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Governance 101

Early-‐ and Growth-‐Stage Tech Companies

Dave Litwiller Execu>ve-‐in-‐Residence

March 5, 2014

Important Disclaimer This presenta>on is made with the understanding that the author is not engaged in rendering legal, accoun>ng, securi>es, or other professional services. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.

Copyright, David J. Litwiller 2014 3

Overview

•  Board of Directors and Board of Advisors

•  Roles and responsibili>es of directors

•  Building, managing and evalua>ng the Board of Directors

•  Evolving governance at the speed of a rapidly changing business

•  Director compensa>on


My Background •  Twenty+ year opera>ng trajectory in early-‐, growth-‐ and

scaled-‐up tech companies in the Waterloo region –  R&D; marke>ng and sales; manufacturing; finance and accoun>ng; HR;

general management; acquisi>ons, dives>tures and turnarounds

•  Board director of three early-‐ and growth-‐stage companies; two in enterprise SaaS, and one in photonics instrumenta>on

•  Board observer to several other technology company boards

•  Advisor to many technology start-‐ups spanning soYware through clean energy and medical technology


Board of Directors vs. Board of Advisors

Directors Advisors

Choice of Members By shareholders By management

Purpose Oversee business affairs Advise as requested

Obliga>ons Under Statutory and Case Law

Yes: CBCA, OBCA, BIA, OESA, others

No

Agenda Sets own Set by management

Power to Hire and Fire Yes: CEO; appoints officers No

Liability Significant and growing Lible

Du>es Fiduciary, care At convenience of management

Compulsory Disclosure of Business Informa>on

Yes No: informa>on can be selec>vely disclosed

Time Commitment 250 to 450 hours per year Flexible, by mutual accord


Board of Directors (BoD)

Duty of Loyalty (Fiduciary Duty) •  To act honestly and in good faith with a view to the best interests of the corpora>on – Unqualified priority to the corpora>on over personal interests or other compe>ng claims

– Act openly and honestly – Disclose significant informa>on within his/her knowledge

– Maintain confiden>ality of the corpora>on’s informa>on

–  Exercise independent judgment – Act with one voice outside of the boardroom


Duty of Care

•  To exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances – Act in good faith – Act ra>onally, reasonably and on an informed basis

–  Iden>fy and act upon problems which should have been apparent

– Follow reasonable processes and prac>ces


Further Obliga>ons

•  Inform and Advise Shareholders – Provide shareholders with all material informa>on rela>ng to mabers for which shareholder ac>on is sought


Standard of Performance •  Due Diligence

–  Informa>on access and review – Delibera>ve process –  Reliance on experts and independent authori>es when appropriate

–  Record proceedings

•  Business Judgment – Act in a manner reasonably believed to be in the best interests of the corpora>on at the same >me as fulfilling other du>es


Leading Prac>cal Issues

•  Mentoring CEO – Support and appraise –  If necessary, remove and replace

•  Never running out of cash •  Delibera>ng strategic shiYs •  Selling the company; building buyer value

– Next round investors, liquidity event •  Shareholder communica>on


Director-‐CEO Rela>onship

Good Directors: •  Indicate important ques>ons in advance of mee>ngs to the chair and CEO

•  Don’t always demand more data to make a decision

•  Forewarn the CEO about the director’s stance on major issues

•  Avoid ganging up on the CEO to the extent possible


BoD Reali>es

•  It is work, and people need to be work-‐like

•  Liability is significant – Good directors will require D&O insurance

•  The board needs to collec>vely be knowledgeable about all salient aspects of the business and its context, even though individual directors’ skills can be more narrow


BoD Reali>es •  All directors need to be engaged, ac>ve contributors, and documented as such

•  The risk tolerance of directors needs to match the risk profile and stage of development of the business

•  Lible staff or management board support bandwidth; this isn’t like blue chip company governance


Evolving the BoD -‐ General •  Term limits, typically three years

•  Current directors and officers rou>nely networking to develop director candidates

•  Periodic board self-‐assessment to iden>fy weaknesses and skill gaps as the basis for targe>ng new nominees and beber prac>ces

•  Lead director or non-‐execu>ve chairman (not the CEO) to provide improvement feedback to other directors


Evolving BoD Skills with the Stage of Company Development

Company Stage

Typical # of Directors

Typical Director Mix

Key Skills

Concept 1 1 Founder Business forma>on, F3 funding, early customer and technical discovery

Seed and Start-‐up

3 1 Founder 1 Investor 1 Independent

Recrui>ng, technology, opera>onal set-‐up, angel/VC funding, ecosystem rela>onship development cri>cal to success over next 18 months

Growth 5 2 Founders 2 Investors 1 Independent

Commercializa>on, opera>onal refinement, ins>tu>onalizing know-‐how, scaling, growth finance, working capital management, interna>onal reach

Late Expansion

7 2 Founders 2 Investors 3 Independents

Increasing financial sophis>ca>on, acquisi>on or IPO savvy, governance discipline, reduc>on of surprises


