In this episode of Founded & Funded, Madrona Managing Director S. Somasegar and General Counsel Joanna Black discuss the fundamental role of a board in a startup’s growth and development with Madrona Digital Editor Coral Garnick Ducken. They touch upon the importance of aligning strategic views with board members, managing disagreements, and effective board governance to ensure that the organization is run efficiently. The duo offers numerous insights into the intricacies of board structure at different stages of a startup lifecycle, drawing parallels from recent events at OpenAI. The conversation covers the need for transparency, both in sharing good and bad news, and the necessity for a functional board reflecting a functional culture.
This transcript was automatically generated and edited for clarity.
Coral: What we’re trying to do here is set the stage before we dive into all the advice and startup board governance and structure and everything that we’re going to talk about here. So, to kick it off for us, Joanna, can you give us the quick and dirty with the problems surrounding the board structure that we saw at OpenAI not that long ago?
Differences between Nonprofit and For-profit Boards
Joanna: I think what’s interesting about OpenAI is that it is really a nonprofit. And the nonprofit owns a for-profit subsidiary. That for-profit subsidiary is fully controlled by the OpenAI nonprofit. Most people don’t realize that a nonprofit board is very different from a for-profit board. We all understand that a for-profit board tries to maximize shareholder interests. However, in a nonprofit board, they are guided by a stated mission. So that’s a very different output. The nonprofit board does have the same duty of care and duty of loyalty, but they have this separate duty that’s not found in a for-profit organization, which is a duty of obedience. They have an obedience to the laws and the purposes of the organization.
Coral: Before we unpack a lot of that and then apply it to startups and founders more broadly, why don’t we just define the term governance a little bit? I know that in a lot of the media reports and other things that we’ve all been hearing and reading, it’s gotten thrown around a lot, and I don’t know that people fully understand what that means. Okay, governance, yeah, okay, we all get it, but I don’t think a lot of people do.
Defining Governance and its Importance
Joanna: Governance, from a legal standpoint, really refers to how an organization is managed or governed. So, by who and how. For most entities, governance starts with their governing documents. These are the foundational rules for the entity. They’re typically a charter and the bylaws. The charter is where you will find the rules by which everyone must follow when it comes to governing the company. Now, the charter is typically what sets up a board of directors or whoever is going to manage and govern that organization. They have the ultimate management authority over the organization. And then, the authority of the leadership team, the CEO specifically, derives from the authority of the board.
Coral: So then, Soma, if we pivot to you a little bit, you’re obviously the guy with all of the board experience here. I’ve heard you say before that, basically, a board is half company building and half governance, especially in the early stages. So why don’t you break down for us? What’s the purpose of the board and some of the experiences you’ve had in early-stage board building?
The Role of a Board in Early-Stage Companies
Soma: In general, I think a board is all about how you provide the right level of checks and balances to ensure that an organization is being run or managed in the most appropriate way. You follow the laws. You ensure that the right things are happening. You also keep in mind the fiduciary responsibility that the board has in terms of putting the shareholder’s interests first. As much as I say that, you know, governance is important right from day one. Usually, what happens is in a very early-stage company, the responsibility of the board is twofold.
One: Focus on ensuring that the right startup board governance is in place. But it’s also being a trusted partner to the CEO and the founding team and helping with what I call the company building — whether it’s building the team. Whether it’s helping with product building, product strategy, go-to-market plans or go-to-market strategy.
There is a bunch of things that need to happen in early-stage companies where everybody is learning as they go along. And it’s the board’s responsibility to be a trusted adviser and a trusted partner to the founding team and to the CEO. In the early days, it’s actually probably more time spent on company building. And as the company scales, as the business scales, then more of the governance comes into existence. By the time a company reaches a level of scale and becomes a public company, then the board is predominantly about governance and about what I call strategic alignment.
Coral: You made a good point there. Startups are growing — it is basically their purpose. And the board needs to grow along with it, while making sure all of the missions and everything are aligning, which obviously is where we got into a little bit of trouble with the OpenAI stuff.
So why don’t we talk through the board at those different stages? When you bring in independent board members and that sort of thing, and I think you can, both of you can tackle that a little bit. Joanna, why don’t you start by setting that stage and tell us how things evolve as more funding comes in.
Board Evolution with Company Growth
Joanna: I do think, exactly what Soma is saying, although the ultimate role of the board is oversight, that oversight changes over time — just like when you’re a parent. Your parenting duty over a toddler is very different than your parenting duty over, say, a teenager or even an adult child.
I think very much that, at the end of the day, the board’s role is oversight. They oversee strategy. They monitor risks. So, when you launch a startup, you might have a sole director on the board. Like when you don’t even have any investors, you are literally having a board of maybe one, maybe two, maybe both of the founders, if there’s two founder. So at this stage, it’s literally the founders company, and the board directors and officers are often exactly the same people. Once you raise some money at this point, it’s often comprised of three people. One is the CEO. One would be what we’d call the preferred director, which is usually the representative from the lead investor at that Seed stage. And then a third really depends. It could be an independent member. It could be another founder. It could be another investor representative. Something to note here, Coral, and I think most people know this, but since decisions are made on a majority basis, for the most part, it is good practice to have an odd number of board members. Having five members at this stage is a bit unwieldy, so we usually don’t go quite a five. As a company raises more and more money and more investors, such investors may ask for a board seat. We might want to change the composition as they grow and tasks change. And so, the number of board members you will have might increase, but we usually keep it odd-numbered and balanced.
