When forming a Delaware corporation, one of the first decisions you’ll need to make is who will be on your Board of Directors.If this is your first time forming a corporation, you may even be wondering what a Board of Directors is and why you need one.
Delaware corporations are required to elect a Board of Directors shortly after incorporation, and as soon as the company has its first shareholders. This is because the Directors are appointed, in large part, to protect the interests of the company’s shareholders. The number of directors constituting the Board is determined either in the company’s Bylaws or in its Certificate of Incorporation, which is also where any restrictions or requirements on the directors, or the shareholders entitled to vote for them, are ascribed.
Under Delaware law, the Board of Directors is tasked with managing the business and affairs of a corporation. While a company’s officers, like the CEO, COO, and CFO, are tasked with managing the day-to-day operations of the company, the Board maintains macro oversight over the company and controls the company’s major business decisions. The Board is even required, under Delaware statute, to approve or authorize certain decisions of the company, such as issuing new shares of stock, entering into a merger or acquisition or similar transaction, and dissolving the company.
Starting Out: Keeping the Board Small
When a company is first formed, it is common for the founders to be the only shareholders, and to have one or all of them fill the statutorily required officer roles of President, Secretary, and Treasurer, as well as the management roles of CEO, COO, CFO, etc. It is this group of early shareholders who are responsible for determining the size and makeup of the company’s first Board.
As with all decisions for an emerging company, a key consideration for building your first Board is how to structure the Board in a way that allows you to stay nimble so that you can pivot and scale with limited impediment. At the company’s earliest stage, the Board has its smallest impact; of course, you will need the Board’s approval to issue new equity, or to create an equity incentive plan, but the vast majority of decisions will be made by the company’s officers. It is with that in mind that we typically recommend that a startup’s first Board be comprised of only one director. This person is usually the primary founder of the company, or the founder with the largest financial and/ or equity stake.
Some co-founders feel uncomfortable with a one-person Board as it may feel like an unequal distribution of authority or control. And from a founder’s perspective, that can certainly be a concern, especially if all of the earliest shareholders are not aligned on the overall vision for the company. It is for this precise reason that Delaware law provides for checks and balances, and many of the decisions that must be authorized by the Board under Delaware law, must then be approved by the company’s stockholders: there are protections in place to ensure that the company is not a runaway train with a power-hungry conductor. Still, there are other options if the founders are vehemently against a one-person Board. If a one-person Board is not for you, then normally the next best option is a three-person Board. Ideally, all three members will be stockholders, and actively involved in the day-to-day operations of the company. This size still allows the Board to be flexible and to move quickly on the business decisions that matter most, and it also prevents any decision-making deadlock that can come along with a two-person Board.
Finally, some early-stage companies will consider placing an advisor on the company’s first Board. While advisors can bring a tremendous amount of value to a new company, especially in the areas of the business in which the founders lack experience, a company can get advisor input without giving away the control that comes along with placing an advisor on the Board. It’s common for companies to set up “advisory boards” which, despite the name, do not act as a controlling authority for the company. Instead, they contribute limited amounts of time and strategic input to the company and its founders, in exchange for a small fee or a fraction of the company’s outstanding equity.
Growing Your Company and Your Board
As a company grows, the founders’ ability to control the Board and all of the company’s day-to-day decisions will begin to soften. At each early financing round, investors will begin to negotiate certain information rights. This can be as simple as quarterly access to the company’s financials, or a Board Observer seat, which allows an investor appointee to sit in on all Board meetings, and to receive all Board-specific correspondences and materials. By the first instance in which the company sells preferred stock to accredited investors (usually, in a Series Seed or a Series A financing, the company’s first “Priced Round”), it is common for at least one investor to have negotiated a Board seat be appointed by that investor, or the group of investors that they represent. While this level of outside control can feel foreign to some founders, it makes sense that an investor would want authority to monitor and weigh in on large corporate decisions to protect the value of their investment in the company (and, as we know, the whole purpose of a Board is to protect the interests of the company’s shareholders).
As your Board begins to grow, the size at which you started will have a large impact on where you land. If you started with a Board of five founders, an investor may not feel like one Board seat is adequate to protect investors’ interests, and the investor may request two or three Board seats. All of the sudden, your lean Board will have a number of new voices and opinions that must be heard and considered before the company can act. If the company started with a single founder Board member at the outset, one new investor Board member is typically sufficient, and you’ll be better situated to keep your Board tight as you continue to grow and scale. This is not to say that any particular Board size is too large, but the Board will continue to grow as the company continues to accelerate and raise capital, so it’s important to try to grow your Board at a pace that is commensurate with the growth of the company. An early-stage company does not want to be overly burdened by the administration of the Board during the lean years when it is critically important for the company to move quickly.
Beyond the investor Board members, once you start raising capital you may also begin to consider introducing independent Board members. These are typically individuals who are not employed by or affiliated with the company or any of its investors. Independent board members can be a strong asset to the company, as they are impartial voices or decision-makers without a vested stake in disputes which inevitably arise. Independent Board members typically also bring strategic value to the company in experience and expertise that the Board may be otherwise lacking. And, if you have an even number of founder and investor directors, they can give your Board the odd number that it needs to avoid a decision deadlock.
Every company is different, and there’s no one-way or right way to structure a Board. But in order to ensure that your Board adds value, rather than impedes progress, it’s important to always be mindful of your Company’s vision, and how you can get there with the least resistance from the governing body established to shepherd it.
