Among the many critical components of a business at any stage of it’s life cycle is the establishment of a Board of Directors.
A Board of Directors is a group of elected or appointed individuals, called members, who jointly oversee the activities of a company or organization.
The duties and responsibilities of a board of directors is technically determined by the authorities conferred to it in an organization’s constitution and bylaws.
However, broadly speaking, a Broad of Director’s main objective is to oversee the strategic direction of an organization, and select it’s primary leader, typically the Chief Executive Officer.
The purpose of an organization's corporate constitution and bylaws is to define how many members of the board make up the Board of Directors, how the members are chosen, how often they are required to meet, their fiduciary responsibilities and what powers are bestowed to them vis a vis the company or organization they represent.
The details of the constitution are particularly important because they detail the responsibilities, policies, and procedures of the Board of Directors during events of significant change including; a corporate turnaround, hiring a new CEO, restructuring the business, or a corporate emergency when members must act as agents of change.
Here, we examine the general responsibilities and duties bestowed to the members of a Board of Directors of varying type of organizations.
Form of Organization
Depending on the type of organization the authority bestowed to a Board of Directors can differ significantly.
In an organization with voting members who select board members, the Board of Directors is subordinate to and acts on the behalf of all the personnel associated to the company or organization. The arrangement is common among private and small to medium size businesses.
In a corporation that issues stock on public markets, the Board of Directors is elected by the shareholders and represents the highest authority in the management of the corporation. Their main duty is to appoint the CEO and set the strategic goals of the organization. This is is common of large publicly traded companies.
In a corporation that does not issue stock as a form of corporate ownership, and which does not have a general voting membership, the Board of Directors represents the supreme governing body of the institution with the authority to select it's own members. This arrangement is typical of non-profit corporations.
Size of Organization
In addition to the type of enterprise, the focus of a Board of Directors will vary rather significantly depending on the size of your company or organization.
Startup entrepreneurs who have been operating their business between 12-24 months typically seek to establish a Board of Directors of between 3 to 5 members.
At this stage, the main focus of the Board of Directors is to support the CEO or the startup's founders achieve early milestones and acquire funding from a Venture Capital firm.
The profile and responsibilities of a Board of Directors at this stage include:
Founders are typically included.
Early investors are typically included.
Financial/Legal expertise should be provided.
Advisors and/or members with deep knowledge of the startup’s space should be sought.
Future investment is a primary objective.
Members should ensure that the Board of Directors fulfill its legal and fiduciary obligations.
Entrepreneurs who are leading businesses that have been operating for more than 24 months and who have raised a significant round of investment from a Venture Capital firm, typically establish a Board of Directors of between 5-7 members.
At this stage, typically called growth, the main focus of the Board of Directors is to help the CEO and the founding team grow the business as effectively and efficiently as possible, particularly if one of the strategic goals is another round of investment.
The profile and responsibilities of a Board of Directors at this stage include:
Lead investors of each round are offered a seat on the board.
Prior board members may be asked to step down to open seats to new members.
Minority investors typically become “observers”, meaning they are no longer actively involved in the boards decision making processes.
Legal counsel is or should be present at all board meetings.
Strategic direction is cynically defined and tested with clear metrics.
Members should ensure that the board fulfills its legal and fiduciary obligations.
As a company grows, the role and involvement of the Board of Directors gradually shifts from short term to long term strategic planning.
For the startup, cash and investment is the paramount concern to support operations.
But, for mature businesses, the leadership and strategic direction of the company becomes the paramount concern of it’s board members.
Historically, nonprofit boards have adopted large boards with up to twenty-five members. But the modern trend is for companies and organizations of all types and sizes to have smaller boards of around seven individuals.
Studies and anecdotes from past leaders suggest that after seven people, each additional person reduces the effectiveness of the board's group-decisions making responsibilities and processes.
Types of Board Members
When creating a Board of Directors, entrepreneurs should be aware of the different roles individuals can have on a board depending on their professional background and the level of direct or indirect involvement in the company.
The following terms represent different ways board members typically describe their membership and involvement on a Board of Directors.
