Dear reader,

Welcome to the February 2014 edition of The Director’s Dilemma. To read this email in your browser, go to www.mclellan.com.au/newsletter.html and click on ‘read the current issue’. It seems like only yesterday that I was writing to you with the first newsletter for 2013 and now it is time to wish you all the greatest of success for the following year. I really enjoy each issue and the chance to discuss real life board scenarios with such a knowledgeable and insightful group of fellow governance practitioners.

Like most of the true situations the case study this month came to me from one of our readers; he had lived through this precise situation and felt that it had gone ‘less than optimally’. Hopefully the various different ideas in the discussion will assist him to be better prepared in the future. Feel free to email me with dilemmas of your own encountering and articles of interest about boards and governance. By sharing our problems, ideas and experience we can all advance.

This month our case study considers the particular requirements of fast growth entrepreneurial boards. 

Consider: What would you advise a friend to do under these circumstances?

Daniel is an experienced company director and, after many years on the boards of the largest listed companies, has been asked by his nephew to advise on the formation of a board for the nephew’s start-up company. The nephew has an ambitious business plan to list the company within two years.

Daniel has never been on the board of an early stage company and has no start-up experience potential problem so he asked around and found two conflicting theories: 

The first theory was that the nephew should keep the board as small as possible and have a group of experts whom he could use as a reference source in an advisory board without any governance role. This would allow the nephew to maintain the maximum control for the longest possible period, growing the company and then attracting a good board immediately prior to listing.

The other theory was that the nephew should put together the best board that he could attract so that, upon listing, investors would have a board with experience of governing that company and with credentials suited for a listed corporation.

Daniel can see the logic in both arguments. He knows that as an experienced board member he would prefer to see a good track record before joining the board but also that it is important to build a company for the future and to have infrastructure, including a board, to accommodate the next phase of growth rather than just the current situation.

What information should Daniel seek to determine how to advise his nephew?

The two approaches serve two different needs both of which should be addressed. A committee of advisors serves him, the CEO and currently I assume sole owner. A board of directors serves the shareholders.

The nephew should first recruit a committee of advisors on start-up, management for success and IPO development. He wants to build the start-up not only for success, but also to be attractive to potential shareholders, he needs advisors that can support him in this dual process of managing for business success and developing for an IPO. Development for IPO should include developing the governance model and recruiting a credible board of directors.

A board of directors should not be thought of as advisory to management. A board of directors’ fundamental responsibility is oversight of shareholder investment. A board of directors’ responsibility is to set expectations of management and hold management accountable. Advising on management can be a distraction from oversight and any board involvement in management should be considered secondary to oversight and can conflict with oversight.

Management advisors work for and are accountable to the CEO. Their job is to support and advise the CEO on what the CEO wants and needs to do. A good board of directors should expect their CEO to have or access expert advisors as needed. Some of the advisors may transition into the Board of Directors when that stage is reached. When they do they cease to serve the nephew and begin to serve the shareholders present and future.

Al Errington is an entrepreneur and governance advocate based in Ontario, Canada.

Daniel can help by being a sounding-board for the founder and giving an advanced governance perspective which will help clarify long term strategies.

Daniel needs to understand the company, its markets, prospects and need for cash. These affect the type of investor, timing and quantum of investment required. If the nephew requires pre-IPO funding he will need a strategy to attract the right kind of investor. If the business is able to grow with capital injections he may not need to list. If there are any additional shareholders their views, also, should be taken into account.

It is not clear what governance arrangements exist now. Early stage investors may request a board seat to safeguard their investment and, sometimes, contribute to the development of the company. They may attempt to act in their own, rather than the company’s, interests. A desire for dividends or share-price appreciation, listing or trade-sale etc. could conflict with the founder’s plan.

Daniel can identify and help manage conflicts of interest.
Friends and family often join early stage boards. They may not thoroughly understand their governance role. Daniel can help to clarify this.

Daniel should spend quality time talking with his nephew about what success would look like, how fast the company should grow, what products or services it will (and what it won’t) provide, how many people will be involved, what the culture will feel like, what geographic scope is envisaged and, most important of all, how much control the nephew wants. He should encourage him to be as specific as possible. Daniel must understand the desire for listing. If it can be avoided or deferred then it possibly should be. The nephew must understand his options and make choices to improve his chances of success. He may have to choose between listing and control based on his own preferences.

Not all CEOs or chairmen of listed companies are happy!

