Reading List: Secrets of Sand Hill Road
Early-stage Boards can be brutal. The simple fact is that many times you have inexperienced CEOs and sometimes inexperienced Board members both trying to show fast growth in unproven markets. Even when there are more experienced players, you often have some combination of divergent opinions on strategy, misalignment of financial incentives between stakeholders, asymmetrical information and shifting power dynamics (sometimes in favor of the company and sometimes in favor of the investor-Board members).
My own bias is apparent every time I discuss the topic and my point of view easily shifts between two perspectives: the idealist, how I think a Board should operate; and the realist, how most Boards actually operate. As a recent example, one of my portfolio companies was trying to determine if we should allow a new investor to join the Board. My approach to this question was to think about what type of skills and experience we need to add to the Board to round out its effectiveness. The other preferred Director suggested we evaluate the new Board member by the standard of “do no harm”. In other words, will they be disruptive, creating an inappropriate dynamic on the Board? If not, then we should allow it. This conversation is sticking with me because it is so foreign to my idealistic view of a good Board, but I have enough experience to understand and appreciate the point.
Luckily, CEOs have a new resource to help them better understand the Board room dynamic in Scott Kupor’s book Secrets of Sand Hill Road. I encourage every early-stage CEO to read this book from cover to cover. Some parts are technical and legal and may not hold your attention the first time through. Don’t skip them – just read them. Then, keep the book within reach. The next time your Board does something that you just don’t understand, pull it out and reference the book. And, before you go through any kind of exit scenario, re-read chapters 12 and 13 again. The book is helpful in several ways generally laying out both the idealist and realist view.
First, Scott helps provide a backdrop on how terms in a financing round can have long-term implications. Too often founders get focused on valuation at the cost of all other terms. At MATH, we usually take the approach of generic terms and conditions. We advocate for terms that we are comfortable with being repeated in later rounds, often with straightforward pari-passu liquidation preferences. Our fundamental belief is that these type of generic terms align the interest of different classes of shareholders. In fact, recently, we passed on a follow-on round for a portfolio company that we really believe in due to what we perceive as favorable, but misaligned deal terms. Fundamentally, we feel the structure of the round does not set the company up for long-term success.
Second, Scott outlines the basics of the role of the Board and how well-meaning Board members and/or investors can sometimes over-step. Having been an operator with an over-active Board member, I am extremely sensitive to this. At MATH, we sometimes get deeply involved, but only when requested to do so by the company. And, I tell Founders, I am like volume, you can turn me up or turn me down without penalty. Being active in a company can help them through a temporary need, but has to be managed and communicated carefully so it is not confusing to the team and/or to other Board members. Also, it is helpful to not be the actual Board member, the five times I’ve rolled up my sleeves with portfolio companies, I have either been a Board observer or was asked to help on a specific issue for an investment one of my partners was leading.
Third, Scott provides both a direct and nuanced view of the concept of dual fiduciaries and the challenges that are inherent with investor board members. This is the number one issue that I think can trip up most Boards, as VCs sometimes get wrapped up in how a particular outcome will reflect on their fund. And, because so many funds participate in multiple rounds, sometimes the Board meetings become a series of constant pitch meetings instead of true Board meetings. Having generic terms that align preferred share classes helps, but this can be a real conflict bound to come up at some time or another.
Finally, and this is where the realist side of me is speaking out. You must manage the Board for it to be effective - even if you have aligned interests, even if you trust your Board implicitly. You must line out what you expect in Board meetings. You may need to call ahead to socialize important topics and gather feedback before the meetings. You need to be an expert facilitator. And, in most cases, you should select an independent Board member to serve as Chairperson. Do not choose your best friend for this. Do not choose a common or a preferred Director. Choose someone highly respected, neutral and experienced. They can be the voice of reason when dual roles get confused and the stakes are high.