Good Boards, Bad Boards and Why They Matter

What distinguishes an effective board of directors of an early-stage biotech company? The ability to walk a very fine line between constructive engagement and outright control. Good boards: small, focused, with an independent, mentoring chairman.

Q: What distinguishes an effective board of directors of an early-stage biotech company?

A: The ability to walk a very fine line. A good board needs to provide constructive input and when appropriate challenge management's recommendations, while being neither controlling nor adversarial. Yet good boards do not operate in a managerial vacuum; they need CEOs who want and know how to use them. Some CEOs would like their boards to rubber stamp their decisions and regard them as periodic annoyances, a state of affairs that can lead to serious corporate miscues.

Biotech company boards are usually combinations of representatives of venture capital investors in the company and management. The VCs provide useful perspective on a multitude of start-up company issues, but their influence on the board--the number of seats they occupy--is often way out of proportion to the value they contribute.

Normally under-represented on boards are independent industry experts: a retired pharma head of R&D, for example, who can lend the perspective of a potential customer, or a former biotech company CEO that can mentor an inexperienced one.

Academic scientists are often recruited for boards, but don't belong there—their place is on an SAB. Nor can a fledgling management team attract or afford the national political or business leaders populating Fortune 500 boards—and they shouldn't try. This window dressing usually comes at the expense of receiving timely counseling and assistance.

Additional, unnecessary window dressing: the financial expert. The Sarbanes-Oxley legislation has proven to be an annuity for law firms of public companies as they guide compliance and try to divine what set of qualifications meets the definition of the now legally required financial expert board member. But the law has no practical effect on boards of private biotech companies. Unemployed ex-CFOs and former partners at big accounting firms argue that they should be the board member of choice even for private biotech companies, based on the rationale that when the time comes for an IPO all of the proper financial oversight measures will be in place.

But the fact is that the reporting of financial information is relatively simple for private biotechs and is rarely the subject of dispute or difficulty. Rather than trying to locate unindicted ex-accounting firm partners for Audit Committee membership as the blizzard of memoranda on Sarbanes-Oxley compliance advise, start-up biotechs would do better to identify ex-pharma and biotech execs with real management experience.

A particularly sensitive decision concerns the position of chairman. To avoid the appearance or reality of self-interest clouding judgment, a biotech company chairman should not be an investor, founder, or member of management. The ideal choice is an ex-large biotech company CEO who can mentor the typically inexperienced start-up CEO. Often, the start-up CEO is apprehensive about going too often to his board for advice, for fear that his investor board members will lose confidence in him. Alternatively, residual large-company hubris sometimes misleads a new biotech CEO recently out of pharma into thinking that he knows what he is doing, despite the entreaties of his nettlesome VC board members. A perfect bridge to the board and mentor to an inexperienced CEO is a chairman with considerable pharma or biotech executive experience. Indeed, choosing the right chairman is almost as important as the selection of a CEO.

Post Tyco, conflicts of interest among board members merit attention and can be tricky to handle. Some conflicts are obvious: investor representatives can't ignore that their salaries are paid by venture funds which are company shareholders, and management representatives can't really separate their dual status as fiduciaries and company employees. So by definition, VCs and management are often in positions of conflict, particularly for major decisions like the sale of the company or the terms of a new financing. The deciding vote appropriately falls to the disinterested independent directors.

Problems arise if the independent directors include the company's investment banker or lawyer or other service provider who can earn a fee based on the outcome of a board decision. Similarly, an individual who is currently working for a pharma or biotech company may have a vested interest in the outcome of a board decision. Better to look for recently retired executives. But when they sign on, it is prudent to review their other board memberships, to make sure that they are not on the board of a competitor (and they should agree to stay off problematic boards going forward).

Biotech company boards should be small, ideally five to seven people who can meet monthly and be available for telephone calls between meetings. Larger groups can paralyze decision-making. They make it difficult to obtain quorums; board meetings by telephone call become chaotic. Large boards also encourage sporadic attendance by individual board members, who fall out of touch with key management issues and make poor decisions as a consequence.

Venture investors often reflexively condition their investment in a later round of financing on being granted a board seat. But this request shouldn't be agreed to reflexively. By the time of a Series B or C financing, several VCs will already be on the board. A sensible later round VC investor can be persuaded to accept observation rights in lieu of a board seat, particularly if the lead investor in the round is awarded a seat. However, observation rights should be dispensed carefully as well. Some biotech companies have awarded observation rights to so many people that they have made their board meetings into a meaningless showcase, holding only a few board meetings a year in some suitably cavernous meeting space, while holding interim non-board "advisory" meetings or the like to avoid having to invite the legion of observers--clearly not a desirable outcome.

Excellent boards follow sound procedure. Board members get materials a minimum of five days in advance of a meeting, which is run by an effective chairman who tracks a tight agenda--four hours maximum (attention wanes in longer meetings). Longer, unofficial meetings can be held for a special purpose, such as brainstorming or strategy development. Regularly scheduled board meetings shouldn't concern themselves with the business of the compensation, audit or other committees, which are meant to function as such outside the board meeting.

The fear of future discovery in litigation or required disclosure as part of due diligence for a transaction typically reduces the official minutes of a board meeting to uninstructive, legal boilerplate. But these hypothetical worries shouldn't preclude a summary of action items being prepared immediately after each meeting so that there is a living, substantive corporate memory created that can be reviewed by board members and then discarded before the next board meeting.

Board meetings should be held at company headquarters, not at the law firm, a fancy resort, or an investor's office. Board members need to stay in touch with members of the management team besides the CEO, which is far more difficult outside of the company's offices. The quality of information flow between board and management dramatically improves, both in the formal board meeting and in informal conversations.

Finally, good boards rotate membership. For most venture-funded start-ups, this issue is typically forced only every few years in connection with a financing round. But board positions should turn over more frequently, to reflect the changing oversight and mentoring requirements as a company matures and the evolving responsibilities and needs of the management team. Founders of biotech companies often request long-term appointment to a board and, like US Supreme Court justices, believe that they should leave feet first. Acceding to this request is a mistake. Board membership is not an entitlement or an honor; it must be earned by contributions that continue over time to be relevant to the needs of the biotech company.

The same principle applies to VC representatives on biotech boards. Unfortunately, there is a perception among some VCs that it is a mark of high status to sit on numerous boards. More sensible VC firms limit each of their partners to 5-6 boards, knowing that no human being (however obsessive-compulsive) can adequately serve a larger number of companies while doing each justice.

Sadly, the importance of a high quality board of directors to a start-up company is most often felt by its absence rather than its presence. It is simpler to attribute a biotech company's success to a strong CEO or management team or a third party-driven event, such as a major corporate partnership or other transaction. This misperception obscures the real value of a corporate board to a biotech company's management team—continual feedback, advice, coaching, and encouragement. The miraculous process by which a grain of sand is a starting point for a sequence of events that culminate in a pearl is testimony to the value of constructive irritation—good boards of directors serve the same function. Michael Lytton is a General Partner of Oxford Bioscience Partners. E-mail any comments directly to [email protected].