This Week in Startups - How to run an efficient board meeting with Becki DeGraw | Wilson Sonsini Startup Legal Basics

Episode Date: March 12, 2021

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Hey, everybody, welcome to our startup legal basics series. Really simple. I get asked a ton of legal questions. I'm not a lawyer. Have a cursory knowledge of the law. I'm faced with making decisions every day about legal issues in startups. This is a very specific area of law. And startup law, corporate law.

There are really two or three different things you have to keep in mind. There's like the letter of the law. There's the spirit of the law. And then there's like what happens practically in Silicon Valley in the traditions. and what people's basic expectations are. And you need to know all of these things. You need to know what's the law and understand why it exists. I find that's very helpful.

The intent of the law. And then what are the standards and the expectations in the community about those laws? And then practically, how do you execute them? So I'm very lucky to have Becky de Grau with us again. Becky, how are you? Good, good. Good to be back. We've been doing this series together where we just talk about really basic stuff.

we assume the audience is aspirationally starting a company. Maybe they've already started working on their project. Maybe they've just incorporated. But they're basically, let's call it in year zero or year one. And one of the topics is board meetings. Why do board meetings exist in private companies? What is the background here? What is the purpose at its core of a board meeting?

I would say that the number one purpose is good corporate governance. At the end of the day, like the, the board. The board is driving the direction of the company, setting the strategic plan of the company, and is in charge of a lot of responsibilities of guiding the company. So the board should meet on a regular basis and discuss how the company is doing, particularly in early stage companies, right, as when you're getting things off the ground, you may have a plan for sales and for marketing and for your product. How is it actually working in real life when you're getting?

getting out there is it coming all together perfectly? Because that's usually not the case. Usually you have one plan. You set out on that. You realize that that isn't quite working. We need to figure something else out. The board meetings are a great place to have that conversation and to figure out what's working, what's not.

When you have investors on your board, that's a good time to give them an update and for them to help too, right? I mean, most of the time, the people that are setting on your board should be experts in industry should be good advisors for you. And if you're struggling to figure out why do we keep having customer churn here, why can't we get traction with the right customer base, maybe the folks around the board can also help you figure that out. Okay. So in a way, it's a forcing function that X number of times per year, and we'll get to what's the proper cadence, depending on the stage, the board gets together and reflects on the performance of the company and what the

company's plan is. And so it acts as a way for there to be a discussion about the big picture, but there's also some items that are housekeeping, I guess, most people would say, and sometimes they even call it that, like, hey, do we have any housekeeping at the end? So we should get into both of those sort of functions. But legally, are private corporations forced to have board meetings? Is it a legal requirement? Or, and then if so, how often are they legally, required to do so. It's not legally required. There are certain things that the board has to approve. And you can do those in a meeting or you could do them by unanimous written consent. And a lot of our early stage companies do them by unanimous written consent before they have meetings or in between meetings. You know, if your cadences is only once a quarter and you need to get something approved, you do it through a written consent. There are certain things where you would want to have a meeting and to show that there's been a discussion about it. particularly really big stuff like a big financing, an M&A transaction for sure, right? You don't want to just say, oh, well, we didn't have any discussion about it, but I just sent

around this unanimous written consent. We all signed it. We're all good to go. Those types of transactions, there probably should be something more than just asking for a signature. You probably should have a conversation about it. But other than that, there's not really a legally, a legal requirement to have a board meeting. Okay.

Now, the cadence of these, I have always been asked when I form a company, how often do you want the board to meet. And I'm always like, I don't know. And it's like, well, it depends. And what would, you know, your investors like to have? What would you like to have? And usually for a neophyte and somebody, you know, starting out, you just don't know what is the proper cadence. And I've had people say, we should do this, you know, other investors. Okay, I want to meet monthly. And I'm like, that seems like a lot. And then I've had other people say, let's meet twice a year, four times a year. And I'm like, maybe that seems too little. So what in your mind is a good cadence for a company, let's say that is raised a million dollars, has two seed funds in it for 500K each.

I'm just picking a common scenario here in Silicon Valley. Yeah, I would say once a quarter is pretty reasonable for that setup. And maybe you increase that frequency around you're starting to burn cash and you're getting close to your cash out date and you haven't found a new investor. Maybe you need to start checking in with the board more frequently to make sure that you can find funds before the company gets to cash out. You know, you can always add in an extra meeting throughout the year, but I would say a good cadence is probably quarterly. Then how many people should be on the board in the early days and how should those be set up

for representation? Let's just say this is a company with two seed investors who put in 500K each. It's got a, I don't know, $7 million valuation. So those two investors each own you know, 7, 8%, and let's say there's two founders. What would be a board construction of that early stage startup? In that scenario, I would say it's probably best that the company still maintain control. At that early of a stage, I would argue that there's not enough dollars into the company yet for the founders to lose control of the company. So I would say a good result. We always like to see odd number of board seats.

that you don't have a deadlock. So I'd probably say three common and two preferred in that situation. Or, you know, ideally it probably would have been only one preferred and two common, keep the board smaller. And the two preferred, you know, they are still fairly small checks for a board seat. So maybe you come up with some scenario where they switch every other year or something along those lines. Ideally, it's just one.

but if you had to satisfy both of them, or you give one of them a board observer seat and let them, you know, just absorb. Let me ask two follow-up questions there. What is a board observer seat versus a voting board seat? And then what is the percentage ownership and outside investor would have? That would be a no-brainer they should have a board seat.