A Director is simply the title awarded to a person who is a member of a company's or organization's Board of Directors.
An Inside Director is an individual who in addition to serving on a company's board, has a meaningful and/or direct role in the company or organization.
Inside Directors are typically employees, officers, chief executives, major shareholders, or someone similarly connected to the business. They often have special knowledge of the inside processes of the company, or of it’s financial and market position.
An Outside Director is an individual who other than serving on a company’s board, has no direct or meaningful connection to the organization.
Outside Directors are typically executive leaders or directors of companies and/or organizations in other industries. They are chosen because of the valuable experience and perspective the can provide to the board they serve on.
Outside Directors can be valuable for a Board of Directors because they can present little risk of a conflict of interest. They are also well positioned to keep a watching eye on the inside directors, and are better placed to objectively judge how the company is managed.
Their outside status typically makes them better positioned to handle disputes between board members, particularly between inside directors and shareholders.
The only significant weakness of Outside Directors is that they may lack familiarity with the operative issues associated to the company and it’s corporate governance.
An Executive Director is an inside director who other than serving on a company’s board also holds an executive position within the company or organization.
A Non-Executive Director is an inside director who other than serving on a company’s board also holds a formal position within the company or organization.
Shadow/de facto Director:
A Shadow Director is an individual who is not a member of the Board of Directors, but who nevertheless hold some position of authority in the company or organization.
A Nominee Director is an individual who is appointed by a shareholder, creditor or outside interest group to act on the behalf of the appointing entity as a member the Board of Directors.
Entrepreneurs should be aware that individual directors often serve on more than one company or organization's Board of Directors.
This practice can result in an interlocking directorate, where a relatively small number of experienced individuals possess significant influence over a large number of impactful companies and/or organizations.
Choosing Board Members
At the earliest stages of a business’s lifecycle, entrepreneurs have significant control over the membership of their company’s Board of Directors.
When selecting board members, entrepreneurs should be aware that above all else the board members have a fiduciary responsibility to the corporation as well as it's shareholders and creditors before all other responsibilities.
This means that board members will and should look after the interests of the company before the interests of it’s founders and executives.
This not-so-subtle reality can sometimes frustrate entrepreneurs who run into disagreements with board members, however their position is an important one for the health and viability of the organization.
After all a fiduciary duty represents the highest standard of care.
Board members who have a fiduciary responsibility owe their duty and care to the principal beneficiary, which in this case is the company and it’s shareholders. This responsibility does not include the company’s leadership, even if the organization's executives comprise part of the shareholding membership of the business.
When selecting a group or individuals to serve as a Board of Directors, entrepreneurs should take into account the following insights;
Members of the board should be appointed based on their reputation and contacts.
It is better to have strong board members than equally balanced investors.
Alignment of culture & goals is critical.
New board members should take the initiative to learn about the company.
Outside board members should be respected, trusted and of high integrity.
It is essential to recruit board members who can offer real, actionable wisdom to the company’s leadership.
Boards often function like a club. When things go bad the board can often transform into a jury.
Board members should retain their position for a defined tenure.
It is important that the Boar of Directors as a unified group and remain honest and transparent with one another on all matters.
It is often the case that an individual shareholder’s interest, or the interest of a class of shareholders, may be in conflict with the board’s responsibility to the corporation and all it's shareholders.
When this situation arises, it is important for a Boar of Directors to address the issue head on and resolve the conflict as quickly as possible so that it does not affect the operations of the business.
Board Members are typically not compensated, particularly at the startup stage. But, they should be awarded between a 0.25% to 1% stake in the company’s equity.
Individual board members of established companies typically receive significant remuneration for their position and involvement in the company. The economic rewards vary between corporations, but commonly involve an annual salary, stock options, and other benefits including paid travel, hotel and meal expenses when attending board meetings.
Inside directors typically do not receive compensation for their board position, however outside directors are usually paid for their services.
Entrepreneurs should be aware that serving on a board of directors is not a career onto itself. The individuals on a board of directors are typically professional leaders in their respective fields. Serving on a Boar of Directors should be considered a privilege and honor.
