Your board should protect you!

All other board functions are secondary.

Even venture capitalists who sit on boards where they have significant investments often forget this point.  They write in their investment documents that they will occupy a seat on the board for as long as they are invested in the company, thinking of this as a protection for their investment and tool for them to influence growth.

Actually, there are two legal duties of board members. 

They are: the duty of care, and the duty of loyalty.  Everything else is a self-imposed duty or responsibility.  The duty of care is to care for the corporation’s asset itself, not the shareholders whom they represent.  Each corporation, when chartered becomes a live person in the eyes of the law, independent and subject to the care of its board of directors.  Shareholders such as investors are granted few rights by law. They can elect directors for their class of stock, approve mergers and acquisitions; approve increases or changes to the capital structure of the company and other more minor actions.

[Email readers, continue here…]  It is the board, made up of individual members, that is responsible for the care and maintenance of the corporate person.  Sometimes, there will be a conflict of interest between the people representing the various shareholder classes on a board.  This happens often when one class would be quite satisfied with the outcome of a sale of the corporation because it has lower expectations of exit value and a lower cost of shares, while another later investor class would see little relative gain in a sale and veto’s the proposed transaction.    The duty of care is the legal responsibility of each board member and cannot be shed because the member was elected to protect a particular class of shareholder.

Second is the duty of loyalty…

…Loyalty to the corporate person, not to the shareholders who elected the board member.  Once again, there is a need to educate board members that in conflict of interest cases, the corporation comes first.  Some investor board members are also member of boards for companies that may overlap in markets or even compete directly, although rare.  Either way, I have seen many instances over the years of my board service with VC’s on the board, which the VC’s have had information about other firms that would be classified as confidential – that they offered at least piecemeal in a board meeting of another company where they serve.  There are issues that stress the loyalty of board members such as placement of employees or recruiting of executives from firms where the VC or board member has inside knowledge.  These are rare, but each stresses the duty of loyalty to the corporation on whose board they sit.

Well, how far should a board member go?

Should board members therefore withdraw and not participate in corporate planning, coaching the CEO and other issues not related to the duty of care or duty of loyalty?  Of course they should not.  A board, in exercising its duty of care, must do everything it can as an entity and each member as an individual to become acquainted with the issues, problems, opportunities and threats that overhang the corporation.  In fact, there is a legal concept (not a duty) of “reasonable care” that board members must meet in order to be protected by the insurance carried by a company for directors and officers.

Reasonable care means that members deliberate issues in depth, attract expert advice when appropriate, attend meetings regularly, stay current on corporate issues and hold regular sessions of the outside directors without management present. None of these requirements are by law, but the sum of these add to a powerful statement of commitment by board members and therefore a protection under the law when a group of shareholders sue boards or members for irresponsible actions.  Most every court will side with the members of the board under the rule of reasonable care when these behaviors are in evidence.

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Hire a consultant; ignore the advice!

The ideal use of consultants…

At one time or another, most all businesses use consultants to fill the gaps in knowledge or to provide guidance for management.  Consultants are good in that you can sample their work with short projects, change to other consultants quickly, and stop using them when a project is completed.

A personal story of ignorance of good advice.

I have a partner in a consulting practice that specializes in the travel industry.  Several years ago, we were hired by one of the largest companies in the industry (yet another Fortune 50) to perform a top-to-bottom audit of their processes across 27 facilities, and recommend measures to increase efficiency, increase income, better the customer experience, and of course, decrease costs while also increasing the quality of service.  We were quite confident that our services would yield great, measurable results.  The work continued for about eight weeks between the two of us as we visited the 27 locations and worked with employees in departments across all disciplines within each location and at central offices that performed services for all locations.

The result of the consulting project…

Finally, at the end of the project, we had identified nineteen specific issues, each of which would, if implemented, accomplish one or more of the goals outlined at the start of the project. The sum of the savings and increases in revenue were worth multi-millions annually, well worth the implementation of most or all of the recommendations.

