Professor Sam GARG is an Associate Professor of Entrepreneurship at HKUST Business School. Prior to earning his PhD at Stanford University, he worked with established and young entrepreneurial firms and founded an online payments venture in Singapore. He is a pioneer and global leader in the research area of board dynamics in privately-held ventures and newly public-listed firms.
The following article is based on a unique study with rare access to board meeting observations and multi-wave interview data on new venture board dynamics in Silicon Valley. It examines how venture CEOs effectively engage their boards for strategy-making.
Venture capital (VC) financing of entrepreneurial firms receives a lot of press coverage. VC financing is very difficult to obtain for most entrepreneurs, so there is much to discuss about who gets it and how. Yet, as both entrepreneurs and venture investors know, the odds of success after the venture financing remain very small. My research with Kathy EISENHARDT at Stanford University suggests that CEO-board relationships and strategy processes in VC-backed ventures can be a very important driver of a venture’s success or failure.
In contrast to the boards of established public-listed firms, where the primary focus is on monitoring, venture boards primarily focus on creating value. A venture board comprises of a subset of investors, executives (some of whom may be founders), and perhaps independent directors. The boards are expected to help with advice and referrals, and work closely with the CEO on key strategic decisions.
Unfortunately, the promise of a venture board is not easy to realize. Consider the following quotes:
“I bet that 70-80 per cent [of venture board members] add negative value to a startup in their advising.”
Vinod Khosla, a renowned venture investor and former entrepreneur
“I believe 50% of venture board members do nothing, 48% actively destroy value and 2% create value.”
Personal interview with an experienced venture board member
These quotes may be surprising. After all, ventures would seem to be an ideal setting for productive CEO-board relationships. Venture directors – many of whom are professional investors – are often well-informed about the sector, and have substantial financial interest in the venture’s success. Venture CEOs are also often aligned with a significant financial stake and high personal identification with their ventures. Since ventures are often resource-constrained, CEOs depend on their boards for resources like funding, strategic advice and social connections. Conversely, venture directors have the knowledge and financial incentives to assist these firms. Overall, it seems that venture CEOs and boards would naturally work well together.
Yet, these quotes suggest otherwise, and point to challenges that venture CEOs face in strategy-making at the board level, and more broadly in the CEO-board relationship. One challenge that many CEOs face is the limited time that outside directors have, and that makes it difficult to tap their expertise. Venture CEOs often face the added challenge of working with directors who can offer valuable advice, but may be misaligned due to their involvement in rival firms. Furthermore, venture CEOs may be less powerful than their boards if they have given up substantial equity, and may find themselves dismissed by the board even when the venture is performing well, to pre-emptively scale up the management team. Yet at the same time, venture CEOs need their boards for resources like funding, legitimacy, advice and social connections. Finally, venture CEOs are expected to set a successful strategy for new firms which possess few stable processes, and often exist in rivalrous, high-velocity markets. Overall, venture CEOs have a complex strategy-making process – that is, they must work with knowledgeable but sometimes busy or misaligned directors to draw out their best advice in a difficult operating environment where strategy is critical.
Key behavior of strategy makers
Seasoned venture investors, board members, and entrepreneurs privately confess that it is a challenge to make venture boards work well. Yet there is very limited systematic understanding of the effective processes that venture boards need to follow. To address this major gap, I conducted one of the first studies on venture board dynamics, and my research context was Silicon Valley. In particular, I focused on how venture CEOs, some founders and some non-founders, effectively engage their boards for strategy-making.
I tracked CEO-board interaction over time through observations of board meetings, and several waves of personal one-on-one interviews with CEOs, board members, and executive team members. All boards comprised of prominent investors and independent directors, and all CEOs had top-ranked MBAs and extensive work experience.
The emergent framework indicates that venture CEOs with an effective strategy-making process (“effective CEOs” for brevity) engage in four key behaviors. First, they launch the strategy-making process with dyadic (one-on-one) interactions with each director in unique roles, and continue this behavior throughout the process. This allows the CEOs to focus their directors’ attention and gain relevant advice from each of them. Simultaneously, this approach maintains CEO power by enabling CEOs to occupy uniquely central positions for information that also enhance their perceived and often actual competence, and constrain the influence of wayward directors who might pursue their own broader interests at the portfolio level.
