Raising the performance bar for VC-backed boards

A wide variance exists in the application of best practices on VC-backed company (VCBC) boards, largely influenced by the weight of individual personalities at the board room table. Unique aspects of our industry create special factors that can lead to dysfunction in the boardroom—such as the steady influx of new entrepreneurs who are inexperienced directors and challenges posed by inherent conflicts of interest for directors who are VCs, who must be fiduciaries and still represent their funds.

Last year, the NVCA released its first ever board study, which revealed an overwhelming consensus between entrepreneurs and VCs that VC-backed company boards lack metrics to measure their effectiveness. To respond to the problem, I established the Working Group on Director Accountability and Board Effectiveness, which is comprised of 22 leading VCs, CEOs, attorneys and industry professionals. The result of this collaboration is a new white paper entitled “A Simple Guide to the Basic Responsibilities of VC-Backed Company Directors.” The paper is freely available at http://www.levp.com/news/whitepapers.shtml

“A Simple Guide” promotes better board processes because strategically and economically aligned boards can be a real asset in improving the probabilities for a successful investment outcome. This guide addresses the critical role of corporate governance in contributing to effective boards. It answers essential board service performance questions, recommends guidelines for all VCBC directors and educates the other core VCBC constituents—management, investors and employees—about proper board governance process. It is meant to be useful for practitioners and focuses on corporate governance practices in the context of the emerging privately held company.

The paper is incremental and addresses different stages of company evolution. It is meant to be easy to understand and applies to life science companies as well as to IT companies. We envision the three “education modules” that are the core of “A Simple Guide” becoming a routine part of the “Welcome to the Board of Company X” education process for the newest director. The logical time for this to occur is after a financing round or a CEO change, because it presents the opportunity to ask “How are we doing?” without singling out anyone.

Of the three education modules, two of them only require a few minutes of reading time and are very straightforward in identifying best practices and performance standards. The third, which applies to companies in later stages of development, requires real behavioral change in terms of adoption.

Someone on the board must take ownership of the process of educating directors about their service responsibilities and implementing the process of director evaluations.”

Pascal Levensohn, Founder, Levensohn Venture Partners

Educate directors

Someone on the board must take ownership of the process of educating directors about their service responsibilities and implementing the process of director evaluations. Whether the “owner” of the implementation process is a VC, the CEO or an independent director is secondary. The Working Group recommends that, at a minimum, the CEO initiate a board discussion to assign this responsibility.

Because VCBCs experience significant changes in board size and composition over their normal life cycles, not all of the processes described in this paper are applicable to every VCBC, especially at the earlier stages of their development. See the table for a matrix that describes the typical range of board sizes and mix of directors associated with the different development stages of VCBCs. It also includes a guide to the types of corporate governance processes that should normally be considered for implementation during these development stages.

There is no firm rule for VCBC board sizes or their composition because boards, by their very nature as small groups, are heavily influenced by individual personalities, interpersonal relationships and individual skill sets. Recognizing that the average time from creation of a new VCBC to its exit (an average of six years at the time of the writing of this paper) is the longest it has been in over a decade, VCBC boards should pay particular attention to board composition to avoid duplicative skills among board members.

While it is outside the scope of this paper to address this issue in greater detail, VCBCs should strive to constitute a board where the members have different strengths from each other (technical, operational, financial, managerial). In addition, skills of VCs should complement those of the independent directors (who may have different but relevant sector domain expertise, such as accounting credentials required for audit committee chairs).

Although all boards are made up of individuals with differing interests and responsibilities outside the boardroom, they must serve common goals inside the boardroom.”

Pascal Levensohn, Founder, Levensohn Venture Partners

Standardize peer review

Peer review among VC-backed company directors has historically not been common in our industry. One reason for the absence of this practice in our industry may be because VCs buy their board seats through preferred stock investments. But contractual board seat rights do not absolve directors of their obligation to be accountable to their board colleagues. Annual director peer review is a recommended best practice for Nasdaq companies and a requirement for NYSE listed companies. The annual board review questionnaire developed for “A Simple Guide” is brief and the questions are not controversial. It measures the basic health of the board through the effectiveness of its processes, and it opens a forum for comments in the event that issues exist which should be surfaced but directors are reluctant to do so to avoid confrontation.

By communicating the information to a third party, such as the company’s outside counsel or a third-party consultant, the information remains confidential. Directors can use the review to raise board governance and process questions in a less controversial manner, and any written material should be handled consistent with the individual company’s document retention policy. Based on discussions I have had with seasoned public company directors who are veterans of the peer-review process, the most effective evaluation process is conducted orally by the company’s outside counsel (or general counsel) with the results communicated to the board chair (if that person is an independent director) or to the director designated as the governance process leader on the board. This process eliminates any circulation of documents, is not time consuming, and can be very effective at promoting collegial behavior and open communication among all directors.

Conclusion

As a result of discussing the education modules in “A Simple Guide,” I have personally seen immediate process improvements at the companies where I am on the board. I have also received positive emails from VCs and entrepreneurs who have read and used the guide. It is still “early days” in the process of continuing director education for the VC industry, and we encourage feedback from anyone who has read the paper, particularly process improvement recommendations. This guide is a living document that we hope to revise and improve over time, but we can’t do it in a vacuum.

Pascal Levensohn is founder and managing director of Levensohn Venture Partners, a San Francisco-based firm that manages $164 million in two IT-focused funds. Levensohn sits on the boards of Akros Silicon, Consolidated IP Holdings, Reconnex, Ubicom and Veraz Networks. He keeps a blog at www.pascalsview.com.