[Email readers, continue here…]   On the final day of our assignment, I was responsible for the “reporting out” to the assembled twenty or so executives in the large conference room of this major corporation.  I started my presentation, which had been carefully documented in handouts and PowerPoint, with this story…

A unique description of the “ignore” lesson.

“I want you to all imagine that it is tomorrow morning, looking back upon today’s reporting of these past months of work by your consultants.  Imagine that today I build for you a beautiful sandcastle exactly at the water line of the ocean nearby.  Tomorrow, we both will visit that beach and look at the water line, and find not a beautiful castle, but just smooth sand, just as it had been the day before building our beautiful sandcastle.  In other words, I would not be surprised if you accept our report today with enthusiasm, but then in the overwhelming rush of daily business, fail to implement few if any of these recommendations that you so enthusiastically received.”

The story is true, and the results were as I predicted.

A few of the recommendations were implemented over time, one with great effect and even a national advertising campaign behind it (that you surely saw on TV).  But most were just ignored.  I imagine that our report sits today on someone’s shelf, filed with others from past and from following months and years.

Unfortunately, it is human nature to enthusiastically ignore to act upon recommendations of third-party consultants. There are many, many exceptions, but far more instances of this in the business world.  Not all consultants give advice worth taking, of course. But when they do so, it is only as good as that which you implement.

 

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How to cheat legally on your tax return.

When do you cross the line between honesty and dishonesty in tax planning? 

Is it ethical to allocate income between periods to take advantage of tax breaks?  Can expenses be put off until the next period to increase income, or accelerated into this period by prepayment to decrease net income?  Where do you draw the line, assuming no intent to defraud?

Revisiting corporate vs. personal tax rules

First, corporations are usually on an accrual accounting basis, meaning that income and expenses are accounted for as earned, not when the cash is received.  (You, on the other hand, account for your individual income on a cash-accounting basis, counting the cash not the date of your earning or accrued expense.)  The difference:  If you earn pay due December 31st and it is paid January second, you pay income tax on those earnings in the following year.  But the corporation that pays you accrues the expense and takes the deduction in the year in which the income was earned or expense actually incurred.)

Where do we draw the line here?

[Email readers, continue here…]   It is perfectly legal to hold delivery of goods until after the start of the next period and take the income next year rather than this.  It is a bit murky if you accelerate payment for incomplete services or even for products not yet received into this year to take the deduction from income early.  In either an IRS audit or an accounting review or audit, the accelerated costs and payments will show as an accrual – a balance sheet item – that does not change income, just cash and an asset.

In other words, for the usual accrual-based business, there are fewer ways to affect the outcome than for a cash-accounting individual.  There are lots of caveats here and certainly if the issue is critical to you, an accountant (rarely a bookkeeper) should guide you to the action that is both legal and strategic.

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Do you really need an accountant?

First, let’s be sure we define our terms.

Accountants are trained, certified and usually quite experienced in financial analysis, both creating and reviewing data.  Bookkeepers are often trained on the job although sometimes more formally and handle the physical work of accounting for the transactions.  To expect a bookkeeper to provide analytical planning is to ask for something they often cannot provide, except in a cursory way.

We need to repeat this distinction on occasion, because there is a considerable difference between the cost of a bookkeeper and an accountant.

Why bother with this?

[Email readers, continue here…]    Many early-stage founders and CEOs believe they can delegate design and creation of metrics, flash reports, analytical reports and more from their bookkeepers.  And at some early stages, a bookkeeper can prepare such information.  It does not take long for a growing business and a knowledgeable CEO to quickly outgrow the lack of depth and sophistication such reporting usually offers, looking instead for deeper analytical tools.

