Level Up Governance Presentation - Dave Litwiller - March 2013

Building Better Boards of Directors
Growth- and Expansion-Stage Tech Companies
Dave Litwiller
Executive-in-Residence March 27, 2013
Introduction
Looking beyond standardized recommended and legally required practices for growth- and expansion-stage tech company boards of directors Discussion of the tools, traits and techniques which have the highest direct influence on board performance, and company performance
Copyright, David J. Litwiller 2013
Going from Good to Great

Collective productivity increase:
3* to 10* higher for great vs. good More time thoughtfully researching and deliberating the right things Faster learning Better ongoing adaptation More constructive handling of conflict
Outsized contribution to:

Company leadership , by example and positive tension Winning culture Ecology of sustained outsized success
Copyright, David J. Litwiller 2013 3
Overview
People Board Evolution High Impact Practices CEO Performance Evaluation and Communication Chairmanship Board Assessment - Break Corporate Metrics and Practices to Monitor Governance of High Impact Growth Initiatives Later-Stage Financing and Liquidity Board Issues
My Background
Twenty+ year trajectory of R&D, marketing, finance and general management roles in early-, growth-stage and scaled-up tech companies in Waterloo region Governance Spent a number of years heading M&A, divestiture, turnaround, and corporate venture finance activities in semiconductor and enterprise software businesses, as well as work in instrumentation, automation, and med/biotech As EIR, presently advise over sixty tech companies founders, boards and investors
People
Being a director is work, and people need to be work-like about it Yearly commitment of time to do it well
Regular director: 250 hours Committee chair: 350 hours Non-executive chairman: 450 hours
Devote time outside the boardroom 2:1 compared to the hours spent in board and committee meetings
Available to each other, the chairman and the CEO for 1:1 ad hoc discussions
People
The board needs to collectively be knowledgeable about all salient aspects of the business and its context, even though individual directors skills can be more narrow Capable of expressing independent viewpoints, and challenge others when necessary Not afraid to ask a dumb question
Strongly competitive and ambitious for the business, but tempered with integrity, judgment and adaptability
People
Attuned to the emotions and body language of others as discussion unfolds Able to hear and assimilate what others are saying
Able to adopt decisions as their own, after a decision has been reached
Willingly and easily communicate frame of reference (goals, criteria) and thought process for reaching conclusions, not just the conclusions themselves
People
Bias for action; somewhat impatient Relentlessly questioning to make the most of the companys opportunity Sound out their major concerns off-line with the chair in advance of board meetings
Usually operate more in a Socratic method than telling management what to do, unless a crisis is unfolding
People
At least one person who is the Ying to the CEOs Yang
i.e. if the CEO has a sales background and personality, a counterweight board member with a technology or operations focus
At least one person who personifies the target market or competitive ecosystem
Frequently filled with one or more of the independent director seats
Evolving the BoD - General

Term limits, typically three years Current directors and officers routinely networking to develop director candidates Periodic board self assessment to identify weaknesses and skill gaps as the basis for targeting new nominees, shifting skills and backgrounds, and better practices
Evolving the BoD - General

Designate directors to see that planned new practices get implemented well, quickly, and further tuned Balanced origination of nominees from CEO and non-executive directors as business conditions vary
Dont pendulate from one to the other
Evolving BoD Skills with the Stage of Company Development

Company Stage Seed and Start-up Typical # of Typical Director Key Skills Directors Mix 3 1 Founder 1 Investor 1 Independent Recruiting, technology, operational setup, angel/VC funding, ecosystem relationship development critical to success over next 18 months
Growth
2 Founders 2 Investors 1 Independent
Commercialization, operational refinement, institutionalizing know-how, scaling, growth finance, working capital management, international reach
Late Expansion
2 Founders Increasing financial sophistication, 2 Investors acquisition or IPO savvy, governance 3 Independents discipline and improvement, reduction of surprises, sustaining strong growth
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Minutes
All directors need to be engaged, active contributors, and documented as such A directors duty of care and fiduciary duty require consideration of multiple possibilities on major decisions Bodies under observation (or prospect of future study) behave better than those not
Minutes serve as a kind of self-observation
Vanilla minutes, describing decisions only, are insufficient
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High Impact Board Practices