And then what would be on the low side? For an early, I'll start with the observer and board piece. So observer strictly just means you get invited to the meetings. You have access to the materials, but you do not have any vote. You don't count at all for voting purposes. And then an actual director is you are setting on the board your vote counts for any decision that requires board approval. And you also have fiduciary duties that, you know, determine how you are supposed to vote in your executing your fiduciary duties. So on to the second question then with respect to when.

what's the no-brainer for giving abort a seed away? I would say for your very early financ, call it your series seed, your series A. You know, maybe you're looking at something like 10 to 15 percent. But I'd also look at the dollar amount, you know, in terms of what dollars are coming into the company. So, you know, ideally it's, you know, something north of like two and a half million before you start giving up a board. board seat. And obviously that changes as the company grows. So I would have a very different answer for like a series C or D company. You know, you got to be writing really big checks at that stage to be able to to command a board seat. But 10 to 20% ownership kind of entitles you. You've got

enough ownership in the company that you should be a steward of the company. Yeah. I think that's a good range. Yes. Generally what I've seen is like five to 10% observer, 10 to 20% board seat. But I've ever heard anybody actually say, this is the standard. There's a lot of this that is just tradition in Silicon Valley. The tradition used to be that when you did your round, the investors would automatically be in control, correct? And that flipped? Yes, yes. I mean, we're definitely in a, what I would call a founders market right now. So over time, we went from maybe the board seats being, you know, three investors and two founders, or an independent, two investors, two founders, to being three founders, one investor, one independent,

something in that range, correct? Correct. And we do see that start to balance out a little bit more once you get a little bit more mature. So around like a series B financing, that's often when we start seeing more of what we kind of call a balanced board where you have an equal number of common and equal number of preferred directors. And then you have an independent or a mutual director that rounds it out. Okay.

So having been to countless board meetings. I know they tend to last an hour and a half at this stage, maybe an hour. You know, when they're on Zoom, they seem to last 45 minutes now, which has been wonderful. But in person, they would generally last an hour and a half and maybe even have a dinner or lunch before, a tour of the office. So they would typically take a half day and they really were about bonding. Now, you know, in the pandemic and moving to Zoom, it seems like they're very much more efficient. Am I correct in your experience? because you do sit in on board meetings as an attorney, correct?

Absolutely, quite often. I would say the time period is probably right. An hour and a half is a good, good estimate. We do have some companies that are still doing kind of the three-hour board meeting for a quarterly update. I think it also kind of corresponds to the cadence. If you're getting together, you know, every two months, you're probably having shorter board meetings. if you're getting together once a quarter, you're probably having perhaps a little bit longer to actually get through and catch up on all of things.

But it also depends on what's going on with the company. I mean, if you're killing it on sales and marketing and your product, it just keeps coming out and getting lots of traction, you don't have any issues on a financial side, you can probably go through your board meeting pretty quickly. But if you find that you're not executing, that you're not hitting your numbers, that something's not working, that's when people are going to drill down and spend a whole lot more time and you're going to spend your board meetings are going to take a little longer. So there's this concept of taking minutes at a board meeting. And I guess some people recording

board meetings. And I was on a board meeting recently and somebody recorded the Zoom and somebody said, oh, no, no, no, don't record. We don't want a recording of this. We want to have just tight minutes with the topics discussed and then somebody else like long minutes. So am I correct that we do not record board meetings because it might carry with it liability. And then what are minutes and how long should they be? And, you know, let's say for this hour and a half board meeting, what would you expect the length of the board minutes to be? Who takes them? And what should be in them? Yeah. Yeah. All a really great question. So I, if I was asked, I would say, don't record your board meetings. At the end of the day, there's a lot of stuff that gets talked about. There's a lot of

confidential information that's talked about. If you have that recording a future investor, a future stockholder that's not happy with you, that's making some claim, a future buyer, could all say, I want to see a copy of that. You may not want to share a copy of it. So I wouldn't suggest recording them. Also, if you were on the other end of it and you were to covertly record it, you could be breaking the law depending on the state you're in. Is that correct? I know you're not a Yeah, this is a little out of my wheelhouse, but I know that there are really bad. Yeah, I know you have to, I know in certain states you have to have permission to record people. And I don't know exactly what that is here.

I know California is that two-party consent. And I think New York wasn't. I remember when I was a journalist, they really drilled this into us. The California right, the California folks who are journalists wouldn't be calling certain subjects because they would have to disclose their recording. And the New York journalists could call. So if you got called from a New York journalist, you could assume they were recording. And if you asked them, they might tell you they are to take notes, but they weren't obligated to tell you, which was really weird. So continue about minutes.

