Picture this: a young entrepreneur raises $1 million for her start-up. Investors require a fiduciary board of directors to be formed, to protect their interests. The start-up suddenly has a three-member board, including the CEO, that supplants the previous advisory board.
The Chair coaches the CEO on governance structures and they jointly develop a board pack that satisfies directors and management. A board-meeting schedule is implemented, and the founder is accountable to a board and investors and has extra governance work.
Before long, the board pack degenerates into a short operational review from the CEO, a cash-flow statement and minutes of the prior meeting. Financial reporting is limited, supporting documentation for decisions is not included and nothing in the board pack is cross-referenced with previous papers.
Worse, directors receive the board pack the night before the board meeting, leaving them unprepared for discussion and frustrated with management.
Directors complain to the Chair that management is not providing enough information to make decisions. Legally bound by director duties in The Corporations Act, and with their reputation and the interests of investors on the line, they rightly want extra detail in the board pack.
That strains relations between board and management. The founder is effectively CEO, chief operating officer, chief product officer and chief marketing officer at once. She has limited capacity to produce detailed board packs and there is no in-house company secretary.
Tensions peak when a director asks the founder for written information on the start-up’s cybersecurity policy. The founder, already working 18-hour days, is furious at the request. She thinks the information is a luxury at this stage of the start-up’s lifecycle.
With relations stretched, the founder becomes less transparent with information. She knows the board cannot keep up with a venture that is rapidly discovering its business model and customer base as it scales the opportunity.
Challenges of start-up boards
Welcome to the world of start-up governance. A world where hyper-growth ventures can change direction at short notice, where directors often make decisions when they do not have all the information and where internal resources to help boards are often stretched.
Not all start-ups, of course, go the way of the above scenario. Some make a smoothless transition to boards, benefit from the counsel of directors and lay strong governance foundations to scale the venture. But start-up governance can be tricky.
Holger Arians knows this world well. The start-up expert has served on several boards of emerging ventures, mostly in an advisory capacity. As CEO of Dominet Digital Ventures, an investor in early-stage ventures, he deals daily with high-growth emerging companies.
Arians says directors of large organisations can underestimate the speed at which start-ups operate. “A start-up could fundamentally change its direction in the six weeks between board meetings. Directors who rely on traditional board approaches and meeting cycles to govern disruptive start-ups find out too late to fix problems when they arise.”
Start-up boards, says Arians, should embrace the uncertainty of disruptive ventures.
“The board must accept that the start-up is trying to find the best product/market fit and is constantly experimenting and adapting. Directors can’t only rely on board meetings and board packs to make decisions. Some governance formality is required, but ultimately directors of start-ups must be prepared to be a lot more hands-on, so they can make quick decisions.”
Start-ups can be a governance conundrum. Although the term “start-up” is widely used, there are significant governance differences in the lifecycle of emerging ventures.
An early-stage venture, for example, will typically have an advisory board over a fidicuary board of directors. The unlisted venture, usually funded by the founder, friends and possibly small investors, is often discovering its customer base and best business model. It hasn’t sought larger amounts of capital to scale the opportunity because it is still validating the idea.
An expansion-stage venture, in contrast, has proof of concept, has de-risked its technology and has small but rapidly growing revenue. The venture seeks capital from professional or high-net-worth investors, forms a board of directors and implements governance structures.
As the business grows, more capital is needed, so the venture seeks admission on a stock exchange through an Initial Public Offering. The board expands, and more formal governance structures are implemented now that the organisation is under the stockmarket’s glare, ASX Listing Rules and continuous disclosure requirements.
Each scenario presents boards with a common challenge: entrepreneurship requires management and governance in conditions of high uncertainty. Yet emerging ventures have fewer resources to provide information to boards to reduce this uncertainty.
Understanding the nuances of start-up information
Dr Katherine Woodthorpe, FAICD, has long experience in start-ups and governance. She is the former CEO of the Australian Private Equity and Venture Capital Association; a non-executive director of Sirtex Medical; chair of two co-operative research centres, and of Fishburners, a leading provider of co-working space for start-up ventures.
Woodthorpe says start-up boards must win the founder’s trust. “Start-up founders may not have worked with a board or understand the distinction between board and management. Sometimes, they are wary about sharing information on the venture with directors they are not yet familiar with. So, they hold information very close to their chest.”