On the other hand,

Many early-stage CEOs are not trained and ready for such tools even if available.  The lesson here is twofold.  There is a benefit to using a good accountant to help devise critical reports for a corporation; and CEO’s must quickly become financially savvy in the analysis of financial statements and metrics that measure the health of a business.  To fail to have this skill is to reduce the corporation’s capability to discover problems early and take advantage of growth opportunities.

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Can your lawyer destroy a good business deal?

Let’s talk about lawyers…

Over the years in business and as a member of over forty boards, I have received good advice from corporate attorneys and on occasion bad advice as well.  There is a line that should be drawn in a relationship between corporate attorney and CEO or board.  Attorneys are paid to protect the corporation, not to give business advice.  Some are experienced enough to provide great business advice.

But the law degree they earned does not assure that, even though most CEO’s respect the advice they receive from their attorney highly enough not to doubt the conclusions or the experience behind the conclusions offered.  And since attorneys are paid to protect, often they will give a litany of warnings about what could go wrong when accepting a contract clause that they have been trained to challenge.

Business advice vs. legal advice

There comes a time when a CEO must decide to reject what may seem like important good advice from the attorney and chance acceptance of terms within a contract that may cause risk, but controllable risk or risk that is so remote as to be worth the acceptance of the business represented by the contract at hand.

Another story about this…

[Email readers, continue here.]   I was chairman of a company that had been offered an investment by a Fortune 500 company offering to make a strategic investment in our business, which would be capable of driving new demand to the large company through a series of new web services creating a greater need for the large company’s products.

The business terms had been agreed between the business development officer of the investing company and our board, as both companies turned the details over to their respective attorneys for documentation.  The attorney for the investor was a member of a large, respected law firm in Silicon Valley, and certainly was full of himself as sole legal protector of the rights of his very significant investor.

As drafts of the otherwise standard investment agreements passed from him to our attorney and our management, we immediately spotted a significant number of terms we not only had not agreed to but were contrary to the spirit of the investment.  The attorney held fast defending every challenge, stating that “these terms are standard for our client and cannot be changed.”  We appealed to the business development executive, who deferred to the attorney restating that the terms were unchangeable as far as the big company was concerned.  After conferring between our attorney and board, we walked away from what would have been a fine strategic partnership, killed by an attorney who probably understood the client requirements but was unwilling to offer flexible solutions to problem areas.

Drawing the line…

That attorney had made what we considered business decisions on behalf of his client.  By the way, we immediately found a willing replacement that had an attorney not quite so full of himself and quickly concluded a similar deal to the acceptance of all.  And to this day, I caution my CEO’s not to deal with that Fortune 500 firm because of the experience we had with its attorney.  You never know how much far reaching an action can be, given the speed and extent of communication between CEO’s today.

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What if you see juicy competitor information?

Has this happened to you?     

Many of us belong to industry associations and find ourselves at conferences and trade shows with time to spend with competitors.  Some of these are old friends, some even former associates.  It is natural to want to associate with these people for many reasons, certainly socially. Most CEOs want to obtain information about their competitors in the most subtle and non-obvious ways.  And of course, most are willing to trade information to get information.

A fair example

In my former industry, I became an informal centralized source for knowledge about the revenues of each of the many competitors, with a special skill for asking just the right questions to obtain the information.  How many employees does the firm have today? Are you profitable yet?  Can you guess what percentage your revenue comes from recurring sources such as maintenance revenues?

In return for the answers to these several questions, I was usually able to guess a company’s gross revenues within a few percent and would state my guess to the CEO.  His reaction would guide me to increase or decrease my estimate appropriately.  He’d be a bit amazed with the quick fancy math work, and I would have yet another piece of the puzzle helping me to gauge the total size of the industry in annual revenues and the growth and size of competitors.

[Email readers, continue here…]  All of this was immensely helpful in strategic planning and marketing, even though to this day I do not think those CEOs were aware of the value of the information so easily given.  And none of this is especially considered a trade secret, violating the unspoken covenant between competitor CEOs that there is a limit to such exchanges.

