Online Board Games

As I described in “The Virtual Company” (see, the April 2010 edition of e-Commerce Law & Strategy; www.ljnonline.com/issues/ljn_ecommerce/26_12/news/153540-1.html), many entrepreneurs are, by nature, unwilling to follow the rules of the corporate world. In fact, many have succeeded, precisely because that derring-do approach helped them cut costs and create efficiencies, particularly compared to businesses that followed traditional models.

Yet, even accepting the anti-authoritarian world view of many e-entrepreneurs, I believe there are many valid legal and business reasons why an e-commerce firm, no matter how informally or loosely it is operated, should have a formal board to oversee operations. (I base my opinions not only on many years of practicing corporate law that has included advising boards of directors, but also on my service as a director of several not-for-profit firms.) As a guide for the newly entrepreneurial, as well as for those who have “just stumbled through” all these years, let me discuss how a formal board can help an organization, and how to select its members to achieve that goal.

While some of this advice is true for any business organization, “e” or not, I think there are many reasons online firms need a board even more than their real-world counterparts do. Even a limited-liability company (“LLC”), which technically doesn't require any type of governing body ' only a corporation must have a board ' often nonetheless can benefit from the type of guidance provided by the equivalent of a board.

Different Times, Same Benefits

The Internet has changed corporate governance best practices.

Legally, directors must comply with fiduciary duties of loyalty and care to ensure that they act in the best interests of the company and its owners (rather than their own interests). A recent board retreat I attended tried to make these abstract legal concepts more concrete with specific director tasks. These included that members of the board of directors:

• Participate in planning for the organization (including monitoring implementation of the plans);
• Select and support the executive employees;
• Exercise financial and operational oversight by reviewing and approving budgets and financial reports;
• Oversee operations (without getting involved in day-to-day management); and
• Recruit talent and resources, such as by networking for new business or key hires.

The recent Conference Board Global Corporate Governance Research Center's Special Report on Best Practices, quoted in an American Bar Association (“ABA”) course of study on board conduct, captured well the blend of traditional and evolving demands facing modern boards. The publication stated that:

In general, the Directors' role requires that they provide active oversight of the company's business to minimize corporate risk and promote the creation of shareholder value. The new challenge for boards will be to go beyond their traditional advisory role and increasingly focus on their oversight role. As fiduciaries, boards must be active monitors of management. (Emphasis added.)

A board that can support the company through some of these methods will go a long way to helping a company succeed, online or off. In contrast, e-commerce firms focused on a 24/7 instant-response culture, without the support of more seasoned board members comfortable with these traditional board support roles, may be less able to compete than firms trying to manage this week's, this month's and this decade's business ' all at the same time.

Of course, this advice won't apply to some firms, e or not. The newly formed venture, whether a proprietorship, LLC or corporation, consisting of an owner and his or her family members handling everything from marketing to manufacturing, typically does not have time for board deliberations, nor does it have issues requiring them. When the main day-to-day challenge is surviving until the next day, the foresight to plan into the distant, and not-so-distant, future is a luxury beyond most budgets.

The thing is, though, that it should not be. For all the reasons in this article, the proprietor who wants to build a firm must think about growth strategies, and what to do now, to try to ensure that she is not doing the same thing in five years. As the business clich' goes, “Failing to plan is planning to fail,” and forming and using a board to solicit advice is, at its core, nothing more than getting outside advice from very knowledgeable friends.

For that reason, corporate strategists often recommend independent directors, i.e., those who do not have a family or business relationship with the company to complicate decision-making. Insider directors may “over-rely” on the information provided by management, and become a proverbial rubber stamp ' the exact opposite of the oversight aspect of a board's fiduciary duties.

But let there be no mistake about the price of that decision: A truly independent board, or even just one independent director, will increase the complexity and time needed for corporate decision-making. Before creating a formal board, firms must recognize the practical burdens it will create, and the likely changes to the firm's culture.

Instead of the typical start-up board consisting of the founder and perhaps key employees who may always be on-site if needed for a meeting, outside, independent directors must be carefully tended. From scheduling meetings around their other commitments, to having to justify business recommendations to skeptical outsiders (who should be skeptical of management's views, to fulfill their fiduciary duties), firms with independent directors cannot act as quickly as they could when decisions were made unilaterally. This may be even a greater problem in an e-commerce firm accustomed to reacting in Internet time, without the need for convening meetings beyond those taking place in a series of Tweets. Obviously, this level of formality will delay decisions and increase costs ' both results that e-firms have always proudly avoided.

