In the startups, this is a particularly touchy issue.
So long as the founders are the only investors in the business, the Board of Directors (BOD) normally are the founders except the odd independent director nominated by them – either in an advisory capacity (also good corporate governance) or to embellish the Board with luminaries. Regulatory whips don’t surface in this stage.
Normally it shouldn’t be such a pain, if Board seats can be reserved on the basis of proportional investments made by the investors. But founders sweat it out with their time and effort too besides money, while the outside investors may just have the financial stake. Now how to split the board seats between founders and financial investors, if “quantum” is the only criterion? Can you disregard the value of founders’ sweat?
Unless a method to quantify the value of founders’ sweat is devised, to arrive at the Board composition ratio is not easy. This again depends largely on what is more critical to the business in a relative sense, sweat or finance. If it’s a technology company, it’s always loaded in favor of sweat. What if it’s a financial services business, where capital is the raw material and finished product? What if both are equally critical, as is normally the case?
I have always advised my clients on a consensus route. I call it as “iterative calibration”. It’s not important to decide on the split ratio of BOD all at once. Start with some fair basis of representation between the founders and other investors and keep tuning it as we move forward. It’s fairly simple to define – set milestones of performance and keep measuring it on a periodical basis. If the founders are constantly hitting the milestones or are over-delivering, they shall have the majority (why not when they are doing a good job?). Financial investors are happy since their investments are managed well, and the risk levels lower.
If it’s the other way round, the founders may see their position compromised and investors should have the freedom to have more say, including bringing in superior talent at the helm. So far it has worked very well, but I would like to see more perspectives.