Company Stage Growth Practice Executive sessions CEO and management performance feedback Agenda effort Continuous improvement of governance Methodical director onboarding Seek diversity in director candidates Helps Independence of board Correct quickly and early Keep up spirited inquiry in the most impactful areas Evolution of the BoD as a self-regulating body Accelerate time to full individual and group productivity, facilitating renewal Avoid path dependency
Late Expansion
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BoD Advice
Theres no shortcut for spending the time and doing a lot of reading and networking for a director to bring an informed, independent viewpoint about a companys strategic environment Speed, decisiveness and dexterity improve with a somewhat smaller board than larger, IFF, sufficiently broad, experienced, and dedicated directors are available to span the requisite disciplines with a marginally smaller group Meet eight times per year, in person
Dont let the flurry of other business push aside a deep dive each meeting into the matters which are keeping the CEO and CFO up at night, and to understand what alternate data , viewpoints and interpretations exist to richen the discussion on those matters
BoD Advice
Require board packages be delivered to directors 72 hours in advance of meeting, with a cover memo identifying which items are informational only, and those which will be deliberated and decided Structure discussion so that managements recommendations are clear, yet with room for director input, but stopping short (usually) of unbounded possibilities At every board meeting, discuss the quality of information, agenda, time allocation, and deliberation process with each director contributing 1-2 improvements for future meetings Conduct brief executive sessions at each board meeting to discuss management and board performance without members of management present, as well as who will deliver that feedback
BoD Advice
Have executive management provide regular feedback on where it has gotten the most help, and the most frustration, from the BoD In normal circumstances, use 75% of time in the boardroom looking forward (strategic, market), and 25% looking back (finance, ops)
Dont get into caught in the trap of exciting near term events, routine updates, and KPIs taking all the time
Rotate which board member will take a hard stand on difficult issues as they arise, so that one person does not always take the role of critic Designate one responsible director for the CEO performance evaluation process, even though all directors participate
CEO Performance Evaluation

Make sure this isnt the agenda item that gets cut for time meeting after meeting Have a rigorous process for evaluation Separate short- and long-term goals
Define poor, acceptable and outstanding performance up front

CEO Performance Evaluation

Discuss in executive sessions the potential for incentive bias
Ensure employment agreements include claw-backs for awards which are subsequently wiped out by restatements
Have two or more non-executive directors deliver performance feedback

Criticism then doesnt come across as an axe being ground by one which isnt shared by others
Be very cautions about retroactive performance target revisions for compensation

Quickly becomes corrosive to a culture of execution Trickle down effect throughout organization
CEO Succession Planning

Know who takes over from the BoD or from executive management in the event of temporary CEO incapacitation Routinely discuss who would take over in a planned or compelled transition
The half life of a growth stage tech company CEO is about three years Succession is not a remote probability which can be downplayed The probability of success with an insider is higher than an outsider (culture, industry knowledge, technology know-how) Get to know the high potential executives below the CEO who are able to work within the current system, but can also break from the status quo
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CEO Succession Planning