Basics, Not Burdens

So why choose to add delay and expense? If there is a cost, whether in management efficiency or in out-of-pocket dollars, or both, is there a countervailing benefit? Let me list several.

At a high level, the existence of a formal decision-making body, with independent third parties, can provide comfort to potential customers, investors and business partners. For online firms that often do not have a long history, or a tangible presence, an effective board that actually provides oversight can demonstrate a firm's bona fide existence. This is the management analog to the argument for keeping corporate minutes, even when not required. To the extent that creditors may try to pierce the veil of an e-company on the basis of the lack of evidence of the company's compliance with corporate rules, the trappings and substance of a functioning board of directors provides another line of defense against personal liability of the owners (see, “Dressing Your e-Business Up for
Success,” in the June 2008 edition of e-Commerce Law & Strategy; www.ljnonline.com/issues/ljn_ecommerce/25_2/news/150577-1.html).

Because e-commerce business models change rapidly, having skilled advisers “on call” can help management look at the bigger picture. Good directors will try to spot trends to allow the firm to anticipate them, rather than to just react ' especially if management has its hands full reacting to the day-to-day demands of an ever-evolving (and often highly specialized) online marketplace.

While firms not locked into their leaders' traditional ways of thinking can be an advantage when the marketplace is constantly changing, there is also a value in putting change into the perspective of how prior turbulent times have worked out. Consider: While the technical problems facing an e-commerce firm may be new, along with the strategic challenge of how to exploit that technology in the marketplace, fundamental business decisions rarely are novel. Are the core elements of competition between e-commerce sites such as Amazon.com and Barnesandnoble.com any different from those GM and Ford faced from each other in their industrial heyday?

Moreover, consider the business benefits of getting regular advice from “outsiders,” people not involved in the day-to-day management of the firm: No matter how well rounded a business manager may be, she certainly cannot bring every area of expertise that a well rounded board can add; indeed, an important duty of directors is recruiting additional directors who bring competencies that may be lacking on the board, but that can be helpful to the firm's business.

If the e-commerce firm happens to be a non-profit, then board members face the same challenges as those on for-profit boards, but are also generally expected to assist in fundraising and building connections with other firms (often in ways not possible in the for-profit world because of antitrust concerns). Non-profit directors must also adapt to the demands of the new Form 990-PF (see, www.irs.gov/pub/irs-pdf/f990pf.pdf), the IRS staff's reaction to the corporate scandals and lack of disclosure in the for-profit sector. That form was intended to legislate greater “transparency,” i.e., public disclosure, of the workings of the large non-profit firm. (For further discussion of board duties and challenges in a non-profit, which can take different dimensions than in a for-profit firm but which are beyond the scope of this publication, see, the excellent report “Principles for Good Governance and Ethical Practice: A Guide for Charities and Foundations,” available at www.nonprofitpanel.org.)

The Internet has revolutionized the reality of being a director by making information on directors available online to anyone, which means prospective and current directors must have clean public records.

Looking for Mr. or Mrs. Good Director

The same ABA program mentioned earlier collected a laundry list of factors that can make someone a good director, such as:

• Specific “line” business expertise in a related industry, preferably with profit and loss responsibility;
• Financial knowledge;
• “Soft” factors, such as personality fit, commitment, and the time and energy to attend meetings and to do substantive board work (rather than just use the board seat as a resume-builder);
• An untarnished personal and professional reputation, as discussed above;
• A combination of strategic, financial and operating skills to enable the candidate to effectively oversee;
• Specific skills helpful to particular committee work, e.g., lawyers for a governance committee, finance professionals for an audit committee or personnel executives for the human-relations committee;
• General experience as a successful leader and supporter of the organization's mission;
• For non-profits, a prior donation history, and access to potential significant donors;
• The ability to recruit additional qualified board members;
• Complementary skills that the founders may not have; and
• General diversity of the board, in whatever way may be needed.