Second, effective CEOs propose only single alternatives in formal board meetings, and avoid multiple alternatives or brainstorming many possibilities. These CEOs may update their alternatives offline with their senior executives as needed, but they formally propose only one alternative to the board for approval. This focuses board attention, and enables CEOs to obtain actionable advice aided by group insights from their busy directors. This behavior also helps CEOs to retain power by controlling the agenda, and thwarting directors who might otherwise advocate self-serving or uninformed strategies.
Third, effective CEOs brainstorm strategies with their boards in dedicated strategy meetings which avoid short-term agenda items like operations reviews. This separation improves directors’ strategic advice by avoiding directors’ cognitive switching between short-term, backward-looking and detailed operational issues and long-term, forward-looking strategic possibilities which psychological research indicates is ineffective. This separation also helps CEOs to retain power as they better showcase their competence, and engage directors in an enjoyable activity which creates a social dynamic in which directors want to stand out as being helpful and wise.
Finally, effective CEOs end the strategy-making process (which can otherwise drag on) with political tactics, such as securing external endorsement for strategy, and allying with specific directors and other executives. This behavior improves advice because these alliances can become occasions that stimulate creative thinking. It also helps venture CEOs to retain power by employing tactics (especially alliances) that strengthen their positions, isolate divergent directors, and so expedite ending the strategy-making process.
Overall, through these behaviors, venture CEOs effectively draw out superior advice, avoid power loss, and improve the likelihood of a good outcome for the venture. For example, a CEO and his board who used the behaviors above completed a very successful strategy-making process in just four months. The leading industry publication rated the firm as the sector leader because of its new strategy. The firm was acquired by a large public firm which cited the new strategy as justification for a premium price. The directors praised the CEO’s strategy-making process. As one said, “He is really a role model.”
By contrast, another CEO and his board who did not use these board behaviors made no real progress on developing a new strategy. Two directors resigned soon after my study, citing unhappiness with the strategy-making process. A third director said, “I'm still not clear on what the CEO is really thinking about”. The firm was floundering 24 months later – online traffic had declined by half, and users expressed disappointment. The CEO was replaced, and the firm was put up for sale but had no buyers. One CEO changed from an ineffective to an effective process during our study, further corroborating the efficacy of this behavioral framework.
Divide and Conquer for Board Effectiveness
The unifying logic of the behavioral framework I described above is “divide and conquer”. That is, venture CEOs “divide” their board into individuals with unique roles and allies, “divide” discussions with directors into diverse favorable formats, and “conquer” by inserting themselves as the orchestrators at the center. The core message is that the CEOs need to take charge, especially since venture directors are busy and sometimes misaligned due to other interests, such as those at portfolio level. I also suggest that it may be useful to re-frame the venture CEO-board relationship as CEO-director dyads, not a CEO-group relationship. Of course, venture CEOs engage in group interaction with directors, but the framework suggests that the more fundamental unit of analysis is the CEO-director dyad.
These research findings make significant novel contributions to the academic literatures on entrepreneurship and corporate governance, and have been published in a top academic journal. But, as importantly, I believe they can guide entrepreneurs and their board members to improve their collaboration. In my observation, this is a topic that is almost never discussed on venture boards (or even on the boards of established public-listed firms). This makes it difficult for CEOs to effectively harness their boards, and this not only hurts the firm, but also frustrates the directors.
This behavioral framework can harness the potential of venture boards and vastly improve the odds of venture success – an outcome sought by entrepreneurs, investment funds, and it can also benefit society at large. By contrast, dysfunctional venture boards are likely to lead to loss of innovations and the commercial promise ventures hold. The good news is that these behaviors can be learned by venture CEOs, and investors can help their portfolio CEOs with these research insights.
If you are a venture investor or a venture CEO and would like to participate in the upcoming studies on venture boards, please email Professor Sam Garg directly: samgarg@ust.hk
Reference
Sam Garg and Kathleen M. Eisenhardt, Unpacking the CEO–Board Relationship:
How Strategy Making Happens in Entrepreneurial Firms, Academy of Management Journal
2017, Vol. 60, No. 5, 1828–1858