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Three Steps to Startup Governance (Yes, You Need It)

Three Steps to Startup Governance (Yes, You Need It)

What is governance?

Company or corporate governance helps founders, investors and leadership deal with serious problems when "the shit hits the fan", and will provide helpful strategic direction to the company in alignment with all constituents goals.

You will better protect yourself and your company by thinking about governance before you need it. When a situation arises where you would benefit formality around your company's goals, strategies, or conflict resolution, you will be glad you have it. Like a fire escape plan, you do not want to be coming up with the plan while the fire is burning.

Good corporate governance usually comes in the form of a board, or of some group of people who provide some of the functions of a typical board, and:

  1. Makes it clear who is - and is not - involved in decision-making based on the nature of question: this may be based on the size of a proposed financial commitment, potential strategic impact to the business, key executive hires, equity compensation decisions, etc.
  2. Sets out the key, high level targets for measuring the performance of the business: these almost always include financial performance expectations, but often can include other non-financial expectations as well that measure how the business is progressing towards strategic goals (e.g. workforce diversity, risk management, regulatory matters, etc.)
  3. Provides a mechanism for the founders, leadership or other managers of the business to receive guidance on matters that are beyond their areas of expertise or warrant an outside perspective: this is very dependent on the nature of the business, background of the management team vs the board, and what the long term objectives are for the business.
  4. Prescribes a process for the resolution of conflicts when there is disagreement that cannot be resolved at lower levels: over a long enough time horizon, there will inevitably be conflict between stakeholders in the business. If you don't have an agreed upon framework for resolving the problem, you now have two problems.

Governance should be put in place before you think you need it, but after you've proven that the business has economic value (e.g. you're close to raising money, you've built some early version of the product for which someone is willing to pay).

How do I "create" governance?

The devil is in the details, but the basis for governance is formed in three basic steps:

1. Formalizing some processes in your corporate bylaws or operating agreement

The foundation for corporate governance originates from the operating agreement (for an LLC) or the corporate bylaws (for a C corp or S corp). These documents typically spell out the number of managers (for an LLC) or directors on the board (for a C corp or S corp). They also provide the procedures for how managers/directors are appointed, replaced or removed, procedures for resolving conflicts within this group using formalized, legal measures, and may establish or limit the authority of individuals and their voting rights. There are other formalities that are usually established, like the frequency of meetings of the board/managers.

As a founder, your goal should be to never need to rely on legal processes to resolve conflicts. However, conflicts reach this point more often than you might expect, so it's important to understand the processes you're creating when setting up the company. Some representative scenarios you should consider to ensure problematic situations can be resolved are:

  • fundamental disagreements between founders, managers or directors about how the business will be run, including escalation processes that may include professional mediation, arbitration or other ways of tie-breaking
  • removing a founder, manager or director for cause, like substance abuse problems, abandonment of their obligations, breach of fiduciary duties, or serious policy violations
  • situations that could lead to the forced purchase or sale of equity by an equity-holder (such as a founder being removed from the company), including how that individual's equity can be bought back by the company or other equity-holders and how the price is established in these scenarios
  • the permutations of people with voting rights who are needed to resolve the above scenarios in such a way that deadlock can be avoided

Once the legal framework is in place, think of it as the safety net or process of last resort to resolve conflicts. You can usually avoid conflicts that become legal issues  by managing expectations with stakeholders (founders, board members, etc). When conflict does occur about how the business is being run, it should be resolved wherever possible using interpersonal relationships or board voting processes.

2. Agreeing on goals and metrics to use to manage the business with key stakeholders

Founders, managers or board directors should agree on strategic goals and metrics for measuring the business. For early stage businesses, metrics typically include things like:

  • financial performance: revenue, profit, cost management / burn rate (i.e. how much does it cost to run the business and how is that rate changing over time), capital / debt raising expectations (i.e. do you need to raise more capital or increase debt, how much, and by when), and cash flow management / runway
  • key business metrics: growth rate, customer retention, customer acquisition costs, customer churn
  • regulatory matters: for businesses in highly regulated industries, reporting on compliance or regulatory issues that create systemic risk for the business

For each metric, the process for how the metric is obtained should be rigidly defined and able to be repeatably, accurately calculated (i.e. the metrics are not subjective). Each metric should have a target that is agreed upon by all stakeholders.

3. Follow a rhythm for reporting on how the business is performing and where it's going

Once the metrics are established, you should plan to report on them quarterly to founders, managers or directors. Your "package" for reporting this data should be in a consistent format quarter to quarter. This reporting, along with any management commentary (why a target was or wasn't met, fundamental changes in the business or environment, etc) should be sent out in advance of any governance or board meeting so that all of the stakeholders can review the material and come prepared for discussion and decision-making.

You should set an agenda for your board meeting or other governance routines that are action-oriented. Identify questions about strategy, decisions that need to be made, or areas where you need help in advance. Circulate these as part of the agenda along with the metrics. This is also a good test of whether you have the right people participating in your governance process: if you feel like you can't rely on them to provide valuable input on these types of topics, you probably need different board members or stakeholders.

One important thing to ask yourself is whether your board meeting or governance routine feels like a "check-the-box" exercise where everyone is going through the motions. This is a dangerous sign. Growing, evolving businesses are made better by diverse opinions, discussion, and constructive debate. If that isn't happening, the founders or management team probably have a blind spot. No founder knows everything, has every answer, or can deal with every strategic question without help. Some amount of tension should be expected - good governance should challenge your assumptions and ultimately make you a better leader.

What's Next?

Get back to running and growing the business. Expect that your governance process will become more complex as the business or capital structure becomes more complex. If you're successful and bring on more sophisticated investors or financial partners will likely dictate some elements of governance to you. Creating the discipline around governance early will make these changes easier to navigate!