Board members, particularly outside directors should be professionals with significant leadership experience in order to provide the best possible oversight and direction for the company.
To build upon the aforementioned common responsibilities expected of a Board of Directors, the individual members of a board are tasked with participating and overseeing the following topics related to corporate governance:
Attending cyclical meetings (typically once a quarter).
Governing the business by establishing broad policies and strategic objectives.
Selecting a Chairman of the Board.
Hiring & firing the Chief Executive Officer.
Finding candidates for any vacancies on the company’s senior management team.
Setting performance targets and the compensation package of the CEO and other senior management officials.
Approving corporate strategies and plans.
Monitoring company performance relative to plans.
Ensuring the availability of adequate financial resources for the operations of the business.
Approving annual budgets.
Overseeing all risk management activities.
Monitoring the legal and regulatory compliance of the business.
Ensuring the adequacy of financial controls and disclosure.
Practicing good & efficient corporate governance.
Acting as a vested and fiduciary representative of the company.
In addition to these duties, board members have additional obligations that represent legal protections. The legal obligations board members are expected to fulfill for the company or organization they serve include:
A. Duty of Care
Represents the responsibility of board members to become informed in all the decision making processes.
B. Duty of Loyalty
Directors are required to act in good faith for the best interest of the company first, including: confidentiality, conflicts of interest, and the established corporate doctrine.
C. Business Judgment Rule
Represents a presumption that in all decision making matters, directors act in accordance with elements of the rule: being informed, maintaining good faith, practicing disinterestedness, and no abuse of discretion.
Practically speaking, anything can be subpoenaed, so board members are encouraged to stay brief, not to use names when it is not necessary, and to stick to the facts.
D. Duty of Disclosure
Represents the duty of board members to inform shareholders, directors & managers of any material information relating to the business.
Board members are required to hold all sensitive information of the business in confidence unless otherwise permitted.
F. Risk & Compliance Oversight
Represents the responsibility of board members for the oversight of all regulatory & legal compliance matters including; business conduct, anti-discrimination, health & safety, anti-bribery, and other relevant legal concerns.
G. Good Faith or Proper Purpose
Members of the Board of Directors are required to exercise their powers for a proper purpose, or in good faith, for the interests of the company as a whole, and not for particular or individual parties within or associated to the company.
H. Unfettered Discretion
Represents the ability for Board members to be unbound to any particular vote or decision made in a prior meeting. This allows board members to vote freely on any topic, and differently should the same topic present itself on more than one occasion.
I. Conflict of Duty & Interest
As fiduciaries to the company, board members are not allowed to position themselves in a situation where their personal interests are, or become, in conflict with the interests of the company.
This includes transactions between board members and the company, the use of property and information of the company outside of board meetings and other events directly associated to the business. In addition, Board members cannot directly compete with the company by serving as a board member, executive, or advisor of a competing organization.
All of these responsibilities and obligations effectively guide how board members approach the important oversight duties bestowed to them by the company.
With the responsibilities of board members established, entrepreneurs should take make note of the variety of topics a Board of Directors will likely address during the lifecycle of a business.
The following visual offers a broad overview of the common and diverse topics board members will likely oversee, debate and approve during their tenure.
Each of the following boxes corresponds to the topics which are often discussed and debated by board members during a single board meeting.
Common Board Topics
I.S. = Income Statement
B.S. = Balance Sheet
C.F. = Cash Flows
The efficiency and productivity of board meetings is determined by the tone set by the Chairman of the Board of Directors.
Therefore it is important that board members always select a Chairman who is not only experienced, authoritative and representative of the board and the company, but who is also proactive and committed to efficiently operating board meetings.
The Chairman of the Board should be absolutely committed to getting the most out of each Board meeting because they are only scheduled to occur between 4-8 times a year on average.
Board Questions & Concerns
To provide further insight into the typical concerns board members have of the company they are responsible for overseeing, entrepreneurs should make note of the following standard board questions.
Typical Board Member questions include:
Do we agree with the strategy of the company? And, are all board members in agreement with it?
Are there any areas where members of the Board are in disagreement? What is the nature of the disagreement and why is there a conflict?