Directly confronting CEO succession prompts the most constructive behaviours by the BoD to provide regular performance feedback
Boards which cannot confront succession planning tend to also be much weaker on CEO evaluation
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Director Onboarding
Get to know inbound directors as individuals before the first meeting, outside of the boardroom, to help build communication and trust Have an incumbent non-executive director act as a mentor to a new director Help prepare for first meeting to get a fast start contributing Arrange 1:1 meetings with the CEO, other executive managers, and all directors
Director Onboarding
Onboarding education package including past two years minutes, last two reading packages, corporate by-laws, etc. Disclosure of any matters discussed at most recent executive sessions or full board meetings, not yet minuted, of which the inbound director should be aware
Chairmanship
The BoD can only be as good as its chairmanship for setting the tone and interpersonal chemistry Leading among peers Tact: ability to disagree without being disagreeable; constructive dissent Bringing everyone into the discussion, and not letting one voice dominate Setting high expectations Communicating easily with other directors, the CEO, and management
Chairmanship
Encouraging debate and expression of minority viewpoints while sustaining cohesion Keeping conflict at a task level or a frame of reference level, and not a relationship level or a fact level On difficult, divisive issues
Requesting multiple options from each individual to prevent premature polarization to single views Having proponents express both pro and con arguments to foster balance and intellectual honesty
Knowing directors leading concerns before each meeting Probing for unspoken concerns
Chairmanship
Formally checking with all members before a major decision Keeping debate from dragging on to the point of frustration Structuring deliberation and decision into a two-step process on divisive issues Effort and preparation, leading by example Marshaling varied input into coherent action points Collaborating on agenda development with the CEO, showing a clear sense of purpose Making sure that major business, financial, strategic and team issues get discussed, and not pushed aside by smaller matters
Chairmanship
Driven improvement of board practices Quickly reconciling emerging differences among directors visions for the boards role, and those of management Promoting openness by encouraging board members to make direct proposals, not disguised or oblique ones Weaving themes and points of importance together to create an integration of each meeting around major current issues Set-up each portion of the discussion with a purpose, what management is expecting from the BoD (info sharing, debate, decision), scope, and what has come before
Chairmanship
Being able to both criticize and support management by intermixing comments Quickly dealing with director underperformance Rapidly addressing informational or disclosure issues which cause surprises
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Executive Sessions
Have at least one executive session at each board meeting Better is two
One just before the meeting to discuss any desired changes to the agenda based on review of the reading packages and other late breaking developments The other just after the meeting to discuss impressions and provide feedback to the chair and CEO
Routine executive sessions cut down on CEO apprehension about directors meeting without him/her
Executive Sessions
Regular in camera meetings provide a safe, nonadversarial environment where non-executive directors can speak their minds
Helps keep little issues from growing into big ones
Minutes
Chaired by the board chairman if non-executive, and otherwise by the lead independent director
Executive Sessions
Matters to Always Discuss: Is time being devoted by the board to the right work? Is the supplied information adequate? Strengths and concerns about the performance of the CEO and executive management How were doing coaching and providing performance feedback to the CEO Executive compensation How are we, the board, doing? Gaps in board skills which are emerging? Implementation of action plans coming out from recent board self-assessments
Executive Sessions
Cautions: If self-evaluation of the board starts devolving to structural issues only, rather than effectiveness issues
Can happen to protect egos, out of fear, or complacency
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CEO Communication Biggest Worries

Three Quarters Ago Two Quarters Ago #1 #2 #3 #4 Last Quarter This Quarter
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CEO Communication Reading Package Cover Memo

Summary of: What has gone well vs. plan What has not Portions of the reading package to review with particular care Potential changes to strategic goals What most needs to be discussed Decisions needed from the BoD What help is most needed from the BoD
Board Assessment
Beyond the standard checklist
Systemic Learning
Learning not just about outcomes, but about the decision process the board uses Emphasis
Experience is knowing what happened Learning is knowing why it happened Learning to learn is the ultimate goal It is the only way to achieve peak productivity in a rapidly changing and complex environment
Board Assessment
Decision Process What have I learned about my own frames of reference? About the frames of others? About the way we gather intelligence? About the process we use to reach conclusions? Overall, what do I value and not value about our decision process?
Board Assessment
Decision Process Where should we spend more and less time versus the recent past?
Discussing frames of reference Gathering information Coming to conclusions Learning from outcomes
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Board Assessment
Lessons learned
From two recent successes From two recent failures
Balance is vital in lessons learned analysis because human bias is for successes to be seen as more relevant over time, whereas more learning potential is often embedded in the failures
Immediate after-action lessons learned are particularly important in time- and resource-critical decision environments
Board Assessment
Learning Capacity

Sufficient and clear information about decision results Enough time to make sense of the information available Opportunity to test learning conclusions in new decisions Ability to see how observed conclusions might be interpreted differently Willingness to expose ourselves to learning feedback Open mindedness before reaching conclusions Feedback fidelity, acceptance and assimilation Objectivity separating skill from luck Learning fast and early, in time to make midcourse corrections
Board Assessment
Like many other tools, assessments get dull over time and less effective if the format and questions dont change
Change the format yearly to get people thinking and communicating in new ways
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BoD Early Warning Signs