Changing Nature of BoD Issues Company Stage

Sales AccounAng Legal

Seed •  Customer discovery

•  Managing by bank statements

•  IP: rights, deadlines, chain of >tle & assignment, licenses

Start-‐up •  Early sales •  Strengthening

value prop •  Compe>>ve

strength

•  P/T bookkeeper •  Monthly I/S and B/S •  Tax returns done •  Source deduc>ons

made and remibed

•  Director resolu>ons to approve equity rights grants

•  Complete minute book •  Material contract review

Growth •  Accelera>ng growth

•  Revenue predictability and quality

•  Rising efficiency

•  F/T CFO •  Audited financial

statements •  Annual forecasts

with predic>ve value •  Variance review

•  Records management •  Compliance •  Risk management •  Li>ga>on, real or

threatened, especially employment, partner, and IP


High Impact Board Prac>ces Company Stage

PracAce Helps

Seed and Start-‐up

•  Prospec>ve hindsight •  Reference class analysis •  Pre-‐commitment •  Commitment limits

•  Manage risk, coaching, coach-‐ability •  Reduce sampling and intui>on errors •  Catalyze learning, an>dote groupthink •  Counter decision driY & confirma>on bias •  Do more with less; pivot effec>vely

Growth •  Execu>ve sessions •  CEO and management

performance feedback •  Agenda effort

•  Independence of board •  Correct quickly and early •  Keep up spirited inquiry in the most

impacnul areas

Late Expansion

•  Con>nuous improvement of governance

•  Methodical director onboarding

•  Evolu>on of the BoD as a self-‐regula>ng body

•  Accelerates >me to full individual and group produc>vity, facilita>ng renewal


BoD Advice (I) •  There’s no shortcut for spending the >me and doing a lot of reading and

networking for a director to bring an informed, independent viewpoint about a company’s strategic environment

•  Speed, decisiveness and dexterity improve with a somewhat smaller board than larger, IFF, sufficiently broad, experienced, and dedicated directors are available to span the requisite disciplines with a marginally smaller group

•  Meet eight >mes per year, in person

•  Don’t let the flurry of other business push aside a deep dive each mee>ng into the mabers which are keeping the CEO and CFO up at night, and to understand what alternate data , viewpoints and interpreta>ons exist to richen the discussion on those mabers


BoD Advice (II) •  Require board packages be delivered to directors 72 hours in advance of

mee>ng, with a cover memo iden>fying which items are informa>onal only, and those which will be deliberated and decided

•  Structure discussion so that management’s recommenda>ons are clear, yet with room for director input, but stopping short (usually) of unbounded possibili>es

•  At every board mee>ng, discuss the quality of informa>on, agenda, >me alloca>on, and delibera>on process with each director contribu>ng 1-‐2 improvements for future mee>ngs

•  Conduct brief execu>ve sessions at each board mee>ng to discuss management and board performance without members of management present, as well as who will deliver that feedback


BoD Advice (III) •  Have execu>ve management provide regular feedback on where it has

goben the most help, and the most frustra>on, from the BoD

•  In normal circumstances, use 75% of >me in the boardroom looking forward (strategic, market), and 25% looking back (finance, ops)

•  Always know the company’s financial runway, be proac>ve raising funds, and become expert in accessing alterna>ves in the financial model and capital structure to improve funding op>ons

•  Rotate which board member will take a hard stand on difficult issues as they arise, so that one person does not always take the role of cri>c

•  Designate one responsible director for the CEO performance evalua>on process, even though all directors par>cipate


BoD Advice (IV)

•  Know what is in the ar>cles of incorpora>on, corporate by-‐laws and shareholders’ agreement detailing which issues require board approval and which ones require shareholder approval

•  If there is debt in the business’ capital structure, have a summary of covenants as an appendix to each board reading package


Board of Directors Compensa>on   As a company moves towards IPO, Board of Directors op>on grants decline. The following chart presents

the low to high ranges of typical Board op>on awards (for independent Directors). Cash compensa>on is not generally employed un>l the IPO run-‐up period. Appropriate levels of cash compensa>on are highly dependent upon firm size and industry.

Extremely Rare

• Tend to be significant advisors or

mentors

• At most 1-2 Directors

Rare

• Tend to be significant advisors or

“names”

• At most 1-2 Directors

1st Independent Director

• Tend to be industry figures

• 2-3 Directors

More Common

• Tend to be industry figures,

related businesses

• 2-3 Directors

Almost Mandatory

• Tend to be industry figures,

“brand enhancers”

• 3-5 Directors

Independent Director Pre-IPO Equity Participation

0.00%

0.50%

1.00%

1.50%

2.00%

Pre-Angel Pre-Round 1 Pre-Round 2 Post-Round 2 IPO Run-Up

Equi

ty P

artic

ipat

ion

(una

djus

ted

for d

ilutio

n)

