A well-functioning board is the company’s brain trust that steers the company amidst a tumultuous sea of a startup’s life. But as you assemble this team of seasoned professionals, one question often presents a significant challenge: “How should I compensate my startup board?”
The answer isn’t always straightforward, with options spanning cash, equity, expense coverage and potential investment opportunities. As we delve into these alternatives, we’ll guide you toward a compensation strategy that effectively reflects the value of your board’s guidance and aligns perfectly with your startup’s vision and resources.
Types of Startup Board Members
To answer the board compensation question, the first thing to understand is that there are three types of startup board members as described below:
- Founders. These are the individuals who start the company. They often serve on the board because they have a deep understanding of the company, its vision, its market, and its product or service. Founders often serve in a leadership role on the board (such as the board chairman or CEO) because they are usually the most invested in the success of the company and have the most knowledge about its inner workings. They have the ability to make critical decisions and drive the company toward its goals. However, it’s also important for founders to understand that the role of the board is governance, not management, and that they have a responsibility to all shareholders, not just themselves.
- Investors. These are usually venture capitalists or angel investors who have invested a significant amount of money in the startup. They are often granted a seat on the board as part of their investment agreement. The primary role of these board members is to oversee their investment and ensure the company is being managed in a way that maximizes shareholder value. They often bring a wealth of business and industry experience, as well as valuable networks of contacts. They might be more focused on financial performance and growth strategies, and may push for an exit strategy (like an acquisition or initial public offering) that provides a return on their investment.
- Independent Board Members. These are individuals who are not part of the founding team and do not represent significant investors. They are usually industry experts or experienced executives who are brought in to provide unbiased, third-party advice and oversight. Independent board members bring a different perspective and can help mediate between founders and investors. They often have a wealth of experience in business growth, strategy and governance, and can provide valuable guidance and mentorship. Their role is to contribute to the strategic direction of the startup, ensure the company adheres to legal and ethical standards, and protect the interests of all shareholders.
Founders are already being compensated for their service to the company. They hold stock, and they are receiving a salary. There is no need to compensate a founder for their board service.
Investors have purchased an equity position in the company. Generally, the lead investor in each round gets one seat on the board of directors. They want a seat on the board, not to earn some compensation; they want to protect their investment and help guide the startup to the most successful outcome. There is no need to compensate investors for their board service.
Independent board members are outsiders. They bring expertise but have no stake in the outcome of the company. This is a bad thing. Generally, you want a person with that level of authority to have a vested interest in the success of the company. In order to ensure that the independent board member is sufficiently motivated to make wise decisions on behalf of the company, it’s important to compensate them for their service.
But what form should that take?
Avoid paying cash compensation to board members of startups.
Startups operate within tight budget constraints, unlike their well-established, publicly traded counterparts. Allocating resources to cash compensation for board members takes away crucial funding from key growth-focused activities. Moreover, requesting cash payments may indicate a transactional approach that lacks the committed, growth-minded relationship startups need from their board members.
If a potential board member insists on cash compensation, it should raise red flags for founders. This likely suggests a misalignment of priorities, indicating a lack of understanding of startup dynamics where the emphasis is on long-term value creation, rather than immediate cash compensation. This demand for immediate gain could also display an impatience that’s generally incompatible with the long-term perspective often needed in startup environments. If a potential board member is seeking cash compensation, it’s a strong negative signal. It shows that they don’t really understand startups and are likely not a good fit.
Equity-based compensation is more suitable for startups than cash compensation. It aligns the interests of board members with the long-term success of the startup, fosters a sense of shared risk and reward, and incentivizes board members to increase the company’s value. Thus, requests for cash compensation from potential board members should be treated with caution, as they may indicate a misunderstanding of startup dynamics and a misalignment of interests.
- Amount of Equity. Board members should receive between 0.25% and 1% of fully diluted equity, depending on their level of contribution, similar to advisors.