Signals of insufficient director effort or poor skill correlation with the needs of the business: Overreliance on service providers; they do not just provide expert input, the BoD effectively outsources decisions Routine over-deference to the one board member with the most expertise in a subject area Vital decisions are almost always made just with the facts and arguments on hand, rather than spending time in some instances to question the source information and get more, varied, and better data
Early Warning Signs

Insufficient give and take between directors and management Lackluster inquiry into areas of underperformance Poor meeting management Time Agenda Spiraling out of control on issues without an ability to summarize work to date, forward actions, and move ahead to other business Insufficient declaration of conflicts
Early Warning Signs

Lack of discretion or confidentiality
What goes on in the boardroom stays in the boardroom
Inability to discuss
Assumptions Dependencies Next best alternatives Scenario plans and signals/conditions to shift tracks
Premature major investments

- Break -
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Corporate Metrics
46
Master Metrics
Customer preference ranking quantitative and qualitative
Get data not just from current customers, but also those that are wavering and recently departed Good customers define quality Cohort analysis to monitor trends
Rising efficiency (RoA, RoE, margins)

Aim for fast completion of measurements, not for perfection It is big changes that need to be picked up upon and investigated
Returns above the cost of capital (CoC)

Regular review of past major investments and whether they retuned at the expected levels, above the CoC, and why
47
Master Metrics
Growth of market share well above the markets rate of growth
Look also for further evidence of whether or not the company is setting industry expectations to which competitors have to react, rather than the reverse
Variances in results from success-premised plans

Rapid attention when variability first re-emerges after a period of relatively consistent and predictable growth Correlation=causality mindsets in mgmt & BoD often have taken hold during the recent past time of smooth sailing Drill into recent past variances at more atomized level to diagnose lurking trouble quickly
Master Metrics
Speed of execution, and, speed of feedback adaptation
Idea to product Market to sell Quotation to cash Forecast to delivery Issue to resolution
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Diagnosing Corporate HR Practices

People There is selective recruitment, challenging training, methodical enculturation and removal of misfits The business targets and rewards those who seek responsibility and not merely accept it
Staff and management see themselves as responsible for more than their job descriptions

Leadership Defines, communicates and reiterates corporate vision and strategy
Staff is engaged and involved in the debate, though decisions are made by leaders Once decisions are made, everyone abides by them as if those decisions were their own
Over-communicates about company progress, challenges, measures of performance, and relationships to mission objectives
Particularly in challenging circumstances, communication keeps up
Hires for capability and a positive, winning attitude

Roots out passivity, poor attitudes and passive dissent
Walks the talk, leading by example
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Culture Results matter. There is a desire to win in all circumstances Work is fun. Energy is high. Whining is unacceptable There is one ego in the company, the company itself. There is esprit de corps and a shared pride in the organization Group pursuit of mastery in the companys endeavor. This superordinate goal produces engagement, grit and determination. It releases greater creativity than more rote objectives and converts much more of work into something pleasurable
52

Culture Motivation for staff comes from developing and maintaining the respect of their peers as much as from monetary rewards
Obsess over customers. Do what it takes to make them successful

Exhibit mutual respect for what different people and functions bring to the table The best idea wins, no matter from whom or where it came

Culture Truth speaks to power, connecting leaders authentically to people, protecting the capacity to inquire and improve Value learning and constructively harnessing the lessons of failure
Smart failure fast, cheap and not the same way twice - is not harshly punished Mistakes are disclosed as soon as they are known so that they can be corrected most quickly and cheaply
Integrity is without compromise

If integrity lapses occur, they attack all other aspects of an otherwise enduring and strong culture Integrity breaches rapidly become malignant Any integrity deviations must be swiftly and decisively fixed
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Major New Growth Initiatives Re-Learning Early-Stage Skills

Growth- and expansion-stage companies are accustomed to being right far more than they are wrong Overconfidence can easily start overtaking governance and executive teams Slowing growth leads people to seek to reaccelerate through nonlinear growth endeavours Major new growth initiatives require a diametrically different mindset
The initial trajectory is likely wrong The name of the game is to decrease the amount of wrong-ness as quickly and methodically as possible Back to the Future: An early-stage mindset
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High Impact Board Practices Major Growth Initiatives