How well do we think the CEO is doing his/her job? What are his/her strengths and weaknesses? And, how can we improve or help their efforts?
How well does the CEO manage his/her relationship with the Board of Directors and it’s members?
What can the CEO do better in relation to the Board of Directors?
Is the CEO able to navigate the company through the growth phase of the business to a desired exit? If not, what plans do we have to ensure that the company has the right leadership?
What do we think about each member of the company’s senior management team? What are their weaknesses and strengths? What can we do to improve or help their efforts? And, is there a need for additional expertise in a specific area?
Is the information being presented to the Board of Directors, accurate, reflective and valuable for our decision making processes and fiduciary responsibilities? And, are we getting all the information we need?
Does the CEO have reasonable milestones? Does he/she report on them to regularly? And, has the CEO met the milestones he/she set in the past?
Does the Board of Directors need to take aggressive action on a pressing issue of corporate governance?
Are there any regulatory, legal, or compliance issues which need addressing and action?
How is the company positioned in the marketplace, and what can be done to improve it’s positioning at a strategic and Board level?
What are the processes of the Board of Directors? How can we improve the policies and procedures? What can we add or subtract from our meetings that may help our ability to successful oversee the company?
Is the Board of Directors meeting frequently enough? Or too often?
Does the Board of Directors need to vote for a new member? Replace a member? Or possibly downsize the membership of the Board of Directors?
To ensure that the Board of Directors successfully executes it’s fiduciary duties, it is important for entrepreneurs and business leaders to clearly establish policies regarding the board meetings.
For early-stage businesses, entrepreneurs should encourage their Board of Directors to meet on a monthly basis to review the progress of the company and to address any concerns.
Established companies typically organize quarterly Board meetings.
To facilitate the decisions making processes of the Board of Directors, board members should be encouraged to create committees to focus on and investigate particular issues that may be too substantial to cover in a single board meeting.
Typical types of committees include:
Responsible for overseeing the financial reporting process of the company.
Responsible for overseeing the financial health of the company.
Governance & Nominations Committee
Responsible for overseeing the nominations of new members, and the governance of the Board of Directors.
Generally speaking any topic that is directly related to the organization can benefit from a committee's oversight.
Although entrepreneurs should be aware of 2 common exceptions;
A. Compensation should be handled by the entire board.
B. Auditing, while led by a board member, should be handled by an outside party.
Committees are responsible for presenting their recommendations to the board, which typically follow the recommendations of the committees they establish.
To facilitate the overall processes of a Board of Directors, members should select a staff member of the company to record the minutes of the meetings in a brief and factual manner.
Prior to any and all board meetings, information packages detailing the “topics to be discussed" should be prepared and provided to each board member to facilitate their attendance and understanding of the issues covered in the board meeting.
It is important that the Board of Directors operate in as efficiently as possible because it’s members are typically established professionals with very charged calendars.
Lastly, when legal matters arise, board members should be encouraged to seek the counsel of a legal professional familiar with the company.
For startups, entrepreneurs should seek to include a legal professional who is willing to provide their expertise at little to no cost as an advisor to the company.
Additional Board Highlights
To build upon the common topics and questions board members typically focus on during scheduled meetings, entrepreneurs should also consider a number of common and recurring topics Board of Directors often address.
No matter the industry, commonly discussed topics in Board of Directors include the following items:
Particularly for large corporations that have overseas operations, whistleblowers can be a real problem for the reputation of the company. When one individual speaks out, it typically leads to a series of other outbursts from dissatisfied employees.
To help prevent this situation, it is the responsibility of the Board of Directors to set the policy regarding whistleblowers.
Another common issue is payroll concerns, particularly when a company needs to recruit a senior officer whose demands are beyond the common package awarded to senior executives of the organization.
The members of the board are responsible for resolving such conflicts, and for ensuring that all personnel within the company are paid in a timely and efficient manner.
C. Illegal Actions
Businesses of all shapes and sizes suffer from individuals who preform illegal actions for their personal benefit, or for the benefit of a specific vertical in a company.