- Vesting. The equity grant should include a vesting schedule that lasts no less than two years and no more than four years without a cliff. In this case, single-trigger acceleration is appropriate because board members will not be working with the company post-acquisition. As with any vesting schedule, it is essential that both parties understand what happens if the board member leaves; they keep their vested shares but not their unvested shares.
Covering reasonable expenses related to board service for startup board members is a common and fair practice. Board members are typically busy professionals who dedicate significant time and expertise to assist the startup. They often travel for board meetings, spend time preparing for these meetings and may incur other expenses in the course of their duties. Reimbursing these costs is an acknowledgement of the value of their time and contribution. It also ensures that they are not financially disadvantaged by their board service, enhancing the attractiveness of the role for potential board members and demonstrating the startup’s respect and appreciation for their contributions.
In addition, covering these costs underlines a commitment to good governance. It ensures that board members can fully participate in necessary activities without concern for personal financial impact, enabling them to focus on their governance duties without potential distractions. This may include costs such as travel to attend board meetings, accommodations, meals or any other reasonable expenses directly related to their board duties. Reimbursement policies should be clear, fair and transparent, contributing to a culture of trust and professionalism in the startup’s board governance. Such a practice aligns the startup with standard business practices, further bolstering its reputation and credibility in the eyes of stakeholders.
Opportunity to Invest
Offering board members the option to invest in future funding rounds can have several advantages for a startup.
First, it aligns the interests of board members even more closely with those of the company. If board members have a larger financial stake in the startup, they are likely to be more invested in its success, as their own financial outcomes would be directly tied to the company’s performance. This can lead to greater commitment, deeper engagement and more strategic contributions from board members.
Second, board members often bring significant expertise and valuable networks to the table. If they invest in the company, they are likely to leverage these assets even more extensively to support the company’s success. This can help startups tap into new opportunities, partnerships or resources that they might not have access to otherwise.
Third, board member investment can serve as a strong signal to other potential investors. It shows a high level of confidence in the company’s prospects, which can help attract additional investment and potentially enable better terms for the startup.
However, this option should be just that — an option. Board members should not feel obligated to invest, and their decision should not impact their role on the board. The key is to create an environment that encourages alignment and commitment, while respecting the individual circumstances and decisions of each board member.
Exploring Non-Monetary Incentives for Board Member Engagement
While equity compensation is a common method of incentivizing board members, startups can also explore non-monetary incentives to keep their board members engaged and motivated. One approach is to provide board members with access to networking opportunities or industry events that can help them grow their skills and expertise.
By attending these events, board members can gain valuable insights into industry trends and best practices, which they can bring back to the startup and use to make informed decisions. This not only benefits the startup but also helps board members develop their own professional networks, which can be valuable in the long run.
Another alternative is to provide board members with opportunities for professional development. This could include access to training programs or mentorships from experienced executives within the startup or industry. By investing in their development, startups can help ensure that their board members have the skills and knowledge necessary to make informed decisions that benefit the company.
Startups can also consider providing board members with perks such as access to exclusive company events or products. For example, a food delivery startup could offer its board members free meal delivery for a certain period of time each month. This not only provides value to the board member but also helps them stay connected with the company’s product offerings.
Overall, non-monetary incentives can be an effective way to keep board members engaged and motivated without placing a significant financial strain on the startup. By exploring these alternatives in addition to monetary compensation, startups can build a strong leadership team that is committed to driving long-term success.
In conclusion, compensating startup board members is a complex issue that requires careful consideration. While cash compensation may not be appropriate due to the financial constraints of startups and the potential misalignment of priorities, equity compensation, expense reimbursement and opportunities to invest can be effective ways to incentivize and retain board members. Non-monetary incentives such as access to networking opportunities, professional development and exclusive perks can also contribute to board member engagement and commitment. Ultimately, the key is to create a culture of trust and mutual respect that aligns the interests of all stakeholders toward the long-term success of the startup.