Coral: And Soma, what should founders and CEOs keep a lookout for? Any sort of markers or moments that, okay, maybe it’s time to reevaluate what the board looks like. Do we need independent directors? Are there moments that you look for specifically when it might be time for some of that?
Soma: I think it’s twofold, Coral. It’s a balance, right? You don’t want a nine-member board for a company that has two employees. You also don’t want to have a thousand people in a company and like two members on the board.
But having said that, they should focus initially on getting people on the board that are really, really aligned with you — both from a strategic perspective and from a creating value perspective. The reason the firm that leads your Seed round of financing wants a board seat is — they are putting their money where their mouth is, so to speak. And, they are responsible. They have fiduciary responsibilities to their LPs. And they want to make sure that they have the right level of oversight, governance, and visibility to ensure that all the right things happen.
So every founder has to think about which venture capital firm they’re taking money from and which partner is going to be on their board. And is that partner somebody that they’re excited to work with? Because there is a meeting of the minds, so to speak.
The closest story I can tell you, Coral, is the following. If you are sitting in Seattle, let’s say. And, let’s say you’re the board member, and you have a CEO who wants to take a road trip to San Diego. Both of you need to be aligned that you want to go from Seattle to San Diego. Then you can argue over whether to take I-5 South. Should I take 101? Should I take some other road? But let’s say the CEO wants to go to San Diego, and the board member wants to go on I-90 East. Then you’ve got a problem.
Coral: So, how do you navigate that? Obviously, you do your best to pick those people that are aligned with you and those best partners. But at some point, if you get into a place where things, you’re not aligned anymore, obviously, like we saw in OpenAI, what’s the actual route that should be taken to handle that sort of conflict?
Choosing the Right Board Members
Soma: That’s why it is important for you to know who you’re going to be working with. And you know that like, Hey, this is a person I’m ready to work with because it’s not like you’re always going to be in agreement. There are going to be disagreements. There are going to be what I call debates. There are going to be some ferocious arguments along the way. But as long as you know that you are aligned on doing the right things. And people have different perspectives and different points of view, then I think you can work it out. Sometimes a board and the CEO might just decide “This is one thing where we disagree.” But they have enough trust in the other person that they are going to disagree and commit.
That, I think, is a good way to solve things sometimes because it’s not like everybody’s going to say yes to everything all the time. That’s not what a board is all about. And that’s not what a CEO should be expecting. And if a board expects a CEO to behave that way, then probably they’re not the right CEO in the first place anyway, right? So having arguments and having different differing points of view is okay as long as you can work through them and get to a common place of understanding about how you’re going to move forward. But if you realize that the relationship is so strained for whatever reason and you can’t navigate through it, then some change needs to happen.
Coral: Is there a process by which that change has to happen whether in terms of what the rules are that have been put in place, Joanna, or otherwise?
Navigating Disagreements and Conflicts within the Board
Joanna: There’s usually rules in the charter and the bylaws that talk about how you would remove a board member or how you would add a board member or you would switch out the board members. But you know, again, all of those rules, like almost all legal documents, are there just to be a fail-safe for what to do if you have to figure things out. Ultimately, it’s about the relationship, like Soma is saying. You have to work things through. A very functional board, I think, reflects a very functional culture. And the startup does best when there’s a functional board that knows how to work with its management. Ultimately, it involves both sides figuring that out.
Things that I have seen in my past where it hasn’t worked out great is when the CEO or the management don’t want to bring things to the board. They don’t think the board will understand. They don’t think the board will consider it. And I think oftentimes that can cause some issues when the board does find out. I think it’s really helpful for the founders and the board to have a good trusting relationship and vice versa. The board having honest open conversations with the leadership and the management really go a long way toward having good startup board governance and not having sudden decisions that come out of nowhere and surprise either the leadership or the board.
The Importance of Transparency and Communication in Startup Board Governance
Soma: The thing I would add to that is that it is a two-way street. As much as you could argue that, you know, uh, the CEO reports into the board, the CEO and the board should really think of themselves as like sort of partners. Right. And partnership works when even both sides, like, you know, operate with the same level of, uh, uh, what I call integrity, transparency, communication, and willingness to work together. The other thing is — as a CEO, sometimes you have good news to share, you have bad news to share, you have lousy news to share with the board. Rather than try to be super nuanced about it, ensure that communication happens as real time as possible, whether it’s good or bad, doesn’t matter. Because if you want to build a trusted partnership, it’s really important that you communicate as and when something happens that you think the board needs to know. But things that you think ought to be shared with the board have a different velocity for good news versus bad news. In some sense, I would say, the velocity for bad news should be higher than the velocity for good news.
Coral: Never wait to tell any news, just keep it open and transparent, all lines of communication always.
Well, I think that this will be really helpful for people, you know, thinking about starting a company or those sitting in companies right now. And I thank you both so much for joining me today.
Joanna: Thank
Soma: Absolutely, Coral. Thanks for doing this. And, I think, this year has been particularly interesting with what happened with like FTX and what happened with OpenAI. And all these conversations about like, hey, how do we ensure that the right startup board governance is in place, until we realize it’s too late kind of thing. And so this is a good reminder for every founder and every CEO, no matter whether they are day one, or they are looking to go public tomorrow, or they’re a 1-year-old company — governance and oversight is really, really important. Have the right level of energy and focus and attention on that. Don’t go overboard, and don’t underinvest in that.
Coral: Perfect. Thank you guys both so much.
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