Board members are responsible for reviewing, reporting and resolving any illegal actions taken by individuals within the company, and for setting policies on how to manage illegal actions.
The Board of Directors is tasked with monitoring the performance of the business, and when times are tough implementing limits on the signing of checks is a common method of avoiding possible concerns about insolvency.
D. Regulatory Compliance
The ongoing operative activities of a business, particularly growing businesses will often illuminate regulatory concerns from a range of topics including; new production facilities, raw material extraction or purchasing, international rules on trade, and accounting practices.
It is the responsibility of the Board of Directors to carefully review every concern and make sure the company is in full compliance to any and all local, state, federal and international regulations.
E. Claims of Wrongful Acts
When disputes emerge, particularly at the senior management level, it becomes a very real and pressing concern for the Board of Directors. To protect individual board members against any claims against the Board of Directors, companies should obtain Directors and Officers Insurance.
Additional protections entrepeneurs should consider include; coverage for employment practices liability, entity liability, product liability, and professional liability. All of these measures can meaningfully protect the company from potentially damaging law suits.
Because of the significant legal responsibilities and accountabilities of the Board of Directors, entrepreneurs should always involve the participation of legal counsel in all legal matters.
Board Meeting Actions
The typical way a Board of Directors enacts change upon the business it serves is by voting on relevant issues presented to the board during meetings. Practically speaking, either a unanimous or majority vote will authorize a specific action or the implementation of a specific policy.
Board members are required to vote in accordance with their fiduciary responsibility to the company, and not for their own personal benefit or agenda.
Instances are common when board members vote in one way when acting as a board member and a different way when voting as a shareholder. This is because the vested interests of an individual are different when considering the differences of position between serving as aboard member and owning equity of the company as a shareholder.
To maintain the integrity of the board, it is important that all of it’s members practice full transparency during any and all voting processes. With the right approach and attitude, these differences can be understood and resolved.
The last thing an entrepreneur or business leader wants is to have a Board of Directors in conflict with it’s own members.
In theory the control of a company is divided between two bodies; the Board of Directors and the shareholders.
But, in practice the amount of power exercised by a Board of Directors varies depending on the type of company.
In startups and small businesses, the Board of Directors and shareholders are typically the same people, in which case the division of power is purely on paper.
However, in larger companies and publicly traded corporations, the Board of Directors tends to exercise a more supervisory role. In these cases, the responsibility of managing the business is often delegated from the board to individual senior executives who deal with specific areas of the company’s operations and affairs.
Large public companies with a substantial shareholding body often award the Board of Directors significant de facto power. Sometimes groups of shareholders and institutional investors appoint individual directors to represent their shares, and act on their behalf as a voting authority.
This practice allows for more fluid decision making as individual shareholders who do not hold significant equity power, often lack the time or resources to be heavily involved in the day-to-day direction of the company.
In this setup, individual shareholders typically accept all the recommendations of the Board of Directors, who in turn typically follow the recommendations of the company's senior management.
This structure only breaks down when there is a loss of confidence in the ability and/or strategy of senior executives, or when board members act in contradiction to their fiduciary responsibilities.
Historically, the duties and responsibilities of Board of Directors were owed exclusively to the company it represents and it's fellow board members. Under this model Board of Directors exercised its power for the financial benefit of the company and it's shareholders.
However, times are changing. Current trends have attempted to provide greater scope for directors to act as good corporate citizens.
Board members can no longer act for the sole interest of their company. They must also take into account the needs of the people the company serves, and the community within which the company operates.
New regulations including the Sarbanes Oxley Act of 2002 have introduced new standards of accountability and transparency that have meaningfully impacted the way boards function and businesses operate.
Similarly, the United Kingdom Companies Act of 2006 demanded that Board of Directors act for the greater good their customers, community and industry and fulfill higher standards of business conduct and equanimity.
All in all, these regulations are reflective of a more interconnected and interdependent world for nations, peoples, communities and businesses.
The long term trends indicate that the responsibilities of future Board of Directors will not only include direct oversight of their organization, but of stewardship towards a more inclusive, egalitarian and virtuous model of leadership and administration.
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