Of course, no individual director is ever likely to have more than a few of these characteristics. The goal is to attract a board that has a diversity of talents and connections in areas that will help the firm grow. In the e-commerce world, that would include a blend of familiarity and comfort in navigating business and technical worlds that no one has yet imagined, as well as experience in translating familiar solutions to the new business challenges of the online and tech worlds.

Typically, directors are recruited, whether by individuals or by a formal nominating committee, in much the same way as candidates for employment are identified. Industry and personal contacts, recommendations of the firm's professionals, business associations and corporate recruiters (also known as “headhunters”) are all excellent and established methods. Because e-commerce may still be too young to have truly established networks of this type (at least outside California and New York), firms may have to be more creative recruiters ' but e-commerce may itself provide the tools for such creativity, as in social-networking and professional association blogs, though traditional interviews and references are still important.

From personal experience, let me add a note of caution about inviting a lawyer to join your board. While attorneys frequently have a breadth of experience, and can identify legal implications of board decisions, the board and management should understand that a lawyer on the board is not the lawyer for the company (much less a “free” one). Board membership does not create a formal attorney-client relationship carrying with it the benefits of attorney-client privilege. Other directors may also overvalue the business advice of a lawyer acting outside his or her professional capacity. Even worse, board service can create troublesome conflicts of interest between the board member's professional duties and those he owes to the company and its owners.

Director vs. Adviser

So, because all these responsibilities may scare off some candidates, let me highlight the differences between a “Board of Advisers,” which many firms today have, and a formal “Board of Directors.” Just as with the entrepreneur uncomfortable with formal titles and positions, the Board of Advisers is a common way to try to accommodate the qualms of trusted counselors who don't want the commitment (or legal liability) of a full directorship. For example, the following resolution was recently used to create such a board:

Section 123 Board of Advisors
The Board of Directors, from time to time, in its discretion, may designate one or more persons to serve on a Board of Advisors to the Corporation, to provide advice and guidance to the Directors and Officers of the Corporation in the exercise of their duties to the Corporation, on such subjects as the Board may designate, from time to time, as and when such Officers and Directors may request, or as and when the members of the Board of Advisors deem it in the best interest of the Corporation to offer such advice and guidance. Members of the Board of Advisors shall not be, and shall not be deemed to be for any purpose, members of the Board of Directors of the Corporation; members of the Board of Advisors shall not be subject to the legal duties, liabilities or responsibilities of directors of a [State Name] business corporation. Any member of the Board of Advisors so designated by the Board of Directors shall be indemnified to the fullest extent provided under this Agreement or the Business Corporation Act, and shall be entitled to rely upon all provisions of Article __ of the Bylaws of the Corporation, and any other provisions of the [State Name] Business Corporation Law concerning indemnification and advancement of expenses. The Board of Advisors shall meet at such times and under such rules of procedure as shall be determined by its members. Members of the Board of Advisors shall receive such compensation for their service as shall be established by the Board of Directors of the Corporation.

Despite their effort to straddle this legal fence ' to get the prestige, if any, of a title, and the influence of an insider, without the liabilities or commitment that the law requires of a director ' I think that members of such bodies who provide substantive “recommendations” risk getting the proverbial worst of both worlds ' all the liabilities, without the legal protections provided by modern business codes and documents to formal directors. Absent formal election as a director, the liability limitations and rights to indemnification and advancement of expenses authorized in modern corporate codes and most standard bylaw forms, would not likely provide protection. Similarly, to the extent that directors' and officers' liability insurance is in place, it would not apply to someone who is by definition outside the scope of its coverage ' even though one who acts as a director in all but name will likely be sued along with those who have been formally selected. This is especially true in entities that do not keep good records or corporate minutes, so that it may be difficult for a court to distinguish the differences between a director and a person who is just an adviser when challenged to do so by a creditor.

Really Not Just a 'Game'

Anyone who has watched any Saturday morning television has seen commercials for toys and board games that everyone using them lost at because the wares didn't work as advertised. While that may not have mattered to everyone, losing in the “real world” board game means having an ineffective governing body. That could mean an inability to adapt to the constant change in e-commerce. Then everyone involved will lose.

Nostalgia for board games whose outcome meant nothing more than bragging rights and an opportunity to have fun made the online versions top hits in the dawn of the Internet era.