Start-up boards can cause problems, says Woodthorpe. “Some start-ups have inexperienced boards or directors who come to the start-up from a management or board role at a large organisation. They don’t understand the nuances of start-ups and they struggle to make decisions because everything moves faster and there is less information to go on.”
Woodthorpe says start-up board packs tend to be much shorter and focused on near-term opportunities and issues, compared to board packs in larger organisations. “There’s a lot more focus on monitoring the venture’s short-term cash position, sales, cash-flow projection and R&D spending. The venture’s cash burn rate is often analysed to the nearest minute.”
Woodthorpe says good start-up boards coach management on governance expectations and structures. “The starting point is ensuring the founder understands that directors of fidicuary boards have significant legal responsibity and are within their rights to ask for, and expect, the right information from management to make decisions. The founder is no longer dealing with an advisory board that is there to bounce ideas off or help the organisation through its members’ networks.”
The next step is agreeing on the board pack’s structure, timing and board-meeting cycle, says Woodthorpe. “The Chair needs to help the founder/CEO allocate resources for the board cycle. It’s mutually agreed as to what information is required and when it will be delivered. I’ve seen start-ups over the years that give the board pack to directors on the night before the board meeting. Or provide a quickly written, short board pack because management is too stretched.”
Woodthorpe says directors from large organisations should consider how they can tailor governance processes to the start-up. “You can’t slow down the start-up with layers of reporting and governance structure. You need to ask what the board can do to fulfil its compliance requirements while freeing up as much time as possible to focus on the opportunities and challenges that matter most to the venture. It’s all about balance.”
Pushing back on poor board information
Theo Hnarakis, FAICD, chairman of ASX-listed companies Crowd Mobile and DropSuite, says directors must resist giving too many governance concessions to start-ups. Hnarakis is a former CEO of Melbourne IT and one of Australia’s most experienced directors with start-up tech companies and boards.
“If a small listed tech company is changing its business model every six weeks, it frankly shouldn’t be listed,” he says. “The venture should probably be private and have an advisory board rather than a formal board of directors. Once the venture is listed, it must expect to have a more formal governance structure and provide more information for the board.”
Hnarakis says start-up boards must be clear on the venture’s strategy and its performance levers. “Then you work backwards to structure information in board packs. If you know business development is a key driver of the organisation at this stage in its lifecycle, you have more information on that in the board pack and extra time for discussion on that topic.”
Start-up boards that Hnarakis chairs have a heavy focus on sales. “It depends on the organisation, of course, but boards I’m on spend a significant amount of the meeting discussing sales targets and prospects, conversion rates and sales timelines. Directors of large companies might not be used to discussing things in this detail in board meeting or being as hands-on.”
Hnarakis says 50-100-page board papers are appropriate for start-ups (some large organisations have board papers from 500 to 1000 pages). His board packs require a CEO summary, reports from division chiefs in the organisation and financial information with an emphasis on cash flow. The CEO presents to directors on the venture’s highlights and challenges during the board meeting.
He says about 90 per cent of the board meeting is on strategy/performance: 10 per cent on compliance. A typical board meeting runs for three hours in organisations Hnarkis chairs. In addition, he has a weekly or fortnightly call with the CEO and updates the board as needed.
“You can’t bog the venture’s management team down in long meetings. Even three hours can be a big time investment for a CEO who is running a high-growth venture with stretched resources. Start-up boards must add value to the CEO and not just be there for compliance.”
Hnarakis says start-up Chairs must manage information requests from directors. “You don’t want a director who wants to be seen to be doing a good job asking management for information that is not critical. I ask if this request is a ‘must have’ or a ‘nice to have’. If it’s not essential, the Chair should push back on directors so that management is not distracted.”
Validating information from the founder/CEO is equally important, says Hnarakis. “Obviously, you must trust the CEO, but you can’t view all board information only through the CEO’s eyes. You have to eyeball the rest of management and encourage other executives to give honest feedback about company performance, even if the CEO does not always like it.”
Hnarakis adds: “The board must be satisfied it is getting enough information to make decisions, in the context of a start-up. If the board feels uncomfortable it should push back on management and say it can’t make the decision until it has the information it requires. Directors cannot and should not make decisions on the run, just because it’s a start-up.”