In my earlier post on management carve out plans (see it here), I gave a detailed description of what these plans are and why boards of VC-backed companies often use them.

Recall from the prior post that an executive’s allocation from the carve out pool is normally reduced by the value of that executive’s equity (if any) at the time of the change of control triggering the carve out payment.  This is to make sure that the executive does not double dip (i.e., get both the carve out amount and the equity value; I guess double dipping is only for VCs that have participating preferred stock 🙂 ).  Said another way, the carve out is an insurance policy that pays out when the executive’s equity is not worth enough (or nothing at all).

I recently was discussing a management carve out plan with another board member.  He brought up the good point that in addition to reducing the carve out allocation by equity value it would also make sense to reduce it by the value of any “signing” or change of control bonus that the acquiring company is paying to the executive.  I can clearly see why this would make sense in many instances (not all instances to be sure, but many).  For example, in the worst scenario, an executive might low ball an exit value knowing that he was getting a fat signing bonus from the acquiring company.  This is obviously a pretty cynical view point, but none the less worth considering.

Enjoy the weekend.

You are starting a company.  Let’s assume you want to raise some $$ from outside investors and/or that you think you might want to grant equity interests to employees in the future.  Based on either of these assumptions, a corporation (not a LLC) is the right entity choice for you.  Likely it will be a corporation set up in Delaware (typically referred to a DE corp).

Any corporation requires shareholders and directors.  Shareholders elect directors and directors elect officers.  A big question that company founders often have is “how many directors do I need?”  A related question is “who makes a good director”.  Here are some basic nuts and bolts answers.

1.  When you set up the DE corp initially, it is common for all the founders, assuming near equal ownership, to be board members.  So let’s go with 3 founders and so 3 directors (same people) initially.

2.  After the company raises its first equity round, to me the ideal board composition is 2 founders (with the CEO founder definitely on the board), 1 investor rep and 1 independent.  Ideally the independent director is sourced by the founders, but agreed to by everyone.  See my earlier post here.  If the independent is not found for a while after the investment closes, that is fine.  Importantly, one of the founders will be exiting the board at this point.  Typically the CEO and tech founder remain on the board, but there is no hard and fast rule on the tech founder (there is on the CEO).

3.  After the company raises its second equity round and a new investor joins the mix, the ideal board composition for me is 1 or 2 founders (with the CEO founder definitely on the board), 2 investor reps and 1 or 2 independents.  So between 4 – 6 members.  An even number is fine – if votes are not unanimous at a startup it is a signal of big problems.  So, here again, you might have a founder exiting the board.

4.  After the company raises yet additional capital it is likely that the board will get to 7 members assuming another new investor leading the round.  I would highly encourage to cap the number of directors at 7 going forward.  It gets to be an unwieldy job for the CEO to manage all the board members actively and appropriately.  Smaller is often better.  In this configuration, for example, you could have only 6 board members with the founder CEO, 3 investor reps and 2 independents.  Add another founder and you are at 7.

5.  In terms of who, let’s focus on the independents.  In my experience, the best independents are those directors that have deep operational or sales experience in the company’s space.  If you get a solid level of engagement, an independent director can end up like a fabulous extra set of hands.  They can help solve problems, makes intros, etc.  In my experience, outside board members with deep technical expertise are less valuable assuming the inside tech team is good.   Pick independents based on what you “need” to round out skill sets.

Those are my nutshell rules of thumb.  Board politics deserve a separate post for another day.  But do note that the more board members, the more politics that come into play……unfortunately.

Here is a general rule:  unless an employee has an employment contract or severance agreement providing for severance or the company’s employee handbook provides for severance, there is no severance due to a terminated employee.  The employee is “at-will” and can be terminated at any time.  BTW, I highly discourage employment agreements (except perhaps when hiring in a new CEO or other very senior person) and I also doubly highly discourage having the company’s employee handbook (if there is one) provide for severance.  From experience, the more flexibility the top level management team and Board have in dealing with terminated employees the better.

In reality, the severance issue raises its head often.  For example suppose a company had to fire its head of marketing who had done pretty good work for 3.5 years (arbitrary but meaningful time period).  Unfortunately his/her skill set did not keep up with company’s growth (or make up any other non-scandalous reason you like).  Should this employee get some severance to help them through the post-termination period?  Should the company continue to pay for health insurance for this person for a period of time?

I have discussed this with many VCs.  There is a big group that says severance should never be paid when the company is not profitable.  There is a considerable (though smaller) group that says severance should never be paid unless the employee is otherwise entitled (see above).  The reality is that every situation is different with its own set of emotions.  The emotions are a real driver in my opinion.  And obviously, it is easier to pay severance if the company has real cash flow.

My general thinking in a situation where a high ranking employee is terminated without cause is to give 1 to 3 months severance (depending on how long he/she was at the company, the employee’s actual need and the circumstances surrounding the termination).  For lower ranking employees my general thinking is none or maybe a “you are terminated and will be paid for the rest of the week”.  Also note that if an employee is terminated for cause (like stealing or harassment or other culpable conduct) the severance should be zero (and written severance agreements usually have this same “out”).

With respect to continuance of health insurance, this is a bit easier for the company to pay for a number of months b/c the amount of monthly premium is usually in the $300 to $500 range (much cheaper than the severance payment).  I can easily be persuaded to have a portfolio company pay for 6 months of insurance premiums under the right circumstances.

This is an emotional issue that merits independent thought for every high level termination.  One last critical point:  if you do pay severance, the employee should sign a broad release in exchange (releasing the company, the board, offices, etc., from all claims).