Today, the children who once played those games ' and their parents ' have grown up and done serious, responsible things, like forming e-commerce companies. Unfortunately, many of them are still playing board games when they fail to see the benefits of having a traditional board of directors, but they're now playing a game with much more potentially serious consequences.

Tradition Can Help Even Mavericks

As I described in “The Virtual Company” (see, the April 2010 edition of e-Commerce Law & Strategy; www.ljnonline.com/issues/ljn_ecommerce/26_12/news/153540-1.html), many entrepreneurs are, by nature, unwilling to follow the rules of the corporate world. In fact, many have succeeded, precisely because that derring-do approach helped them cut costs and create efficiencies, particularly compared to businesses that followed traditional models.

Yet, even accepting the anti-authoritarian world view of many e-entrepreneurs, I believe there are many valid legal and business reasons why an e-commerce firm, no matter how informally or loosely it is operated, should have a formal board to oversee operations. (I base my opinions not only on many years of practicing corporate law that has included advising boards of directors, but also on my service as a director of several not-for-profit firms.) As a guide for the newly entrepreneurial, as well as for those who have “just stumbled through” all these years, let me discuss how a formal board can help an organization, and how to select its members to achieve that goal.

While some of this advice is true for any business organization, “e” or not, I think there are many reasons online firms need a board even more than their real-world counterparts do. Even a limited-liability company (“LLC”), which technically doesn't require any type of governing body ' only a corporation must have a board ' often nonetheless can benefit from the type of guidance provided by the equivalent of a board.

Different Times, Same Benefits

The Internet has changed corporate governance best practices.

Legally, directors must comply with fiduciary duties of loyalty and care to ensure that they act in the best interests of the company and its owners (rather than their own interests). A recent board retreat I attended tried to make these abstract legal concepts more concrete with specific director tasks. These included that members of the board of directors:

• Participate in planning for the organization (including monitoring implementation of the plans);
• Select and support the executive employees;
• Exercise financial and operational oversight by reviewing and approving budgets and financial reports;
• Oversee operations (without getting involved in day-to-day management); and
• Recruit talent and resources, such as by networking for new business or key hires.

The recent Conference Board Global Corporate Governance Research Center's Special Report on Best Practices, quoted in an American Bar Association (“ABA”) course of study on board conduct, captured well the blend of traditional and evolving demands facing modern boards. The publication stated that:

In general, the Directors' role requires that they provide active oversight of the company's business to minimize corporate risk and promote the creation of shareholder value. The new challenge for boards will be to go beyond their traditional advisory role and increasingly focus on their oversight role. As fiduciaries, boards must be active monitors of management. (Emphasis added.)

A board that can support the company through some of these methods will go a long way to helping a company succeed, online or off. In contrast, e-commerce firms focused on a 24/7 instant-response culture, without the support of more seasoned board members comfortable with these traditional board support roles, may be less able to compete than firms trying to manage this week's, this month's and this decade's business ' all at the same time.

Of course, this advice won't apply to some firms, e or not. The newly formed venture, whether a proprietorship, LLC or corporation, consisting of an owner and his or her family members handling everything from marketing to manufacturing, typically does not have time for board deliberations, nor does it have issues requiring them. When the main day-to-day challenge is surviving until the next day, the foresight to plan into the distant, and not-so-distant, future is a luxury beyond most budgets.

The thing is, though, that it should not be. For all the reasons in this article, the proprietor who wants to build a firm must think about growth strategies, and what to do now, to try to ensure that she is not doing the same thing in five years. As the business clich' goes, “Failing to plan is planning to fail,” and forming and using a board to solicit advice is, at its core, nothing more than getting outside advice from very knowledgeable friends.

For that reason, corporate strategists often recommend independent directors, i.e., those who do not have a family or business relationship with the company to complicate decision-making. Insider directors may “over-rely” on the information provided by management, and become a proverbial rubber stamp ' the exact opposite of the oversight aspect of a board's fiduciary duties.

But let there be no mistake about the price of that decision: A truly independent board, or even just one independent director, will increase the complexity and time needed for corporate decision-making. Before creating a formal board, firms must recognize the practical burdens it will create, and the likely changes to the firm's culture.

