Fred Wilson wrote a post about convertible notes and SAFEs the other day. I agree with what he posted 100%. It’s always better to do a priced equity round than a squishy round. I understand why squishy rounds happen, and have participated in them. But, prefer equity.
One of the principles we are acting on at West Loop Ventures is to drive valuation at seed. Our goal is to lead the seed deal and help the CEO assemble the round.
One of the things that Fred doesn’t talk about in his post is that if you do an equity round, you have to form a board of directors. This gives the company needed structure at an early stage. Giving the company structure is very important. It helps set course. It helps set culture. Furthermore, a good board gives the CEO support. Being CEO is a lonely job.
At seed, it’s virtually impossible to switch out the CEO. It’s probably stupid to do it since the CEO is most likely the founder. The only reason to do it is malfeasance. Boards are not there to serve as arbiters and disciplinarians. They are there to help CEO’s strategize, budget, and build.
At early stages, independent directors on boards should bring a few things to the table. First is credibility. Having a higher profile board member with a good reputation in the industry doesn’t hurt. Caveat; that board member actually pays attention and has the time to devote to the company. The second thing they need to bring is strategy, network and expertise. Independent directors need to be active to help the company grow and get ahead. The requirements change when you get later in the cycle.
Over time, the board needs to change. The seed board won’t look like the Series D board. It is important that early investors keep their egos out of being on the board. They need to know when it is appropriate to step back. Boards should change with up rounds and down rounds. Of course, we are seeing more down rounds today. In a down round, often company personnel changes and the board composition should change too.
In our case, we want to be on the board at seed if we can. However, it gets less meaningful for us at Series A. We might be on the board and we might not. At Series B and beyond, we don’t envision being on the board at all.
When it comes to board composition, egos are involved. If a founder isn’t an integral part of the business anymore, they probably shouldn’t be on the board. If an investor goes from a major to minority investor, they probably shouldn’t be on the board. If you start out as a minority investor, unless you have a special skill that the company can use, you probably shouldn’t be anywhere close to the board room.
Investors need to understand their role. The best thing they can do is find customers and create opportunities for the company. They aren’t operators and they aren’t a judge and jury. If things change, investors should have the presence of mind to proactively tell the CEO that they can’t fulfill their responsibilities and help the CEO find a new board member.
What’s the ideal number of board members? In an early seed deal, 3 is recommended. Why? You need an odd number to vote. Even number boards potentially can be deadlocked. Most votes at an early stage are not controversial. The other reason is communication. The board sees material that other people shouldn’t see. Brad Feld has advocated sharing a cleaned up board deck with employees and outside investors. I agree with that. But, not everyone should see the detailed numbers. Having a smaller board keeps communication tight and makes life easier for the CEO. At an early stage, I am all about making life easy for the CEO. They have enough to worry about without lots of board members demanding time with them.
There are businesses that are heavily regulated where some board composition is outlined in an agency regulatory structure. The one area I know is in finance. At a public exchange, the SEC and CFTC have an independent outside director requirement.
What about post seed? At Series A and beyond, five is probably the best number of board members for a startup firm. I’d keep five as long as I possibly could. If you set good cultural practices with your board in the seed round, you will carry that through to later rounds. You should be able to appease all the egos and have a board that supports the CEO.