Practice Helps Prospective hindsight Reference class analysis Pre-commitment Commitment limits Manage risk, coaching, coach-ability Reduce sampling and intuition errors Catalyze learning, antidote groupthink Counter decision drift & confirmation bias Do more with less; pivot effectively
56
Major Growth Initiatives Warning Signs

Big bang initiatives
Signal overconfidence Start instead with MVP and MVF, and iterate fast toward the long-term goal
Adjacency to the core business that is more tenuous than people first recognize1
Probability of success with true adjacency is about 40% It drops to under 10% as distance in technology, markets and operations depart from the core business
1. Source: Beyond the Core, Zook, 2004
Financing and Liquidity
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Institutional Growth-Stage Equity Financing

Get to know the accounting used by a candidate fund to report to its LPs and for calculating partner variable compensation
Funds dont like to talk about this Differences in accounting models and compensation mechanisms are considerable These mismatches become most acute when work-outs are required to adapt to changing circumstances, complicating board function
Institutional Growth-Stage Equity Financing

Moreover, if the fund has a board appointee, the double fiduciary duty introduces intrinsic conflicts which have derivative impacts to behaviour
Due diligence through past investees of the same fund and partners is the best way to understand accounting models, prospective gaming, and whether the intrinsic conflict for an appointee of the fund is likely manageable or not
Institutional Growth-Stage Debt Financing

Bank Lines and Structured Commercial Credit
Periodically review the key terms, structures and restrictive covenants
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Institutional Growth-Stage Debt Financing

Venture Debt
If the company is not yet cash flow positive, pay particular attention to jurisdictional fiduciary duties in the zone of insolvency if the company is contemplating venture debt financing Be watchful for material adverse change (MAC) clauses (a.k.a. subjective default) which amplify technical, execution and market risk
Learn if candidate venture lenders are co-financing other ventures with the governed business other investors since reciprocity can be at play and introduce conflicts down the line
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Liquidity - IPO
Rely much more on IPO data than i-banker advice when contemplating sustainability and advisability i-banker largely just wants the fees as long as the company can put $75M on the cover of a prospectus, and has some visibility and predictive operating history From a governance perspective, the IPO process itself is just the race to the starting line for crystallizing value; the real race comes after
Liquidity - IPO
There are unique small cap issues which make IPO success about much more than operating execution
Very different world from large caps where execution is enough
Trading volume is the root of almost all premature IPO difficulties, not the culprits people would rather cite which obscure the real issue
Reinforcing Loop of Low Trading Volume

Low(er) Trading Volume
Lack of Analyst Coverage
Illiquidity
Lack of Institutional Interest
Increased Risk
65
Low Public Company Trading Volume

With low trading volume, a tech company ends up in the untenable position of having to try to appeal mainly to retail investors Ineffectual long-term manoeuvres then become the only levers available, such as
Engaging IR communication firms Stock buy-backs and reverse splits These kinds of measures only exacerbate matters midto long-term for companies that should be growing rapidly
Low Public Company Trading Volume

Raises cost of capital, harming strategic flexibility Pressures company to divulge more competitively sensitive information than is wise, to try to recapture investor interest in advance of having better operating results Overall, balance of power shifts:
The company needs investors much more than investors need the company
Liquidity - IPO
Empirically and definitively:
Trading volume falls off exponentially (not linearly) as valuation drops below $500M
Microcap options on venture exchanges in most cases are only productive for junior resource plays and some early stage pharma, not most tech companies
Predictive value of early metrics much higher in resources Jr. exchanges are a financing vehicle, not a liquidity vehicle
68
Liquidity - IPO
Bottom line: An IPO is only a robust liquidity avenue if a market cap above $500M can be comfortably sustained through some post-IPO ups and downs This has inferences even for express or implied competitive liquidity alternatives to M&A as the primary liquidity vehicle
Liquidity M&A
To drive competitive buyer dynamics to maximize shareholder value and stakeholder flexibility, there need to be five motivated buyers for a business when it wants to sell
This end-game requirement has inferences for growthstage partnership formation It also affects zero-start auction mechanics requiring at least forty plausible suitors in steady business conditions, and up to eighty in more challenging times
Hiring Legal Counsel Tectonic Events