Instead of the typical start-up board consisting of the founder and perhaps key employees who may always be on-site if needed for a meeting, outside, independent directors must be carefully tended. From scheduling meetings around their other commitments, to having to justify business recommendations to skeptical outsiders (who should be skeptical of management's views, to fulfill their fiduciary duties), firms with independent directors cannot act as quickly as they could when decisions were made unilaterally. This may be even a greater problem in an e-commerce firm accustomed to reacting in Internet time, without the need for convening meetings beyond those taking place in a series of Tweets. Obviously, this level of formality will delay decisions and increase costs ' both results that e-firms have always proudly avoided.

Basics, Not Burdens

So why choose to add delay and expense? If there is a cost, whether in management efficiency or in out-of-pocket dollars, or both, is there a countervailing benefit? Let me list several.

At a high level, the existence of a formal decision-making body, with independent third parties, can provide comfort to potential customers, investors and business partners. For online firms that often do not have a long history, or a tangible presence, an effective board that actually provides oversight can demonstrate a firm's bona fide existence. This is the management analog to the argument for keeping corporate minutes, even when not required. To the extent that creditors may try to pierce the veil of an e-company on the basis of the lack of evidence of the company's compliance with corporate rules, the trappings and substance of a functioning board of directors provides another line of defense against personal liability of the owners (see, “Dressing Your e-Business Up for
Success,” in the June 2008 edition of e-Commerce Law & Strategy; www.ljnonline.com/issues/ljn_ecommerce/25_2/news/150577-1.html).

Because e-commerce business models change rapidly, having skilled advisers “on call” can help management look at the bigger picture. Good directors will try to spot trends to allow the firm to anticipate them, rather than to just react ' especially if management has its hands full reacting to the day-to-day demands of an ever-evolving (and often highly specialized) online marketplace.

While firms not locked into their leaders' traditional ways of thinking can be an advantage when the marketplace is constantly changing, there is also a value in putting change into the perspective of how prior turbulent times have worked out. Consider: While the technical problems facing an e-commerce firm may be new, along with the strategic challenge of how to exploit that technology in the marketplace, fundamental business decisions rarely are novel. Are the core elements of competition between e-commerce sites such as Amazon.com and Barnesandnoble.com any different from those GM and Ford faced from each other in their industrial heyday?

Moreover, consider the business benefits of getting regular advice from “outsiders,” people not involved in the day-to-day management of the firm: No matter how well rounded a business manager may be, she certainly cannot bring every area of expertise that a well rounded board can add; indeed, an important duty of directors is recruiting additional directors who bring competencies that may be lacking on the board, but that can be helpful to the firm's business.

If the e-commerce firm happens to be a non-profit, then board members face the same challenges as those on for-profit boards, but are also generally expected to assist in fundraising and building connections with other firms (often in ways not possible in the for-profit world because of antitrust concerns). Non-profit directors must also adapt to the demands of the new Form 990-PF (see, www.irs.gov/pub/irs-pdf/f990pf.pdf), the IRS staff's reaction to the corporate scandals and lack of disclosure in the for-profit sector. That form was intended to legislate greater “transparency,” i.e., public disclosure, of the workings of the large non-profit firm. (For further discussion of board duties and challenges in a non-profit, which can take different dimensions than in a for-profit firm but which are beyond the scope of this publication, see, the excellent report “Principles for Good Governance and Ethical Practice: A Guide for Charities and Foundations,” available at www.nonprofitpanel.org.)

The Internet has revolutionized the reality of being a director by making information on directors available online to anyone, which means prospective and current directors must have clean public records.

Looking for Mr. or Mrs. Good Director

The same ABA program mentioned earlier collected a laundry list of factors that can make someone a good director, such as:

• Specific “line” business expertise in a related industry, preferably with profit and loss responsibility;
• Financial knowledge;
• “Soft” factors, such as personality fit, commitment, and the time and energy to attend meetings and to do substantive board work (rather than just use the board seat as a resume-builder);
• An untarnished personal and professional reputation, as discussed above;
• A combination of strategic, financial and operating skills to enable the candidate to effectively oversee;
• Specific skills helpful to particular committee work, e.g., lawyers for a governance committee, finance professionals for an audit committee or personnel executives for the human-relations committee;
• General experience as a successful leader and supporter of the organization's mission;
• For non-profits, a prior donation history, and access to potential significant donors;
• The ability to recruit additional qualified board members;
• Complementary skills that the founders may not have; and
• General diversity of the board, in whatever way may be needed.

