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January 31, 2012

Why Startups Need Outside Directors

I work with a lot of startup companies, and am struck by how many of them lack outsiders on the board of directors. Many startups have boards that consist only of the founder/CEO and investors. It’s not at all uncommon to hear CEOs lament the lack directors with meaningful operating experience on their boards.

Why aren’t there more outside directors?

Before we get to that, consider the contributions of a great board. The best boards help the company get where it wants to go faster, and with fewer expensive detours. Most entrepreneurs would agree that an effective board – one where members are engaged, collegial, and bring knowledge, experience and connections – add a tremendous amount of value.

A great board almost always includes directors who can draw on extensive operating experience. That’s something many investors do not have. OK, you just thought of some exceptions, but I’d argue they only prove the rule.

Here are a few things outside directors can bring to the table:

  • Deep knowledge of the target market;
  • Industry contacts;
  • Credibility in the marketplace and with potential investors and employees;
  • Subject matter expertise on R&D, regulatory, commercialization, M&A, operations, or other challenges the company will be facing.
  • As a side benefit, an outsider can be a “safe” director with whom the CEO can discuss thorny problems before bringing them to investors.

It seems pretty clear that outside directors can make a major contribution to startups. So why don’t more startups have outsiders on their boards?

Some of it is inertia. Even when the board agrees that adding one or more outside directors is a good idea, there are always higher priorities. It’s easy to keep push recruiting outside directors down the list.

Cost and control are undoubtedly factors, too. Founders and investors may be reluctant to bring on outside directors because the downsides (giving up some equity and a board vote) are easy to quantify, but the upside is unknown.

But the upside is very real indeed. If an outside director (or any director, for that matter) contributes just one great idea, or saves the company from a painful misstep, she’s earned her keep.

I welcome your thoughts. What’s your experience with outside directors at startups?

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