For higher success with startups, bring independent directors on board 

Startups are vital engines of innovation and value creation, holding the promise to revolutionise markets. But they face daunting odds, and the low startup success rates reflect this reality. 

Effective startup governance can be one way to turn the tides. Experts like INSEAD professors Theodoros Evgeniou and Ludo Van der Heyden believe that more attention should be paid to the boards of startups to avert value erosion.

In the early stages of startups, the entrepreneurs’ passion and expertise are paramount to the business’ success. During this period, the tendency is for the founders of the startups to enlist advisory boards to provide resources and connections to help them navigate the challenging landscape. 

As startups transit into the scale-up phase, founders often trade some control of the business in exchange for additional resources to fuel future growth for the company. As a result, they reduce ownership stakes and collaborate with structured official boards including external directors acting as proxies of venture capitalists (VCs).

The VCs, once invested, become active advisors to founders, according to Harvard professor Paul Gompers. Consequently, becoming a member of the board becomes a significant means to gain control.

Yet, long-term value creation from VC funding is not a given. A meta-analysis of 48 studies covering close to 37,000 firms in North America, Europe, and Asia only found a small positive performance effect of VC investment on firm growth, not profitability.

One reason is the potential conflict of interest between founders and external directors, who are representing diverse groups of owners as the startups progress into successive funding rounds.

On one hand, external directors representing VCs may have different time horizons and exit preferences, both among themselves and in relation to the founders. On the other, founders may be motivated by the autonomy to decide on the long-term viability of their startups and less by financial rewards. Such diverging interests may cause VCs to prefer strategies that benefit performance that may not be necessarily beneficial for the startups. 

The value of independent directors 

While independent directors are commonplace in publicly listed firms, their presence in startups remains relatively rare. However, there is growing recognition among founders and experts that independent directors can add substantial value.

Independent directors tend to not have interests that are narrowly defined by returns on investment or preservation of control. A recent working paper from the US National Bureau of Economic Research highlighted that independent directors add value to startup performance by mediating potential conflicts between VCs and founders. This is a view shared by Sukhinder Singh Cassidy, founder of online talent marketplace, TheBoardlist, who believes that independent directors are the bridge builders in difficult conversations.

Others like serial entrepreneur Yann Lechelle, said that startups wait too long to bring in independent board members and should consider independent directors as early as Series A or even seed funding rounds.

Moreover, independent directors can better manage exit pressures from VCs. A published study on U.S. surgical device private ventures found that venture boards with more independent directors facilitate high-value mergers and acquisitions as an exit option.

A balance between performance and conformance

There is a balance to be struck between performance and conformance for startup governance by its boards. 

Poor-performing startups may resort to unethical practices to deceive stakeholders, while those neglecting conformance may experience unsustainable growth and lose societal legitimacy.

The value of independent directors therefore lies in providing complementary resources to enhance startup performance and monitor conformance from a broader stakeholder perspective. 

For instance, non-executive directors with backgrounds in sales and marketing can lend their expertise to generate a positive impact on market performance. This is particularly beneficial for early-stage high-tech startups, according to a published study on Belgium firms.

Moreover, like VC directors, independent directors can also govern for conformance by advocating for safeguards and guiding startups towards sustainable growth while complying with rules, regulations, and policies.

In the evolving startup landscape that is fraught with uncertainties, it is crucial for the business to be adaptable to stay relevant, pivoting and evolving whenever the situation calls for it. It is time that we pay attention to the potential contributions of independent directors who bring fewer to zero baggage to the ecosystem.