Julie Garland McLellan is a practising non-executive director and board consultant based in Sydney, Australia.

Daniel should seek experienced directors of start-up companies to learn about their idiosyncrasies and listen to their war stories. He should read about start-ups and ask VCs, private equity players and brokers for their experience with start-up boards.
Start-ups are full of twists and turns, colourful journeys, myriad failures and a few triumphs. They are not for the faint hearted. Many directors of big companies have no skills, experience or desire to join them.

From this research Daniel should determine the key needs and how the “disasters” that befall start-ups may be averted or alleviated by a board. Then he can think about optimum board composition to operate effectively.

Daniel should obtain advice on how long it takes to get a start- up company ready to list. Companies that list too soon often do not get interest from the market and may flounder. He needs to determine how long the company has been going and what progress it has made. The nephew may have an ill founded dream or “get rich quick” desires. These ambitions are common and boards must halt unrealistic or avaricious attitudes.

There are issues with small boards which allow the founder to maintain the maximum control for the longest possible period. The approach is not well viewed. Founders can have strong egos and controlling natures. They may view the company as their own, without due regard to other shareholders. This can be exacerbated if they have a large shareholding.

Daniel should ask how start-up boards are remunerated and motivated as this influences the availability of board members. Typical start-ups are cash poor and have issues with board fees. Board members are generally paid little but rewarded with equity. Before they sign up, potential directors need to be aware of the solvency position and satisfy themselves the company has sufficient potential to be built into a viable business.

Daniel should investigate forming a larger board with bigger “names”, able to take the company through to an IPO.  Forming the best board possible has merit, but it should be based on what is required at the time and not simply for listing. The board can and should be changed as the company evolves.

The best start-up board may not be the best board for an IPO.

Another area to investigate is the skills required for this stage of the company’s development. Typically these include governance, strategy, raising capital and managing risk. In addition board members may mentor founders. Board members need to “roll up their sleeves” and do things that non-executive directors of listed companies would not do. Once the company seeks to list, directors may be added for specific skills or to help sell the company in the IPO. Once listed, the board functions typically change placing more emphasis on governance and risk management; less on day to day involvement.

Thorough research will help Daniel to understand start-up boards and provide guidance to his nephew.

Alison Coutts is Chairman of NuSep Ltd, Director of Data Dot Technology Ltd and a former founder of Emerging Growth Capital. She is based in Sydney, Australia and consults on capital raising for emerging companies.

The opinions expressed above are general in nature and are designed to help you to develop your judgement as a director. They are not a definitive legal ruling. Names and some circumstances in the case study have been changed to ensure anonymity. Contributors to this newsletter comment in the context of their own jurisdiction; readers should check their local laws and regulations as they may be very different.

Book Review -  Achieving the Execution Edge - Chris Bart and Elliot Schreiber This little book is seriously concentrated wisdom. In just 64 useful pages it gives boards all they need to enable thoughtful and value creating analysis of strategy implementation. I am so glad that Richard Leblanc recommended it to me. It will be a staple in my board and consulting work. It is such a sad, and yet horribly true, fact that most strategies are well intentioned, look great in the planning document and fail miserably in implementation. Shareholders appoint directors to make sure the company does what it is supposed to do; not to have interesting and entertaining strategy retreats that result in beautiful planning documents. This book will give directors the tools they need to meet shareholders’ demands for successful action. Available at Amazon.com in kindle and paperback editions.

Inspirational quote -

I have subscribed to a service that delivers an inspirational quote every day. It is a good way to get into a positive frame of mind for the work day ahead. I thought I would share my favourite quote each month. This month my favourite quote was:

"Remember not only to say the right thing in the right moment, but far more difficult, is to leave unsaid the wrong thing in the tempting moment."
~Benjamin Franklin

Oh dear - not a lot has changed since 1790 and I am guilty of succumbing to temptation far more often than I should. This quote will form my new year’s resolution for 2014. It is advice all directors could heed.

If you would like to subscribe the service is run by Darren La Croix at: https://365inspirationalquotes.com/.

This newsletter - If you have any ideas for improving the newsletter please let me know. If you are reading a forwarded copy please visit my website and sign up for your own subscription.

Suggestions for dilemmas - Thank you to all the readers who have suggested dilemmas. I will answer them all eventually.

Farewell until the next issue (due 1 March 2014).

Enjoy governing your corporations; we are privileged to do what we do!

Best regards,
Julie