Ask a MoFo: The Evolution of the Board of Directors in Startups and Emerging Companies

The board of directors is a group of individuals, elected by the shareholders, who are empowered by law and a corporation’s charter documents to manage its business and affairs. They can aid in creating a successful business and go-to-market strategy, putting together the right management team, structuring strategic transactions, building good financial habits, and avoiding legal and compliance issues. In making these decisions, the board owes fiduciary duties of care and loyalty to the corporation and its shareholders (see more on fiduciary duties here).

In this article, we explore the basics of how the makeup of the board is determined and how it evolves over the life of a typical startup or emerging company.

Electing the Board

The board of directors is elected by the shareholders of the corporation. The methods for electing boards of directors can vary significantly depending on the corporation’s state of incorporation and governing documents. The default starting point is that the holders of a majority of the outstanding voting shares have the right to elect all of the directors. Eventually, most venture‑backed startups evolve from the default state and negotiate bespoke arrangements in connection with raising equity financings, as discussed further below.

Size and Composition

For startup companies, a board’s size and composition will depend largely on its stage, industry, and financing history. Determining the optimal size of a board is crucial. Boards that are too small may lack diverse outlooks or objectives and risk becoming stagnant. Conversely, boards that are too large can become unwieldy, complicating governance and operational efficiency. The boards of most venture‑backed startups largely track the balance of its shareholder base with proportionally more directors representing the investors the more dilution the company has taken on over its fundraising rounds.

At Incorporation:

Under Delaware law, where an overwhelming number of startup companies incorporate (see more on the choice to incorporate in Delaware here), there can be as few as one director. When a startup company first incorporates, the board will typically consist of the founders. It is not uncommon for an early-stage company to have a board of directors, all of whom are shareholders and all of whom are also officers of the Corporation. This arrangement allows the founders to maintain control and make decisions quickly.

Pre-Seed to Seed Funding:

As emerging companies grow, they often need to take on funding from external sources. Many initially rely on convertible instruments, such as convertible notes and SAFEs, which do not carry votes at issuance (read about the differences between these convertible instruments here). Investors in convertible instruments do not typically have any entitlement to vote for or sit as the directors on the board. With that caveat in mind, a larger seed investor may request a board seat or observer rights to influence the corporation’s direction and protect their interests.

Priced Equity Rounds: Series A and Beyond:

The board typically evolves as the company matures. For most venture-backed startups, changes in a board’s size and composition are negotiated during funding rounds and can be made a closing condition of a financing (i.e., certain resignation and appointments need to occur to receive new capital). In most cases, voting agreements are entered into to ensure the desired outcome and specific series of shares or specific persons/investors are given the right to designate representatives who the other shareholders are in turn required to elect.

In a traditional Series A financing, where the startup company sells equity in the form of preferred shares at a fixed price, the board is expanded to provide a seat for the lead investor with the remaining seats left for the common shareholders. As more venture capital rounds are completed, additional board seats are commonly added for the lead investors in those new rounds. In connection with these future rounds, further variations, such as removing an earlier investor’s board seat to add the new lead’s designee or freezing the size of the board without a representative for the new lead, become more common.

At some point, investors and/or management may look to round out the expertise around the board table and add one or more independent directors join the Board (i.e., those without an affiliation with the corporation or any of the investors). This often comes up when there might otherwise be an equal number of common and preferred director seats, as a sort of tiebreaker. The designation of this individual usually requires some cooperation between the holders of common shares and the investors.

As the company matures, it is not unusual for the number of board positions allocated to the common shareholders (and therefore the founders) to be more restricted. Often, for example, there is a seat reserved for whoever the current CEO of the company may be, regardless of whether that person is a founder or controls the common share vote. To the extent that there are more founders or significant common shareholders than there are allocated board seats, sensitive conversations are necessary in order to determine who gets to be on the board. Among its many duties, the board determines who the officers of the company are, and so the balance of power on the board is important in determining who is running the company.

Further Considerations and Concluding Thoughts

At different stages in a company’s life cycle, its board’s size and composition will change to reflect its changing shareholder base and needs. As the ultimate decision-making body for a corporation, the board’s composition is one of the most important keys to success. Parties should take into consideration the background and skills of potential board members, as well as the personality and culture fit of those individuals, to build a governing body that maximizes the company’s chances of success.

While there are market norms (which are always evolving), there are few hard and fast rules about what a private company board needs to look like at any particular stage. Make sure to work with experienced legal counsel and other advisors to determine what is appropriate and best fits the needs of the parties in your particular circumstance.