Founders should not underestimate the value of a well-constituted board of directors.

The board of directors has tremendous significance to a startup company. While the company’s management team is responsible for day-to-day business operations, the board of directors is ultimately responsible for making the most critical decisions that face the company, and must also approve any and all issuances of the company’s equity securities, including securities convertible into equity such as options and warrants. In addition, should a company wish to adopt an equity incentive plan to incentivize its employees or others, the board of directors must approve the plan and determine the fair market value of the company’s shares of common stock underlying any stock option awards. 

1. Board Formation

Under Delaware law, a company’s initial board of directors is formed upon the filing of the company’s certificate of incorporation, if the board members are named in the certificate of incorporation. More often, the board is appointed by the incorporator of the company simultaneously with or immediately after the filing of the certificate of incorporation. The board serves at the pleasure of the stockholders, who can remove and elect individual members by majority vote (unless otherwise specified in the company’s governing documents or in agreements among the stockholders). 

The board serves at the pleasure of the stockholders...

Typically, the initial board consists of one or more members of the founding group. Initially, the board should be kept small and consist of either one or three individuals. A board that is much larger than three members in the company’s early stages can quickly become unwieldy as the company evolves and raises outside capital; the company’s investors will often negotiate to designate a member of the board, adding at least one member to the board in each round of financing if a then-serving member does not resign. A board that consists of an even number of directors can lead to deadlock and stagnation; although some states permit a company to provide for different voting structures in its governing documents, the general rule remains one person, one vote.

2. Taking Action

Generally, the board may take action in one of two ways – either by majority vote at a meeting at which a quorum (a specified minimum number of board members) is present, or by the execution by all board members of a written consent detailing the matters being approved. If a board vote at a meeting results in a tie, or if less than all of the board members sign a written consent, the company would not be able to take the action sought to be approved.    

3. Skillsets

It is important that the board consist of individuals with varied skillsets. Ideally, the founding team fulfills this need, but if the founders do not possess one or more critical skills deemed to be necessary for the company’s early success, the company may look to fill out its board with a member from outside of the founding group, such as an expert in the company’s industry. Such an independent director is often an investor requirement by the time a company raises its first or second institutional round of financing, and often this issue does not present itself until that time, at which point the board begins to shift from founder control to investor control.

It is important that the board consist of individuals with varied skillsets...

Many founders seeking the guidance of industry experts, but wishing to keep the board under founder control, choose to create an advisory board. Such an advisory board can offer the company valuable guidance without the authority to bind the company or the obligation on the part of the company to follow the advisory board’s guidance.

4. Financing

If the company plans to raise capital in a standard preferred stock financing such as a Series Seed or Series A transaction, the lead investor in such a deal will usually require the right to designate a representative to the company’s board. In this scenario, the designating investor or investors will insist on documenting its or their designation right in a shareholders agreement among all shareholders of the company, generally referred to as a voting agreement. The shareholders, or voting, agreement would terminate if and when the company consummates an initial public offering, at which point the company will be subject to public company governance standards, including those that govern how the board members are selected. 

A typical board after the company’s first round of financing would consist of three members, with the founders having the right to appoint two members, and the lead investor having the right to appoint the other (one or more of the initial board members may have to resign in connection with a financing in order to keep the board at a reasonable size). Despite this seemingly lopsided board constitution favoring the founders, the negotiated financing documents will contain protective provisions and other voting requirements, and these serve to even the playing field.

Over time, the founders can lose control of the board as the company raises subsequent rounds of financing. For this reason, among others, finding the right investors is critical to a company’s development. Practice pointer – investors may wish to tie a board seat to the then-current CEO, which means that even if the CEO is a founder that has been on the board since the company’s formation, that founder can lose his or her board seat if removed as CEO by the board (the board has the authority to hire and fire the executive officers). 

5. Fiduciary Responsibility

It is important to remember that board members have fiduciary responsibilities to the company and its stockholders. This is true even of the members of the board appointed by the company’s investors – those board members have legal duties to look out for the best interests of all stockholders, not just the investor or investor group that appointed him or her. In order to fulfil these responsibilities, each board member has an affirmative obligation to be informed. Successful companies hold regular board meetings so that the company’s management team can discuss with the board the company’s finances and results of operations, as well as any other important matters that the management team would like to bring before the board for the board’s consideration or approval. Boards that consist solely of the founders often meet more or less informally, but companies that have raised venture capital or other institutional financing can expect to be required to hold regular formal meetings on a quarterly basis, if not more often. 

Founders should not underestimate the value of a well-constituted board of directors. Board members challenge management, they offer industry insights and often have relationships with potential investors, customers, acquirors and strategic partners. Board members with varied skillsets can complement management, especially in an early stage company. In addition, recognized industry or technical leaders on the board enhance a company’s reputation and inspire confidence in management, the marketplace and among potential investors.

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[A partner at McCarter & English, Joseph Ferino’s practice includes all areas of transactional and securities law, with particular emphasis on representing early stage and emerging growth technology companies and the investors who support them.]