By Fernando Berrocal
Few first-time startup founders are familiar with the rather mysterious organization known as a "Board of Directors", which complicates the founder's need to make informed judgments about who should be on the board and how it should be managed.
Why does a startup need a board of directors?
The short answer is that "Delaware Law" applies. A board of directors is needed by law for a Delaware corporation. The corporation's operations and affairs are managed by the board of directors, who have a say in declaring dividends, buying property, and issuing debt, stock, and options, as specified in the corporation's Certificate of Incorporation and Bylaws. In addition, the board chooses the corporation's first officers (CEO, COO, CTO, and so on) and delegates part of the board's powers and responsibilities to those officers. In terms of function, the board is in process of setting the startup's strategic long-term vision and priorities. The officers are in charge of carrying out the orders.
Because the founders often perform all three positions, differentiating between the board, shareholders, and officers can be challenging for an early-stage startup founder. However, founders should comprehend the differences between acting as an officer, a board member, and a stakeholder. Each has its own set of obligations. As the startup expands and adds new investors, these positions become more prominent.
The board of directors has fiduciary responsibilities.
Directors of Delaware businesses owe the corporation's investors two fundamental fiduciary duties: the duty of care and the duty of loyalty. In situations involving breach of fiduciary responsibilities, courts often have broad discretion in determining the appropriate remedies for the aggrieved party. This might result in the board member's removal, personal financial penalties, or a variety of other outcomes.
Before making a business decision, board members have a duty of care to get all pertinent facts in a reasonable amount of time. This implies that while making decisions for the startup, board members must conduct due diligence and possibly contact other specialists. This also implies that directors must review materials provided to them before meetings, be engaged, and take the appropriate time to evaluate and consider any potential decisions. Directors are considered to have made a business decision by acting in good faith and the honest belief that the action was in the best interests of the company. The business judgment rule is the name for this assumption.
A director's duty of loyalty requires them to put the interests of the investors ahead of their own. This implies that a board member cannot use the startup's secret information for personal advantage, related to unethical self-dealing, or put their interests ahead of the startup. This obligation also requires board members to report any potential conflicts of interest relevant to any decision or action, or risk losing the duty of care assumption.
What is the average number of directors in a startup?
Delaware only needs corporations to have one board member; however, it’s typically better to name three. The benefit of this is that having an odd number of votes ensures that a majority can always be achieved, preventing the startup from becoming stuck in a voting deadlock, which may bring plenty of difficulties and complications. The board of directors will typically increase to five members as the startup grows and attracts more investment.
Who are the members of the board of directors?
A three-member board of directors is generally created when the startup is created, consisting of two co founders and a trusted advisor. The adviser is usually someone who is assisting the startup in its growth and may have subject matter knowledge or contacts in the investing world. When a startup receives its first professional investment, whether, from angels or venture capitalists, the investor(s) generally choose someone to take the advisor's position on the board of directors, giving the new investors some authority over the startup. After a few rounds of VC funding, the board generally expands to five members. Typically, two board members represent the interests of ordinary shareholders, the other two represent the interests of stockholders, and the fifth is an independent who has been agreed upon by the founders and investors. This structure helps to balance control of the startup between investors and founders, with the fifth board member serving as a neutral tie-breaker in the event of a disagreement.
Finally, the “chairman of the board” is the most senior member. This person is a current board member who was elected by the other sitting directors. In most cases, the chairman is not a startup employee but rather an early lead investor. This individual is in charge of running board meetings and is a member of all board committees. While the chairman only gets one vote, he is widely considered as the most senior member with the most power.
Other participants in board events, known as board observers, are frequently present in addition to real board members. Individuals who participate in discussions between board members and attend board meetings but don’t have a vote are known as board observers. Certain investors who didn’t obtain a board seat as part of their investment agreements may be given board observer seats by the startup.
Giving board observation roles to startups should be done with caution. Board observers add to the board's complexity by allowing them to offer their views on the startup's direction. Founders should ensure that anybody has given a place at the board table, even spectators will be a constructive and beneficial contribution to the startup that will help lead it to success.
Overall, managing the board of directors is not a difficult or time-consuming process, but it does need a startup founder's familiarity with the necessary structures and terminologies. When it comes time to incorporate or take investment, knowing the regulations that govern the board of directors of a Delaware C-Corporation is one less thing to worry about.
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