Of course, no individual director is ever likely to have more than a few of these characteristics. The goal is to attract a board that has a diversity of talents and connections in areas that will help the firm grow. In the e-commerce world, that would include a blend of familiarity and comfort in navigating business and technical worlds that no one has yet imagined, as well as experience in translating familiar solutions to the new business challenges of the online and tech worlds.

Typically, directors are recruited, whether by individuals or by a formal nominating committee, in much the same way as candidates for employment are identified. Industry and personal contacts, recommendations of the firm's professionals, business associations and corporate recruiters (also known as “headhunters”) are all excellent and established methods. Because e-commerce may still be too young to have truly established networks of this type (at least outside California and New York), firms may have to be more creative recruiters ' but e-commerce may itself provide the tools for such creativity, as in social-networking and professional association blogs, though traditional interviews and references are still important.

From personal experience, let me add a note of caution about inviting a lawyer to join your board. While attorneys frequently have a breadth of experience, and can identify legal implications of board decisions, the board and management should understand that a lawyer on the board is not the lawyer for the company (much less a “free” one). Board membership does not create a formal attorney-client relationship carrying with it the benefits of attorney-client privilege. Other directors may also overvalue the business advice of a lawyer acting outside his or her professional capacity. Even worse, board service can create troublesome conflicts of interest between the board member's professional duties and those he owes to the company and its owners.

Director vs. Adviser

So, because all these responsibilities may scare off some candidates, let me highlight the differences between a “Board of Advisers,” which many firms today have, and a formal “Board of Directors.” Just as with the entrepreneur uncomfortable with formal titles and positions, the Board of Advisers is a common way to try to accommodate the qualms of trusted counselors who don't want the commitment (or legal liability) of a full directorship. For example, the following resolution was recently used to create such a board:

Section 123 Board of Advisors
The Board of Directors, from time to time, in its discretion, may designate one or more persons to serve on a Board of Advisors to the Corporation, to provide advice and guidance to the Directors and Officers of the Corporation in the exercise of their duties to the Corporation, on such subjects as the Board may designate, from time to time, as and when such Officers and Directors may request, or as and when the members of the Board of Advisors deem it in the best interest of the Corporation to offer such advice and guidance. Members of the Board of Advisors shall not be, and shall not be deemed to be for any purpose, members of the Board of Directors of the Corporation; members of the Board of Advisors shall not be subject to the legal duties, liabilities or responsibilities of directors of a [State Name] business corporation. Any member of the Board of Advisors so designated by the Board of Directors shall be indemnified to the fullest extent provided under this Agreement or the Business Corporation Act, and shall be entitled to rely upon all provisions of Article __ of the Bylaws of the Corporation, and any other provisions of the [State Name] Business Corporation Law concerning indemnification and advancement of expenses. The Board of Advisors shall meet at such times and under such rules of procedure as shall be determined by its members. Members of the Board of Advisors shall receive such compensation for their service as shall be established by the Board of Directors of the Corporation.

Despite their effort to straddle this legal fence ' to get the prestige, if any, of a title, and the influence of an insider, without the liabilities or commitment that the law requires of a director ' I think that members of such bodies who provide substantive “recommendations” risk getting the proverbial worst of both worlds ' all the liabilities, without the legal protections provided by modern business codes and documents to formal directors. Absent formal election as a director, the liability limitations and rights to indemnification and advancement of expenses authorized in modern corporate codes and most standard bylaw forms, would not likely provide protection. Similarly, to the extent that directors' and officers' liability insurance is in place, it would not apply to someone who is by definition outside the scope of its coverage ' even though one who acts as a director in all but name will likely be sued along with those who have been formally selected. This is especially true in entities that do not keep good records or corporate minutes, so that it may be difficult for a court to distinguish the differences between a director and a person who is just an adviser when challenged to do so by a creditor.

Really Not Just a 'Game'

Anyone who has watched any Saturday morning television has seen commercials for toys and board games that everyone using them lost at because the wares didn't work as advertised. While that may not have mattered to everyone, losing in the “real world” board game means having an ineffective governing body. That could mean an inability to adapt to the constant change in e-commerce. Then everyone involved will lose.