I spoke with a friend recently who was forced to step down as CEO of his startup. The board felt he wasn’t getting the job done and that was that. Happens regularly. But in this case, he had only raised a small amount of capital, so his CEO job should never have been in question.
The issue here was that this founder had ceded control of the board. What this means is that outsiders had a right to appoint the majority of the seats in the board.
Thanks to some wise counsel from his seed investor Peter Thiel, Mark Zuckerberg knew the importance of board control at Facebook. It’s easy to speculate that as a young founder, his CEO job might have been in jeopardy if he was not firmly in control of the board. Who knows what impact that might have had on the trajectory of the company? Mark dismissed revenue early on in favour of reach and engagement. Would a ‘professional’ CEO have done the same? Luckily, we’ll never know.
As a rule, if you sell 20% of your company to investors, then investors should not be able to appoint more than 20% of the board seats. The relative ownership of the company should be reflected in the board since the board is there to represent the interests of all shareholders.
All too often unfortunately, investors ask for more seats than the cap table would suggest they are eligible for. Especially when you’re raising 2nd and 3rd rounds and you’re trying to keep your current investors happy while making room for the new investors.
Sometimes the solution is to offer an ‘observer seat’ instead of a full board seat. But beware: observers are not benign. They don’t just sit there quietly taking notes. While they don’t formally vote, they are often full participants in meetings. And they develop relationships with full directors further influencing the board.
So, what’s the solution? Have the tough conversations upfront. It’s tempting to cave and accept disproportionate investor representation on the board in order to close investment. But you’re doing a disservice to your other shareholders if you do that.
It’s not that your professional investors are bad board members. On the contrary, they sit on boards for a living and bring a ton of experience. But, almost universally, they will be holding different shares from the founders, early angels and employees. And it’s often hard to separate board duties from investment management. Make sure your common shareholders are proportionately represented on the board at all times.