So we're definitely not recording. I agree. Definitely not recording. Then minutes. Long, short, are they more like a transcript? Are you using quotes of what people said? Or are you just saying, we discussed a possible acquisition of company X? We discussed a fundraising.

We discussed, you know, the new hire of a CTO and just leave it brief and tight. I encourage for standard board meetings brief and tight. Simple is better. And the way I think about it is these minutes are in the corporate record. They are, again, from the people that could request to see them and will definitely request to see them, future investors, future buyers, and the potential claimant who is potentially suing the company. You don't want to give too much away in the minutes.

You want to be able to show what happened, that there was a discussion about certain things. And if there was a lengthy discussion about certain things, you can note that. A lengthy discussion ensued among the board members. You don't have to go into detail and quote what John said and Jill said, like, just leave it out a lengthy discussion. However, there are times when I think longer, more fulsome than it's are appropriate. And that is, let's say, you're in an M&A transaction sale process. And particularly if it's not a good deal for the company. Let's say the common isn't going to be getting anything from the transaction. You really want a fulsome set of minutes that talk about all the company's efforts and going

out and running an auction, you know, trying to find all sorts of different buyers and nobody coming to the table and really talking through the terms and, you know, going through all of that to make sure that there is a good record there because that type of transaction is highly likely to result in some sort of litigation, and it's very helpful to have certain things in the record. So in those situations, beef up the minutes. But for your standard stuff, you don't need to talk about, you know, oh, we failed this on the product side of things. And, you know, we have horrible customer churn. You don't necessarily want that in there for your future investors and potential buyer to read about. And when it comes to stock options, debt, how does all that work? Because

these are things financially that impact all shareholders. So if you give stock options to a new employee or you take on debt, that impacts if I was an employee of the company, a founder of the company, or a previous investor, well, those new shares are coming from somewhere and they're going to dilute me, right? So if you issue a million shares on top of the 10 million or here, you're essentially devaluing my shares by a million. There must be some nuance to this. So When it comes to stock options, let's tackle that one first and then we'll move on to debt. What are the best practices there for making sure that you're doing this tight and right? Yeah.

So all equity, whether it's a stock option, a warrant, stock to just individuals outside of the plan, all of it has to be approved by the board. Every equity issuance has to be approved by the board. So when it comes to option grants in particular, there's a few things that you want to make sure. If it's coming out of the plan, you only have to go to the board, right? You don't have to go to stockholders to get equity approved unless there's some contractual right with respect to that that they've negotiated, which is pretty rare. Most often you'll see if stockholders do have any type of say it's purely on increasing the

number of shares that are authorized to be used for the plan, not the actual individual grants to folks under the plan. But on approvals in general, I would say it's really important if you're going to have a board meeting, reach out to your counsel a few days in advance. You know what you want the board to approve. Give your counsel the heads up of, hey, these are the three things. We want to get approved. Some option grants, debt, minutes from the last meeting. There's a few things that need to be confirmed with respect to those option grants.

One, you have enough shares available to even grant them under the plan. There are securities exemptions that your counsel needs to change. check and make sure that there's no pre-filinges in certain states. Debt, you know, they'll want to check and see if there's any stockholder requirements that are also needed. But have your counsel do all of that legwork so that when you hit the board meeting, everything is nice and organized. It's really clear when questions come up.

You or your counsel can answer them because they've already done the work to understand what the requirements are. And then I also really like to include actual just like proposed resolutions, you know, that you can include in your pre-read material. that go out of like, hey, these are the things we're going to ask you to approve. It makes running the board meeting just so much smoother. I have found that if things are really well organized and the board thinks that, okay, this is all great and everything's running really smoothly and everybody's looked at this,

it's much more likely to get approved than if you're like, oh, I don't know, I didn't think about that. Oh, I have to go back and check that. It starts making people nervous, right? Like, yeah, maybe we need a wait on this. Maybe we revisit next time. So you won't have as, people won't have as much confidence in it. So the idea here is if you set a very tight agenda, your board meeting will have a greater

chance of inspiring confidence and will go efficiently. I've had people even say, here's our agenda for today. Everybody starts with the agenda of the meeting. And they say, we're going to spend 10 minutes on this, 10 minutes on this, 10 minutes on this, then we're going to move into this discussion, which will be 30 minutes. And then we have five minutes of housekeeping to approve the minutes and the 409A and yada. So people actually even putting what they anticipate the amount of time they'll spend on that. And then they're sitting there checking it off and saying, okay, we're going to move on to accounting.

We're going to move on to sales. We're going to move on to, you know, hiring. And that really has helped some of these. Okay, we're going to do another startup basics just on option grants because that is in and of itself a topic, correct? Yes, yes. Lots to unpack there. If you would like to see the entire list of startup basics we're doing, legal account, all of these different topics, you can go to this week

and startups.com slash basics. Or you can go to YouTube.com slash this week in, and you can see a playlist right there on the channel page. So this week in startups.com slash basics or YouTube.com slash this weekend. You can find, you know, almost two dozen of these basics that we've done over the years to really help you understand where to get started.

Thank you so much, Becky, and we'll see you next time.