Source: DolmatConnell & Partners

Board of Directors Compensa>on For an independent director: •  Three to four year ves>ng, with the ves>ng term oYen matched to

s>pulated director term limits (typically three years)

•  One year cliff for new independent directors, no cliff for incumbent directors

•  Monthly or quarterly ves>ng aYer the cliff

•  Post-‐service exercise term of one year

•  Full accelera>on of ves>ng upon acquisi>on (since directors have a large amount of work in the run up to an acquisi>on)


Resources and Further Reading

•  Board of Directors –  Directors’ Du>es in Canada, Barry Reiter

hbp://www.cch.ca/product.aspx?WebID=3688

–  Startup Boards, Brad Feld and M. Ramsinghani hbp://www.wiley.com/WileyCDA/WileyTitle/productCd-‐1118443667.html

-‐  Angel and VC-‐Backed Compensa>on, DolmatConnell hbp://www.hr.com/en?t=/documentManager/sfdoc.file.supply&s=iQATS1TdtcHxlqC5L&fileID=1207584777466

•  Board of Advisors

–  The Four Steps to the Epiphany, Steve Blank hbp://www.stevenblank.com/books.html


Supplementary Slides: Board of Advisors

(BoA)

BoA Roles and Responsibili>es

•  Provide independent advice to CEO and management without fiduciary or duty of care obliga>ons

•  Advise and lend credence to the company in the areas most significant to success over the coming two years

•  Can be any number of members, but typically four to seven


Three Common Forms of BoAs •  Customer

–  To gain heightened voice of the customer in the company’s product and business strategy

•  Scien>fic or Technical –  To help with complex underlying science or technology

•  Business –  To gain selec>ve input on business issues from advisors without either side taking on the mutual obliga>ons or formalism of a fiduciary board posi>on


Ideal BoA Member Profile •  Expert and nearly invaluable knowledge •  World-‐class networks •  Abracts outstanding employees •  Provides an aura of success in advance of the business achieving it

•  Works hard and is responsive •  Comfortable lending name and credibility to the business, and advoca>ng on behalf of the company

•  Someone you’d love to have as a senior employee but is not affordable or abainable on that basis


BoA Nomina>on Criteria

•  Scien>fic or technical skill •  Business strategy and company building •  Product development •  Customer and sales channel development •  Business development and ecosystem rela>onships •  Regulatory wherewithal


BoA Challenges

•  Only half of CEOs with BoAs are sa>sfied with them aYer working together

•  Typical issues:

– Ongoing responsiveness – Advisors taking the >me to fully contextualize the company’s circumstances

–  Interpersonal chemistry – Self-‐interested advisor behaviour


BoA Success

•  Likelihood of construc>vely using a formal BoA: –  Highest: Tech start-‐ups requiring $ millions of funding and several years to get to revenue

•  Biotech/pharma, med devices, semiconductors, telecom/datacom capital equipment, u>lity-‐scale cleantech, advanced materials

•  Enterprises with large regulatory hurdles and risks

– Mid: •  Enterprise soYware, consumer electronics, industrial technologies

–  Low: •  Consumer web services, mobile apps, soYware-‐in-‐plas>c gadgets


BoA Advice

•  In lower investment stake businesses, formal advisors who aren’t also investors can raise more ques>ons about the business for outsiders than they help solve

•  Have an hour+ working session at the outset with a nominee BoA member to assess communica>on, thinking style, energy, and mutual fit

•  Have a wriben charter or mandate which lays out expected commitments and contribu>ons


Managing the BoA for Impact and Produc>vity

•  The BoA will typically only put out as much as the CEO and management team puts into it: –  Be explicit about the expected >me commitment and speed of responsiveness

–  Hold mee>ngs regularly, typically two to four >mes per year –  Set agendas and send materials beforehand –  Ask advisors to present on specific topics for informa>on or discussion to management and the BoA

–  Ask advisors for feedback on industry reports and management plans

–  Ask for referrals and introduc>ons –  Poll for input on point issues 1:1 as they arise –  Keep advisors up to date on the company’s progress, such as with a monthly summary e-‐mail


BoA Advice •  Set term limits, typically one to two years

–  Interest and impact typically wane over longer periods –  Forces everyone to revisit relevance and changing circumstances with

a fast growing business –  Removes s>gma of departure, par>cularly when customers or

partners are represented on the BoA –  Terms should be renewable if the rela>onship is working out well

•  To keep aben>on up, consider compensa>ng not on a retainer basis, but linked to deliverables such as mee>ng prepara>on, abendance and referrals


Renewing the BoA

•  Regularly revisit the top three things that the business needs to achieve over the coming two years –  Early stage: De-‐risk value proposi>on or raise funds –  Later stage: Drive growth, scale and cash flow

•  Ask if the BoA is helping those things happen faster than opera>ng management could on its own –  If it is, it is likely the right BoA at the right >me –  If not, it is >me to revisit skills gaps, composi>on, and even the ongoing value of a BoA
