Being an Effective Director

© 2008, Georgia Institute of Technology

Stephen FlemingChief Commercialization Officer

<[email protected]>

Member of Investment Committee The Seraph Group

<http://www.seraphgroup.net>

Being an Effective VC Director:Coach, Confidante, and Killer

VCI 2008

2Being an Effective VC Director9/17/2008 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; endowedchair in telecommunications; occasional instructor inMBA entrepreneurship program.

• Strong regional technology leader.


• The Fundamentals

• Board Responsibilities

• CEO Relationship

• Other Board Relationships

• The Mechanics

• Difficult Times


“All happy families arealike; each unhappyfamily is unhappy in itsown way.”

–Leo Tolstoy,Anna Karenina


Board Composition

• By the time a company has attracted venturecapital, 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


Board Size

• Each round of financing will involve new leadinvestor(s), each of whom will want at leastone board seat.

• Other syndicate partners may want observerseats.

• Mechanics of scheduling and maintainingopen communication break down when youexceed 7 members

• 16-member boards are fine for GE, but notfor a startup!


Odd or Even?

• Conventional wisdom: You want to have anodd number of directors so you can neverhave a tie vote.

• Reality: It doesn’t matter.–In “happy family” boards, all votes will be

unanimous. If you’re down to counting noses toget a majority, you’re already in trouble.

–Who’s to say that one member won’t be absent, orsick, or recuse himself/herself, or...?

• Get the right people around the table. Don’tworry about odd or even.


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






• The Mechanics

• Difficult Times


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, thehigher responsibility wins!

• “Fiduciary responsibility” is a magic phrase...use it cautiously and with great restraint


List of Responsibilities

• Loyalty

• Candor

• Good Faith

• Disclosure

• Transparency

• Confidentiality

• Best Effort

• Above all: Act ethically and honestly


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 beestablished as needed to help the company.–May give you an opportunity to work with

management team members who are not on theboard. This is a Good Thing™.


D&O Insurance

• Directors and Officers Insurance used to berare for private companies.–Purchased only in the run-up to an IPO.

• Becoming more common in earlier-stagecompanies.–Usually just handled by the CFO... a mistake.–Policies vary widely. Alternatives should be

explored by a committee of the board, and ratifiedby the entire board.

–If the D&O doesn’t cover you for a stockholder oremployee lawsuit, you may be personally liable.Ouch!






• The Mechanics

• Difficult Times


Two Key Questions

• When you walk into a board meeting, youshould only have two questions:

–Are we going to fire the CEO today?

–If not, how can we help?

–Al Paladino, Advanced Technology Ventures


CEO Relationship

• Critical that this relationship works well.–Significant part of CEO’s job.

–Too many of them neglect it... thinking it only isrelevant during the actual board meeting. Wrong!

• Responsibility goes both ways–Coach

–Confidante

–Killer


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 inprior companies!

• Make useful connections using your industrycontacts.

• Provide a different perspective.• Don’t hesitate to suggest professional

development activities for the CEO.


Coach: Perspective

• Your key asset:–You’ve (hopefully) seen many more deals than the

CEO, and you’re currently involved in half a dozenothers.

–You have a perspective that’s impossible for theCEO—who is 100% committed to this business.

• What worked in other cases? What didn’twork? Why?

• Other experiences:–How long can you take to make a decision? When

does this become a critical problem? Who shouldyou call? Where should you look?


Confidante

• Even happy families hit rough patches.

• CEO cannot share all fears/concerns withemployees... 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 willbe exercised at informal meetings like this,not at the actual board meeting!


Confidante or Friend?

• The obvious reality:We invest in people we like, and we don’tinvest 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


Killer

• Sometimes, the CEO has to go.–Very common in early-stage investments... the

required skill set changes dramatically as companygrows. 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 recruita successor to take the company to the next level?”

–Not-so-friendly: Board tells CEO it’s time for achange, start a transition period, launch a search.

–Hostile: CEO has to be removed from office byhired security.


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 shouldhave done this 6 (or 9, or 12) months ago.”

• To ensure a happy family, you should haveregular “Executive Board” meetings...–Consisting of investors and outsiders, but not the

CEO or other company representatives.

–If you have them regularly, then scheduling oneisn’t sudden evidence of an impending coup!






• The Mechanics

• Difficult Times


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)


Other Investors

• In an ideal world, all investors would haveidentical 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.


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 wantto hold out for an IPO, where all stock converts toCommon.

–Series D (or E, or J!) shareholders may settle for aquick M&A exit to double their money in a year.

• This is when the “unhappy family” dynamickicks in... every troubled company isunhappy in its own way.


Your Partners

• At some point, you’re going to ask yourpartners for more money to support thisdeal.–That’s the wrong time to start telling them about

how well (or how poorly) it’s doing.

• Frequent updates... if your Monday meetingsare too crowded, write monthly emails.

• Bring a partner as a board observer to ameeting.–He or she can build relationships with CEO, other

board members; form an independent opinion.

• Don’t be afraid to swap deals sometimes.






• The Mechanics

• Difficult Times


Before the Meeting

• Ideally, board meetings should never containsurprises... 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 thatworks best with everyone in the room.

–But everyone should enter with a rough idea of thecompany’s situation, good or bad.

• CEO responsible for reaching out to board.• Board members are responsible for doing

their homework!


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 theboard members should attend.


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.)


Board Package

• Insist on a standardized board package to beemailed 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 monthlyadmin burden. He’s right. Do it anyhow.


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 replacingwith 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.






• The Mechanics

• Difficult Times


Down Rounds

• Selling a new series of Preferred at a lowerprice 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.


Fire Sale

• Selling the company (or its assets) for lessthan invested capital.–Depending on liquidation preferences, different

classes of Preferred may have dramaticallydifferent payback percentages.

–Common stock (founders, employees, etc.) will beat the back of the line.

• Usually means that the existing investorgroup cannot or will not continue investingin the company.

• Guaranteed to strain board relationships!


Firing the CEO

• Discussed earlier.–Always an emotional decision, but not an

uncommon one.

• Employees can see this as a betrayal offounding 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 astemporary CEO or “Office of the President.”–Meet with key customers and suppliers right away.


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 ofinsolvency” issues/impending bankruptcy.–Triggers a change in director responsibility.

• In rare cases, board decides to pull the plugwhile there’s still cash in the bank to pay offcreditors and then be distributed toshareholders.


Zone of Insolvency

• Grey zone where company is nearly oractually insolvent–Fuzzy criteria: Cash flow? Balance sheet? Both?

• In private companies in the Zone ofInsolvency, responsibility of directorsexpands 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.


Time to Leave?

• When is it time for you to resign from theboard?–When conflicts between your roles make it

difficult or impossible to fulfill yourresponsibilities.

–When your schedule makes it impossible to devotesufficient time to this investment.

–When your financial stake is diluted to the pointwhere your ownership is no longer relevant.• Unless you’re universally perceived as still adding

value.

–When you don’t think you’re making a differenceanymore.


Time to Leave? (cont.)

• When is it time for you to resign from theboard?–When you reach irreconcilable differences over

company strategy and you’re no longer able toinvest in future rounds.

–When the board grows to an unwieldy size, andyou 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 whatyou’re doing before participating as a board memberduring and after an IPO!


For Further Information

Stephen Fleming

Chief Commercialization Officer

Georgia Institute of Technology

Personal blog: <http://www.academicvc.com>

<[email protected]>

(404) 385-2360

Download this file at <http://www.gtventurelab.com>

Being an Effective Director

Economy & Finance

strain board

actual board

management

board package

private companies

stephen fleming

board relationships

board meeting