Why you should add an independent director to your board
In the public world, it’s very common — even mandatory in some jurisdictions, to have independent directors sitting at the executive board; and much more rare to have a hedge fund manager tackling a seat. Well, in the startup world, it’s quite the opposite. If you’re a Seed or Series A company, your board is most likely to be composed of a combination of VCs and founders. And that’s ok. But as the company matures, its board has to evolve to best support growth and bring onboard additional independent members.
What does it take to be an independent director? Why and when should I care, as a startup, about bringing one to the board table?
What is an independent director?
We typically call an independent director a board member who is not linked to the company in any fashion. Think about someone who is not a founder, an employee, or an investor.
The concept of independence is quite crucial here, as an independent director’s first duty is to bring an impartial vision. You want someone external to your company, bringing additional and complementary skills, fresh eyes, and above all, who is not conflicted.
Why do you need one at your board?
The answer may not be straightforward and vary significantly between companies.
Let’s start with the very obvious: the need for an odd number of board members. Let’s picture what happens for the typical startup: in most cases, you start with 2 co-founders. During the 1st funding round, the lead investor joins, and you end up with a 3 person board. But after the 2nd round, a new investor jumps in, and all of a sudden, you’re 4 at the table. This makes decision making a lot more complicated. By appointing an independent board member after the second round, that person potentially serves another critical role — a tiebreaker. That said, not reaching a consensus in such a small board and actually having to vote is quite rare.
Going beyond the odd number, the Founder-Investor ratio is also key! During the first institutional round of a startup company, a board usually gets set up. Founders are represented as well as the lead Seed investor. But as the company grows and takes on financing rounds, subsequent investors will take additional board seats, while founders don’t typically do. And while the ratio usually starts at 2:1, it can quickly get to 2:3 in a few rounds — leading to VCs getting quickly overrepresented.
While everyone should have the company’s best interest in mind, as it ultimately leads to the shareholders’ best interest, short term interests may take a significant weight in decision making. Think about a strategic discussion around the best timing for a subsequent funding round for example. VCs’ agendas and ability to deploy or call capital may not necessarily be in line with the company’s best timing. And while no one realizes it, misalignment can arise.
Let’s face it: over-represented VC boards may tend to make decisions with their best interests in mind — precisely as founders could do so in their best interests as well, trying to manage some personal ego or aspirations.
To prevent such potential scenarios, it can be useful to call in someone who does not belong in any of the previous groups. And here comes your independent director.
What should you expect from an independent director?
We need to distinguish between the Must-have, in the sense that all board members would need to have these skills, and the Nice-to-have, depending on the skills gap on your current board:
Must-have:
- Neutrality is one of the things you would first expect. We just talked about it, and it’s now clear the independent director should act with the company’s best interest in mind, always. Having one on board avoids letting hidden agendas potentially rule decision making.
- Strategic advice: In addition to bringing Switzerland to your board, you should get someone that understands your business well, and that could provide some operational experience relevant to the business. Think industry expertise. This is particularly true when you operate in a complex regulated industry such as the Fintech space.
- Trust and time: Make sure this person has enough time to dedicate to your startup, and that he/she will be available to build a long term relationship with you and the company’s executives. You also want this person to be aligned with your core values. We’re not talking about selecting a mini-you, as we want skills and background diversity as much as possible. That said, core values alignment is essential to nurture respect and build something big.
Nice-to-have:
- Network: You never have enough of a network, and deep connections to a market you’re willing to tackle are essential. If your board member is a seasoned industry leader or maybe a successful entrepreneur, you would expect that person to have a strong network he or she can open to you. Think about sales, but also service providers like lawyers, accountant or other types of consulting firms, or even key hires.
- Mentorship: While all board members can help mentor a founding team, an independent board member can be the person who asks different types of questions through more casual or less formal conversations. That can be key to a more sane management team.
- Operating advice: Think about someone who grew a company already, knows what it takes to go from Seed to Big Company, and can share process or management best practices with you.
In addition to filling out your board’s skills gaps and looking for professional diversity, also think about social diversity as a key element. At the end of the day, board building follows the same rule as more general team building. And beyond skills complementarity, you want to get to differences of opinion and open-mindedness. Which will be further reachable the more you look for gender, nationality, or even age diversity.
When should I suggest this addition to the board?
Prepare, but don’t panic. Take your time to find the right person. As always in business, you want to find someone who will best fit in — and not necessarily the biggest name.
And while it’s mandatory for public companies in numerous jurisdictions to have an independent director, it is not the case for private companies. As a startup, you can wait until the IPO to formalize your board from a legal perspective. Which means you have plenty of time to pick the right person!
Nonetheless, starting to add independent directors to your board early-on can be helpful for all the above-listed reasons. It usually starts in the second round of financing but can happen earlier if needed.
Take Descartes Underwriting for example. After we led its Seed round back in February 2019, the company appointed Gaelle Olivier as an independent director. Gaelle has 25 years of experience in the financial services industry and currently serves as Societe Generale Asia Pacific’s CEO. Before joining SG, she spent 20 years at AXA where she held several senior executive roles, 10 of which in Asia — across Japan, China, Hong-Kong, South-East Asia, and India. In 2017, Gaelle decided to leave AXA to focus on the support of startups specialized in data and innovation. Her industry expertise, knowledge of the Asian market, and deep interest in innovation and startups are essential to the development of this insurtech.
How much should this member be compensated?
Board members’ compensation typically varies by stage and from one company to the other. The beauty of the private world is that there is no real norm, and as often: it depends.
Investor board members are representatives of the VC funds they work for, and that’s part of their job to serve as board members. As such, they are not compensated. Apart from the typical out-of-pocket expenses, some funds are not even charging back to the company- and the Directors and Officers (D&O) insurance.
However, it is common for independent board members to get compensated for their time and services. This package usually takes the form of equity. As a reference, early-stage companies would offer somewhere between 0.5% and 1% equity. This number would then drop as the company grows. This equity will typically vest over 3 or 4 years, at the same pace management is vesting his.
In a few cases, packages can include cash compensation, but it remains rare and happens at a later stage.
