Why is it that management teams in start-ups assume their Boards want to get down into the weeds every Board meeting and why do Directors buy into this approach and behave like weed inspectors? Board governance isn’t about inspecting everything that management is doing; it’s about holding management accountable for those things that are material.
Start-ups are high risk, but materiality should be those things that have the potential to impact valuation or derail a liquidity event. Sure, the product roadmap (aka Feature List eye charts) is important, but is it more important than GPL compliance?
What impacts valuation more than revenue? Yet how often do you see a Board congratulating management for “hitting their numbers” rather than asking whether these are the right numbers to be hitting? There’s no point in patting management on the back for a year in which a company grew 10%, if the market and their competitors are growing at >50% year over year. Underperforming the market equates to declining market share, which will ultimately impact valuation, multiples, and liquidity opportunities, none of which deserve a pat on the back.
Rather than showing slides that show how the company is “performing to plan”, how about a slide showing how the company is “performing to market”?
It’s a fact of life today that companies leverage open-source software. There’s tremendous pressure to hit dates and add features, and many engineers will look to SourceForge, or similar, for code to help meet development timelines. Without a robust open source license tracking process, it’s very likely that, over time, one’s code base may not comply with all of the license obligations associated with the bits.
Non-compliance is material. Just ask Cisco, which had to publish the source code for its Linksys line when found to be in violation of its open source license obligations. Every licensing and M&A deal that I’ve done has required a representation, signed by an Officer, warranting compliance with copyright licenses. Sophisticated acquirers will require a 3rd-party compliance assessment using a tool from a company like Protecode or Black Duck, and being “caught” during a due diligence will cripple any deal.
So rather than spending the R&D section discussing feature lists, shouldn’t Boards be focused on mitigating the risks of non-compliance with open-source license requirements? Why shouldn’t R&D be required to provide a slide, every meeting, summarizing the open-source licenses for code being used in shipping product? Shouldn’t the CFO and CEO be required to sign-off that the company is in compliance, every quarter? Just as Financial Statements are provided and signed off on, so should GPL compliance, and as with annual audited financials, management should prepare and provide an audited 3rd-party compliance report annually as well.
Non-compliance puts the company and its investors at risk and should be a firing offence, first time, no questions asked. It’s not the engineer that should be fired, unless he/she knowingly violated company policy (that is monitored and real and not “vapor”), rather it is any Officer of the company that was aware of non-compliance or who has oversight and ultimate accountability. This means, in most cases, the CEO.
Many start-ups take a very ad hoc approach to intellectual asset management (IAM), which is odd since it is an asset class that forms the essence of a company’s value. You may see a slide in a Board deck that lists patent applications, but rarely do you see any level of competitive analysis, either in terms of competitors’ patent positions, or potential infringers of one’s own patents. Significant money is spent on patents, without an understanding of the business objectives for so doing. As a result, many patents end up sitting in a filing cabinet or as a plaque on a wall and are never used to the company’s benefit.
So why is this material? Once again, it has the potential to impact valuation. Having been directly involved in a multi-hundred million dollar M&A transaction, where the justification of the 30X revenue multiple was based on IP portfolio strength, I can attest to the power of a coherent, well-documented IAM process. When this is supported by the knowledge of 3rd-party IP in your space, as with a patent landscape analysis, you have a powerful justification for including IP in any discussion of valuation.
Furthermore, Directors and Officers have a duty of care with respect to the management of corporate assets. Recently, I read an article that suggests a corporate officer or director, who is aware of an infringement of some patents owned by his or her company and who fails to enforce these patents, may be held liable for breach of the duty of care with respect to the management of corporate assets. I’m not sure whether it’s ever happened, but it makes sense for Directors to expect more than a simple list of patents.
Rather than a slide documenting a company’s patents (which I can Google or BING anyways), how about an analysis of your IP and your competitors’? How about a discussion on enforcement of IP with some clear guidelines around it? How about pushing management about disciplines related to invention documentation? Are the engineering notebooks signed and dated? What about an international filing strategy? Which markets? Why?
Board members have visibility into a company’s liabilities; monthly Balance Sheets show this, but what of off Balance Sheet liabilities? Many SmallCo’s are disadvantaged at the negotiating table and as such, sign deals with indemnification clauses that effectively “bet the company”. Any contract that includes clauses for liquidated damages or in which the company provides an uncapped indemnity, should require Board approval. At a minimum, it is the CFO’s responsibility to advise the Board as to the existence of these hidden, potential liabilities, but it is the Board’s responsibility to require this of the CFO.
Lastly, I’d like to point out that Directors and Officers have an obligation to all shareholders, regardless of share class. Most Board members are representatives of investors, and often have preferred rights of some kind. But it is incumbent on Directors to represent all classes of shareholders, including common stock holders, and not simply to represent their own stock class.
So what’s my dream Board meeting?
It’s one in which the company is measured, objectively, against those metrics that matter. It’s one that isn’t comprised of 100 eye charts describing the minutiae of the business, but which is focused on issues of materiality.
CEO/Sales: How fast did the business grow relative to the market and its competitors?
CEO/R&D: Are you monitoring open-source license compliance? Will you stake your job on it?
CEO/CTO: How are you leveraging IP to limit competition, grow revenues, create value?
CEO/CFO: What “bet the company” contractual indemnifications exist? What contracts currently under review have “bet the company” clauses?
Ultimately, it’s the Board that needs to convey to the CEO that these are issues of paramount importance to the company, its Directors, investors and all shareholders and that he/she will be held accountable. Don’t take us down the garden path every meeting and don’t pull us down into the weeds. Show us that you have your finger on the pulse of those things that matter.
To paraphrase Peter Parker, “With great power comes great responsibility”, but that’s why CEOs make the big bucks.
That’s my .02!
Martin Suter
Just re-reading this today after your tweet. I'm working on a seminar on board governance for start-ups, I'd like to make this required pre-reading for all participants. Great insight.
Posted by: Cindy Mitchell | January 19, 2012 at 07:00 AM