By Gabor Garai
When entrepreneurs obtain investment funds from venture-capital firms, they often accept something equally important: new members for the board of directors. The reason is simple: VCs usually insist on a board presence so as to closely monitor their investments.
The good news is that startups gain seasoned and experienced hands, experts capable of providing the sage advice that can help a growing company to avoid problems.
The bad news is that the VC's representatives sometimes have competing interests, in that while they are trying to help startup, they are trying to protect their investment. When push comes to shove, however, protecting their investment may take precedence.
TIME TO HAGGLE.
How does an entrepreneur go about managing these new participants in a startup's affairs? First, keep in mind that no matter how firmly VCs insist on getting what they want in relation to board representation, much of what actually happens is subject to negotiation. For example, if three VC firms have provided an initial round of funding, each may insist on representation on your board. If your company has been operating with a three-person board that includes two founders and one outsider, then adding three new individuals will obviously change the dynamics quite dramatically. The two founders may well feel outnumbered -- and vulnerable.
In this situation, you might propose that instead of each VC firm having its own representative on the board, only two will take their seats, while the third will be an "observer." Moreover, in consideration of this new board weighting, the startup may get to add a couple more friendly "industry experts" to the board, folks who have long-term friendships with the founders -- and who, as entrepreneurs themselves, are more likely to be be sympathetic.
Second, entrepreneurs need to appreciate the dynamics at work in the boarderooms of growing companies. It's a common misconception among entrepreneurs and the public in general that important decisions are determined by narrow majority votes of the board, and thus the reason to limit the number of VCs on the board is to keep them from obtaining a voting majority. The reality is that directors of a growing company rarely decide by narrow majority vote, but rather make decisions by consensus. Thus, having "observers" from the VC backers is tantamount to those individuals coming aboard as board members, since they won't be likely to sit in silence at meetings as issues are debated.
VOICE OF AUTHORITY.
Adding four new members and an observer to what was originally the three-person board described previously, will have its greatest impact in terms of significantly changing the dynamic of board debates and discussions, rather than affecting many actual votes (though certainly in rare instances involving sensitive decisions, a vote could become important).
And third, an entrepreneur will usually have a say in the selection of the VC's board representatives. Ideally, founders want people who can add significant value to the board's discussions and decisions. Entrepreneurs should take it on themselves to conduct due diligence about officials of a VC firm to determine which are likeliest to do their outfits the most good in terms of experience, industry contacts, personality, perceptions, and other such qualities. The VC representatives should also be senior enough in their firms that they have clout if it becomes neccessary to seek additional investment funds. It's possible when drawing up an agreement with VCs to include language about who the board members actually will be.
Once a growing company's board has been rearranged by virtue of VC participation, the challenge of managing this new business group remains. Here are some suggestions for getting the most out of VC board members:
• Involve VCs in key company activities. For example, you might bring one or two along to trade meetings and introduce them to industry experts and gurus. The idea is to help them learn about your business and your industry so they can provide ideas and input that will benefit your business.
• Pick their brains. You should assume that your new board members have served on a number of other boards, and that they can provide ideas for getting the most out of board meetings and overcoming the many challenges of running a growing company.
• Look for a champion. The most successful growing companies invariably are blessed with at least one VC who believes strongly in the startup and will go to extraordinary lengths to see it succeed. This individual will help introduce management to key customer prospects and seek out potential strategic alliances -- in other words, make the company's success a personal matter.
Remember, the real goal here is to turn VCs' board members into assets rather than liabilities.
Gabor Garai is a partner in the Boston office of the national law firm Epstein Becker & Green, specializing in the financing and growth requirements of small and midsize companies.