The other kind of example

On the other hand, often a salesperson or marketing manager would show up at my office door with a complete package of a competitor’s materials, including price lists, a proposal with discount percentages clearly shown and a list of feature functionality meant to reinforce the proposal.  The source of this information was typically the purchasing decision-maker for a friendly customer or candidate customer.  The question is one of ethics, since the competitor certainly did not volunteer any of the information, which would have been the competitor employee’s violation of confidentiality and cause for being fired.

How should you respond?

What does a CEO do with this wonderful, rich information dropped at his door at no cost or obligation? Few would destroy it and ask all to forget that it was ever in their hands. Most would absorb the information and then admonish those who had seen it to not repeat to anyone that it was in their hands.  If you’ve been in business for long enough, you’ve seen your share of this gray market information.  My advice is to be very careful, think of the golden rule, never use this information publicly, and certainly never reproduce it, let alone disseminate it internally.

And a warning…

As to sharing information to get information, CEOs and executives are bound by a duty to their corporations not to share trade secrets with anyone who has not signed a confidentiality agreement, including consultants to the company.  For CEOs on the corporate board, it is a large part of the “duty of care”, a legal requirement of board members to protect the assets of the corporation first and foremost, one of those assets being the trade secrets of the corporation.

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Wow! Are your relationships important!

Forming business relationships at the highest level

As you follow these insights from ignition to liquidity event, you’ll detect a continuing theme, emphasizing the need for deep and wide relationships that the CEO and senior staff can call upon for advice and guidance.  This is the time to elevate those insights to the level of highest value for the corporation, one that cannot be listed on a balance sheet nor included in an appraisal of corporate worth.

And yet, such relationships properly used and never overused, can quickly and precisely help you cut through delays in government agencies, speed the process of product planning and ultimate release, aid in positioning in the market and help you avoid a myriad of mistakes that could prove costly in time and money.

Analyzing your commitments of time to business

Often, I am asked by young CEOs how much time should be devoted to various types of tasks by a good senior manager in a small, growing enterprise.  Of course, the response depends upon lots of variables, including whether the company is in a fund-raising mode (in which case the CEO may be spending up to 80% of their time on this alone).

[Email readers, continue here…]   I am chairman of the Technology Division of the ABL Organization, a roundtable organization with multiple CEO roundtables of about twelve members each, meeting monthly.  Each CEO is asked to make a deep presentation once a year in which he or she starts with personal and business goals for the coming year followed by concerns as to how to reach these goals. Much of the rest of the presentation is devoted to explaining to the group the causes for the concerns and offering information for the group to use in the feedback session to help that CEO seek solutions and to provide resources to them for that purpose.

The format also calls for the CEO to examine their calendar over time and report classes of activities by percentage of total time spent, so that the group may add comments about use of that person’s valuable time to the critique.  It is from over a thousand of these CEO presentations over the years that I attempt to make the following generalities.

How much time do you devote to each type of activity?

A good CEO spends at least 30% of their time dealing with customers, including meeting directly with customers and being involved in closing the largest deals, maintaining valuable relationships, and “sniffing” the attitudes of customers toward the company as well as exploring customer needs that might be satisfied by new product development.  15% typically is spent on direct management issues such as supervision of next level subordinates.  15% might be spent networking with those in the CEO’s relationship circle, including the roundtable organizations.  10% is typically spent networking with board members and advisors, usually with frequent phone calls, and preparing for board meetings.  10% is typical in exploring strategic concepts, reading about new developments in the industry and just spending quiet time contemplating opportunities.  That last 10% is most important and often overlooked. It represents strategic thinking.  “What if?”  “How about…” “When should we…” “How could we…” You get the idea.

There are many other classes a typical CEO will list for that remaining 20%, some concentrating upon time spent in meetings of all kinds, lumped together as if all meetings are of some equal value. The group cohort reviewing this time spent often pays close attention when this happens, since it is a sign that the CEO considers meetings of all kinds a drain upon available time, and few meetings of special importance.

