Corporate Governance 101: Its valuable role in the startup lifecycle
Entrepreneurs learn a lot of new concepts and terms as they’re building their new businesses, not all of which sound super exciting. It might SCREAM big company bureaucracy, but “corporate governance” can be one of the most valuable steps in the early stages of your business — so read on.
“Corporate governance is the system by which companies and other organizations are managed, monitored and encouraged. It involves the relationships between shareholders, the board of directors, the executive management, supervisory and control bodies and other stakeholders.”
Sound corporate governance in the early phases of your entrepreneurial journey can provide valuable leverage to your company, helping it go further, faster and with less risk. It can pave the way for financing the business, which is a leading influence on the speed and consistency for which you can scale.
So, what is most important to know now, in the early stages, to ensure your business is set up for success from a governance perspective?
Corporate governance is based on four basic principles:
- Corporate responsibility
This structure is most often a requirement of a financing transaction — especially involving an institutional investor — but it is never too early to begin thinking about or implementing a governance structure. As you progress from ideation to scale, the role and roles within governance evolve alongside it. Let’s look at the evolution through the first three common phases of a startup’s lifecycle: Ideation, Validation (MVP) and Traction (Product Market Fit).
Ideation: At this stage, it’s quite possible that no real operational activity or formal entity exists yet, but the foundation for governance can begin with a focus on the roles and responsibilities of the founders or early-stage partners involved.
Specify the forms of contribution (e.g., cash, time, network, advisory services, etc.) and the resulting compensation or future equity interests in exchange for the contribution, as well as options for withdrawal and discontinuity. Ensure ownership of the company’s IP and contemplate how important decisions will be made. Consider the role that a mentor, external advisor or counsel can play in helping founders/partners reach consensus when they fall out of natural alignment.
Most importantly, draft, sign and retain copies of all agreements (e.g., founders’ agreement, operating agreement if applicable, etc.)
Validation (MVP): Although it’s not always the case, we will assume by this stage that the legal entity exists, and that some operational activity is on the books. During entity formation, focus on the rights and duties of the founders/partners/members. Contemplate adequate but flexible internal controls and an accountability structure between the team and other potential outside parties — a structure that should be codified in your Articles of Organization/Incorporation. If you haven’t already, formalize agreements among founders or early-stage partners and solidify relationships with external mentors and advisors.
Traction (Product Market Fit): At this stage, you’ve gone beyond entity formation, an MVP exists in the market, and the service or product you are offering has been validated by paying customers.
Now, the key challenges are to continue winning customers and increasing revenues while managing your cash, or burn rate, as you build out the team and continue allocating capital to growth and development.
For most businesses, this is the stage where you begin entertaining capital from institutional investors. It’s during this point in your business’s lifecycle that you institute a formal board, clarify the difference between the position of partner and executive, and define hierarchical levels for decision-making and business planning. When the business is ready for formal board structure, consider the differences between an Advisory Board and the Board of Managers/Directors and the differences among the roles as outlined below:
- What is the purpose of the advisory board member? Strategic guidance, go-to-market assistance, access to strategic partners, product engineering support, etc.
- These advisory board members have no fiduciary duty.
Board of Managers/Directors:
- These Board Members have fiduciary responsibility to shareholders.
- They are responsible for providing strategic direction, decision-making support for certain board-level decisions and supervision/monitoring of key executives and other management personnel.
In certain instances, investors who make a meaningful investment in your business may ask for a formal board seat or board observation rights. The biggest difference between a formal Board Member and a Board Observer is that the Board Observer has no vote on board-related matters. They are active participants with the same access to information as Board Members but are not allowed to vote on the topics up for board deliberation.
Again, governance can provide valuable leverage to your company, helping it go further, faster, with substantially less risk. It is important that you take iterative steps towards implementation of sound corporate governance as the business scales. Good luck on your entrepreneurial journey and lean into the uniquely qualified help that mentors, advisors and board members can provide if you get this aspect of your business right in its earliest stages.