Dennis T. Jaffe

Pascal N. Levensohn

Ten Common Pitfalls of Early-Stage Boards

By Dennis T. Jaffe, Professor, Saybrook Graduate School & Pascal N. Levensohn, Managing Director, Levensohn Venture Partners

Many start-up boards are reluctant to confront their own shortcomings. Here are stumbling blocks that directors must identify and address. 

With the downturn in financial markets that began in March 2000 and the extraordinary contraction in venture investing, it’s never been more important for venture boards and management to embrace fundamental governance processes to maximize the probability of a successful outcome for their portfolio companies. What’s more, few VCs see a clear “Next Big Thing” on the technology landscape. That means they are looking for companies that are attacking important, existing problems with solutions that deliver measurable return on investment (ROI) to customers. Clearly, execution, discipline, and efficiency have replaced sizzle and big budgets as the hallmark of the best start-ups. Just as clearly, those qualities rarely develop without an engaged and attentive board.

When business is booming, there is less of the natural tension that commonly percolates through top-level teams. But when resources are constrained and prospects are less certain, those pressures can disable or break apart a board at just the time the company needs leadership the most. Here are some of the common pitfalls that plague start-up boards. This list serves as a useful self-check for both board members and managements concerned about how well the board is performing.

These pitfalls can be used as a self-test of board performance. Members of a board can confidentially assess the degree to which each of these factors is present in their board and tally the results. Each item has some questions that can open dialogue on these issues.

1. Complacency

Larger boards may have misaligned investors who take a stance of excessive complacency and self-satisfaction. Complacent boards are comfortable and don’t go after, seek out, or act on tough issues. They enjoy the power and perquisites of their role, without challenging the company. This attitude has been deadly to some public companies (such as Tyco, HealthSouth, and Adelphia).

            • What are the top three toughest issues facing your company? Is the board actively monitoring and focusing on those issues?

2. Inability to Confront Difficult Issues

This can be common with long-serving board members who are tied to initial or previous perspectives and who inhibit new members from offering important observations. Any group can benefit from new perspectives.

            • Is your board willing to take a step back from time to time and challenge old assumptions about chronic difficulties? Do you face up to issues when they arise, or avoid dealing with issues where there may be disagreement?

3. Distraction, Over-Commitment

VCs may serve on too many boards to be productive, or they may have written down their investment in the company and lost interest. The CEO faces a dilemma if that board member has priorities ahead of this particular company. The CEO is best served if he can ask the VC to consider appointing a less-burdened colleague to the role, or to free up more time for the effort.

            • Is each member of your board prepared, available, and helpful in the issues the board is facing?

4. Lack of Alignment of Board Members and Investors

This has evolved into a major problem in Silicon Valley as a result of the technology capital market downturn. For example, many VCs and others, including passive angel investors, have invested in seed and “A” rounds and expected to see their investments appreciate. Instead, since mid-2000 these early-round investors have experienced significant dilution of their ownership stakes because of subsequent financings completed at lower valuations, often with special liquidation preferences attached to the most recent investment capital. At the same time, these early investors have no assurance of near-term liquidity. The early and later investors have different financial concerns that often do not align. They must resolve difficult competing agendas or else remain deadlocked and severely compromise the future of the enterprise. This is why some CEOs find it hard to trust their VC board members. VCs need to adjust their attitude and get realistic. We are back to business basics.

            • Are board members open about their agendas and willing to work together to forge a position on key issues of valuation?

5. Divided Boards

The best CEOs lead both the company and the board. The CEO brings the right information and helps get the entire board on his side rather than just counting on a majority of allies.

            • Does the CEO of your company work with all board members, or does he or she say: “I have three votes; I don’t need the others.” The latter approach will polarize a board. Does the board strive for consensus on issues, or rely on the votes of a majority for decisions?

6. Paralysis Over Liability Issues

Sometimes boards become so cautious that they cannot act at all. In the world of venture capital, where the competitive environment is extremely dynamic, inactivity is as apt to generate a negative outcome as making the wrong move. Moreover, liability concerns have become so strong for some directors that in one start-up, a director feared liability issues and litigation from other shareholder groups if he agreed to sell the company at a substantial loss, even though this was the most likely way to ensure the company's solvency. Instead, he advocated the liquidation of the assets through a third party in order to avoid the liability risk even though liquidation would result in an even worse financial outcome with no chance for future gains.

            • Is your board succumbing to irrational worries about liability? Should your corporate counsel make an appearance to give a realistic picture of reasonable versus low-probability concerns? Does your board balance risk prudently but take action when it is warranted?

7. Board Member Role Confusion

Board members with operating experience in the company’s domain may become overinvolved and advance personal ideas without support from the rest of the board and without trying to generate consensus. This approach often leads to interpersonal conflict and accentuates board divisiveness. It is crucial in these situations that the board leader step forward in conjunction with the CEO and address the board member’s over-stepping.

            • Are your board members maintaining an appropriate boundary between board and operating roles?

8. Leadership Vacuum

A company may need to restructure its balance sheet, the composition of the senior management team, or both, but the board may lack a leader who will rise to the challenge. Consequently the entire board may conclude that change no longer merits the effort. Before giving up, the board must draw on its experience in companies where new management was able to bring positive and restorative change and look beyond the short-term pain to the possible payoff. The answer may be that the effort is truly not warranted, but the board must consider its duty to shareholders to weigh every option.

            • Does the board have a clear leader who attends to board business and draws out the best advice the board can offer?

9. Loss of Trust in the CEO

There are myriad ways a CEO and board can lose faith in one another: Miscommunication, board meddling, and high-handed behavior by the CEO that ignores a board directive are just a few. If the board loses trust in the CEO, the CEO may respond by becoming even less responsive. This sets up a cycle of phone calls, secret conferences, and plotting.

            • What are the trust issues playing out on your board? Given that active distrust is untenable, how can you move to put issues on the table for resolution?

10. Resolution to Fail

Sometimes, directors don’t see a clear way to proceed, so they lose interest in new thinking and begin plotting an exit strategy to the exclusion of forging a viable path for the company. Board members may subconsciously resolve to see only negative consequences in any turnaround plan, in hopes of clearing the company off their list of concerns.

            • Is your company actively weighing its options, or is the board deciding in advance that nothing will work?

Avoiding Onerous Consequences

Business visionaries live in a universe that orbits around their inventions or ideas. These entrepreneurs typically are talented, dogged, persistent, and creative. They form the core of the business growth engine. But their strengths can also be their weaknesses. Persistence and perseverance, qualities vital for success, can kill a venture if the visionary surrenders good judgment to his will to succeed. That’s why one of the most crucial developmental steps in the life of a good company is the assembly of a good board to complement as well as counterbalance the CEO.