How many hours do you spend on business each week?

Whatever the spread of percentages to make 100% of a senior manager’s time, the roundtable presentation requires the CEO to estimate the average number of hours spent each week at or on work.  Most respond with between 60 and 80 hours a week, emphasizing what you already know, that CEOs are not often 40-hour workers.  But then again, in this new world of always-on communications, who is?

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What are the costs of taking investor money?

Let’s talk about the reality of taking money from professional investors.  It is not the first time we’ve covered this general subject nor the last. But this time, we concentrate upon governance changes.

After friends and family…

Once a company founder has tapped the funds available from his or her resources and from friends and family, if the company needs more cash for growth, the most obvious next step is to look for money from angel investors and venture capitalists, typically in the $300,000 TO $3,000,000 range.

And the restrictions upon your freedom to operate…

This money comes with restrictions a founder may not expect, including restrictions upon the sale of founder stock, clauses that require the investor be allowed to sell an equal proportion of stock upon any other person’s sale of stock, anti-dilution provisions that protect the investor from a subsequent offer of stock at a lower price, and much more.

A seat on your board? 

[Email readers, continue here…]    Almost always, professional investors, including angel groups and venture capitalists, also require at least one seat on the corporate board.  The investor organization is granted the seat if the investment remains, and the documents often name the first representative assigned by the investor group to the position.

Why these restrictions?

In later insights, we will explore the legal and ethical responsibilities of board members.  But the intent of these “forced” placements of a representative on the board is obviously to watch over the company’s use of invested funds and to help grow the company in value.  The combination of restrictive covenants in the investor documents and the new dynamic of board members with an agenda make for a change in the culture of the corporation, certainly one for the CEO.

However, outside professional investor board members can be a very good asset to the corporation with the skills, experience and broad relationships many bring to the boardroom table.

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Do you need an advisory board?

Have you ever thought of creating an advisory board?

As you can guess, that would be an informal group with no legal responsibilities, but one able to be called upon to act as business, industry and scientific advisors to the company or CEO.

Why?

Usually, you would want to create an advisory board to fill in the critical areas of need not evidenced in the board of directors or within the company itself.  University professors, industry gurus, lawyers familiar with patent law and former executives of competitor companies are typical recruits you might consider. Sometimes, celebrities will agree to sit on an advisory board as a gift to the CEO, providing a bit of glamour for the company at small expense.

How about the size of the group?

There is no limit to the number of individuals for such a board, but there is a practical limit to the amount of cash and / or stock to be allocated to these outside advisors.  The rule of thumb for an advisory board member is to expect a half to a full day each year on site, typically in a strategic planning meeting with numerous members of the staff, as well as some reasonable number of phone calls from senior members of management during the year.

How about using the names for marketing, fundraising?

Included in the “package” is the expectation that the advisor’s name will be freely used in the company’s marketing, a bio listed on the website, and occasional calls will come as references to the advisor from potential investors and others looking for deeper insight into the secret sauce of the company or state of the industry than can be provided by many on the inside.

And now the expected cost…

[Email readers, continue here…]    For this, an advisory board member for a small to medium sized company should expect to receive options equal to ¼% of the fully diluted stock of the company, vesting over two years, and subsequent grants if there has been additional stock issued to dilute the advisor, bringing the advisor back to this percentage if an advisor is renewed after subsequent two-year intervals.  Alternatively, some companies pay an advisor a fee of $1,000 to $2500 per “on premises” meeting day and optionally much smaller stock grants, if any.

What if an advisor acts as a consultant with more time?

Additional commitments of time by an advisory board member should be compensated as would any consultant, at half and full day rates agreed upon in advance between the CEO and the advisor. There is no rule as to uniformity of pay, as some advisors may be willing to serve at no cost while others are industry consultants used to receiving fair payment for services rendered.

