Building a startup is a complex process that requires careful consideration and decision-making. Typically, the company’s founders serve as its directors following incorporation. As the startup progresses through various equity funding cycles, it is natural for the board membership to expand. Lead investors in these rounds often request a board seat to oversee matters at the board level.
However, the inclusion of independent directors on the board is a topic that has not been widely discussed. Some assume that independent directors are only necessary for public-listed companies or those with a large shareholder base, where regulations require stronger corporate governance. Since startups are private and require less governance, the need for independent directors at an early stage is often questioned.
As an independent director for a tech startup during its Series A fundraising round, I was able to contribute my VC expertise and governance experience gained from serving on various boards.
This experience has been beneficial for both the startup and myself, and I believe that the advantages of having independent directors for startups should be shared.
What constitutes an independent director
According to the Singapore Institute of Directors (SID), “An independent director is one who is independent in conduct, character and judgement, and has no relationship with the company, its related corporations, its substantial shareholders or its officers that could interfere, or be reasonably perceived to interfere, with the exercise of the director’s independent business judgement in the best interests of the company.”
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It sounds very complex, but in essence, it is a person who does not have any conflicts of interest with the company. The SID continues further with guidelines like tenure not exceeding three years will be defined as an independent director.
The case for independent directors
Having independent directors can bring several benefits to an early-stage startup. Here are some key advantages:
Objective decision-making
Free from any ownership in the company, these directors offer an unbiased perspective on company matters. This can be particularly valuable for startups, where founders may be driven by enthusiasm and a willingness to take risks in order to grow the company.
For example, a founder might be eager to use company resources to develop a new product, but this decision could be based more on euphoria than sound business assessment. By having an independent voice weigh in on the situation and ask probing questions, the company can make more informed decisions. In some cases, this might even mean deciding not to pursue a particular course of action in order to protect the company’s interests. With an independent director on board, the decision to do so carries greater weight and authority.
Expertise and experience
Independent directors bring a wealth of knowledge, experience, and expertise to the table. Their insights, guidance, and mentorship can prove valuable to the management team. In the case of investment deals, particularly for deep tech companies, it is not uncommon to see a tech or science expert serving as an independent director on the board. This is important because it immediately instils a credible belief that the technology IP being created is viable while also providing the founder with a technical and scientific resource to draw from during the technology’s development.
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In addition, successful operators and entrepreneurs are often seen serving on the board as independent directors. They lend their reputation and networks to the company, which can be valuable in attracting stakeholders and building strong relationships to secure good partners and potential first clients. This is particularly important for very young startups that are in the angel-to-seed stages.
According to a report from startupsventurecapital.com, some top reasons why startups fail are due to product market fit, poor marketing, being outcompeted, and other relevant business issues. The presence of former entrepreneurs and operators as independent directors on the board is vital to advising the management team in their business operations and strategy.
Corporate governance and compliance
Corporate governance and compliance are essential aspects of any startup’s success. Independent directors play a critical role in ensuring that the company follows good corporate governance practices. They provide oversight and accountability, helping the startup establish and maintain robust governance frameworks, internal controls, and ethical standards. This, in turn, can enhance the startup’s reputation, mitigate risks, and foster long-term sustainability.
While it may not be necessary for startups to have an independent director until they reach Series A, it is still an excellent foundation for developing a culture of accountability to the board. Having an independent director on board can help the startup establish good governance practices early on, which can be crucial for its long-term success.
Conflict resolution
As someone who has advised and mentored startups over the past decade, I have observed that conflicts between startup founders are quite common. This is especially true among male co-founders, who tend to suppress their emotions until a breaking point is reached, leading to highly contentious discussions. According to a report by startupsventurecapital.com, 13 per cent of startups fail due to disharmony among team members and shareholders.
To address this issue, independent directors can serve as mediators to resolve conflicts within the startup. Their impartial perspective and neutrality can be beneficial in resolving conflicts effectively and preventing them from escalating, thereby safeguarding the interests of the startup.
When to include an independent director
Selecting the right independent director for a startup board is a complex process that requires careful consideration. It is essential to note that the benefits of appointing an independent director may vary depending on various factors such as the industry, startup’s needs, stage of development, and the expertise of the director.
Some potential candidates may be more suitable as technical advisors or mentors if they lack experience in governance or an understanding of their limitations.
Above all, this article hopes to encourage startup founders to adopt the mindset of selecting the most appropriate independent directors to facilitate their startup’s growth to the next level.
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This article first appeared on TRIVE’s blog.
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The post Unbiased guidance, enhanced governance: The power of independent directors for startups appeared first on e27.