of all growth round dollars are actually secondary transactions. This often triggers an “interested party transaction” (e.g. the CEO is negotiating a secondary sale of his own shares as part of a growth round) – these items go over heavy diligence in subsequent rounds and definitely as part of liquidity events. Careful documentation of the decision-making process could save tons of trouble later on.
We briefly discussed here the importance of having board committees relatively early on in the growth stage of a company and provided some details on the role of the Audit Committee and the Compensation Committee. As private companies grow fast, raise a lot of money, and run significant businesses, they should incorporate those measures and be prepared to play in the Major League.
As a group that invests in companies from inception to growth, we put great effort into making an impact as quickly as possible, which is why we’ll be holding a dedicated seminar for our portfolio founders to provide best practices. More content to come on this issue – please reach out – I’ll be happy to provide it.