Create a formal advisor agreement listing expectations.

Advisors fill blind spots in the corporate knowledge base and guide you in areas where you feel you have a personal weakness.  There is usually a formal agreement between the company and the advisor, carefully calling out the time expectation, the forms and amounts of payment, and the indemnifications from liability granted by the company to the advisor in return for confidentiality and non-disclosure of company trade secrets by the advisor.

How about “chairman” of the advisory board?

A particularly strong advisor, especially if well known, may be named chairman of the advisory board, which is often just an honorary title, since the CEO is usually tasked with the planning of the full day meeting of advisors annually, and setting the agenda to match the needs of the corporate board and senior management.

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Do you even need a business coach?

Everyone, even seasoned CEO’s can use a good coach who knows how to bring out the best in a person, is knowledgeable about the business process, and who has an extended list of relationships to call upon to fill needs that become obvious in the coaching process.             

Business coaches come in all sizes and shapes.  

Entrepreneurs will have a relative willing to devote time, a school friend with business experience, professionals who charge for the service, investors with a reason to promote your success and more.

Find a coach who has “been there and done that.”

But by far the best coaches are those that have lived through the process you’re going through and built successful enterprises in your same industry.  Especially if they have sold their companies and live comfortably upon the proceeds, these people are often the most willing to help and the most patient through the process.

Where can you find the best coaches?

[Email readers, continue here…]   One great source for coaches is among fellow members of a CEO roundtable organization, Young Presidents Organization or similar association where you are comfortable with the coach candidate and know something about his or her style.  Another is through industry associations or civic groups such as Rotary or Lions Club or even SCORE, sponsored by the US Small Business Association (SBA).

Some larger communities have organizations of corporate directors, composed of a combination of service providers and professional corporate directors. I’ve personally been involved with the ABL Organization for over thirty years and share problems and solutions with a monthly roundtable of smart CEOs from companies of all sizes.

Board members or lead investors as coaches

If you take smart money from a good angel or venture organization, the lead investor usually becomes your board member and has a vested interest in your success.  If you are lucky enough to create competition among investors for your company, you can select the investor or group with an individual who has experience in your niche and identifies with your vision.

How do you pay a coach?  

If the coach is also a significantly large investor such as a VC fund, the board member-coach will offer a limited amount of time outside of board work at no extra cost, all for the good of the investment.  Professional advisors and consultants are typically paid by the half day or full day, charging anywhere from $600 per half day at the low end up to $4,000 or more at the high end for a full day of work.  Some charge by the hour, making themself available much as an attorney, keeping track of hours spent on phone calls and emails with you. And some will willingly work for stock options, an amount to be negotiated based upon time spent and stage of corporate development.

Years ago, I co-wrote my first book, profiling just such a person, trading his time and experience in exchange for equity – and managing to become wealthy in the process by picking and aiding great young companies that grew large and were ultimately sold at a tremendous profit.  We had no term for such work in those days and created the phrase “resource capitalist” to describe the person and process.  He brought resources to the table from personal experience to a great contact base and was able to help speed the time to market while introducing the company to great potential buyers at the right time in the process.  His average percentage of a company was 5% in return for spending a day a week as I recall.

…and “working for food.”

Jokingly, I used to tell people that I worked for food, with so many free lunches being offered from all sides. But alas, there is no free lunch.  And over the years I have vastly curtailed the practice. However, there surely are experienced executives out there who’ll work for a meal. It is worth asking.

A warning about those willing to take advantage:

There must be many more creative ways to pay a coach, especially for early-stage businesses.  The one warning: avoid those looking to become partners, asking for larger portions of equity than, say, 5% when they contribute no cash to the enterprise.  There may be times when such a person can truly be a founding partner in a young business and devote enough time and resources to warrant more, but this is taking on a partner in every sense of the word and should be done carefully and only after spending time with a number of the person’s references and becoming comfortable with the person, ready for the long run.

 

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