Financings and Litigation
Extensive, recent experience (prior 18 months) Representing similarly situated companies Similar financings or litigation Reference checks (quantity doesnt ensure quality) Not: allegiance or incumbency from earlier times
IP Disputes
Above, plus Venue expertise
Summary
Get the right people Focus as much on what to discuss and independent learning, as is spent in deliberation itself Delve into assumptions, dependencies and alternate interpretations and approaches as much as the facts and figures themselves Keep up attention during implementation, both to foster execution, as well as to provide further adaption Be pleased when things go well, but never be satisfied Never shy away from difficult conversations Evolve, learn and renew Only target an IPO if the market cap can stay >$500M Strategic buyer dynamics are much better with five or more motivated suitors
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Resources and Further Reading

Directors Duties in Canada, Barry Reiter
http://www.cch.ca/product.aspx?WebID=3688
Decisions 2.0: The Power of Collective Intelligence, Bonabeau

http://people.icoserver.com/users/eric/SMR_Collective_Decisions.pdf
The Big Idea: Before You Make That Big Decision, Kahneman
http://www.paginasprodigy.com.mx/RPA1958/BigDecision.pdf
Winning Decisions, Russo and Schoemaker

http://www.randomhouse.com/book/159138/winning-decisions-by-j-edward-russo-and-paul-jh-schoemaker
The Psychology of Human Misjudgment, Munger

http://law.indiana.edu/instruction/profession/doc/16_1.pdf
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Follow-up Discussion
Contact:
dave [dot] litwiller [at] communitech.ca
David J. Litwiller, 2013
74

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Building Better Boards of Directors

Growth- and Expansion-Stage Tech Companies

Copyright, David J. Litwiller 2013

Going from Good to Great

Outsized contribution to:

Copyright, David J. Litwiller 2013

Copyright, David J. Litwiller 2013

Evolving the BoD - General

Evolving the BoD - General

Evolving BoD Skills with the Stage of Company Development

2 Founders 2 Investors 1 Independent

Copyright, David J. Litwiller 2013

Vanilla minutes, describing decisions only, are insufficient

Copyright, David J. Litwiller 2013

High Impact Board Practices

Copyright, David J. Litwiller 2013

CEO Performance Evaluation

Define poor, acceptable and outstanding performance up front

CEO Performance Evaluation

Have two or more non-executive directors deliver performance feedback

Be very cautions about retroactive performance target revisions for compensation

CEO Succession Planning

Copyright, David J. Litwiller 2013

CEO Succession Planning

Copyright, David J. Litwiller 2013

Copyright, David J. Litwiller 2013

Copyright, David J. Litwiller 2013

CEO Communication Biggest Worries

Copyright, David J. Litwiller 2013

CEO Communication Reading Package Cover Memo

Copyright, David J. Litwiller 2013

Copyright, David J. Litwiller 2013

BoD Early Warning Signs

Early Warning Signs

Early Warning Signs

Premature major investments

Copyright, David J. Litwiller 2012

Copyright, David J. Litwiller 2013

Rising efficiency (RoA, RoE, margins)

Returns above the cost of capital (CoC)

Copyright, David J. Litwiller 2013

Variances in results from success-premised plans

Copyright, David J. Litwiller 2013

Diagnosing Corporate HR Practices

Diagnosing Corporate HR Practices

Hires for capability and a positive, winning attitude

Walks the talk, leading by example

Copyright, David J. Litwiller 2013

Diagnosing Corporate HR Practices

Copyright, David J. Litwiller 2013

Diagnosing Corporate HR Practices

Obsess over customers. Do what it takes to make them successful

Diagnosing Corporate HR Practices

Integrity is without compromise

Copyright, David J. Litwiller 2013

Major New Growth Initiatives Re-Learning Early-Stage Skills

Copyright, David J. Litwiller 2013

High Impact Board Practices Major Growth Initiatives

Copyright, David J. Litwiller 2013

Major Growth Initiatives Warning Signs

Financing and Liquidity

Copyright, David J. Litwiller 2013

Institutional Growth-Stage Equity Financing

Institutional Growth-Stage Equity Financing