Tom Taulli
Jan. 11, 2006

LOS ANGELES - In 1997, Stanford classmates Janet Kraus and Kathy Sherbrooke formed a new company, Circles, with the goal of creating a leading experiential-marketing company. For example, it would plan experiences such as a dinner prepared by a celebrity chief, private use of a castle, a zero-gravity flight adventure and so on.

While the business was growing, the founders realized they needed to land big corporate clients. But how to get their attention?

"We decided it would be incredibly valuable to have someone on our side of the table who had some direct industry experience, a ton of professional experience and who could vouch for us," said Sherbrooke.

They identified that person: Phyllis Swersky, who has extensive experience dealing with major clients. She became the company's first outside board member.

"My experience is that entrepreneurs who have taken the step to form a board of directors are serious about growth," said Sherbrooke.

There has been quite a bit of research on boards and small to medium-size businesses. "Research has shown that a board's involvement can be positively related to the financial performance of the venture," said Charles Matthews, professor of entrepreneurship and strategy at the University of Cincinnati.

Here's how your company can leverage a board of directors:

The Right Structure
As an attorney for startups, Kenneth August of the August Law Group has set up many boards. "The big challenge is determining the level of involvement of the board," said August. "In some cases, the board is an underutilized resource. Then, the other case is when the board gets too intrusive--almost becoming de facto CEOs."

August says it's critical to establish expectations early. This means drafting a straightforward agreement that specifies not only the compensation but also a director's role. "Set up regular meetings," says August. "It makes sense to initially have monthly meetings. And, as procedures get established, the meetings may be, say, every couple months."

In terms of compensation, this is usually composed of equity. There may also be reimbursement for out-of-pocket expenses, such as travel. "The level of compensation is really a matter of negotiation," said August. "Basically, if the board member will deliver lots of value to the company, then of course you'll offer more compensation. It is perfectly acceptable to have different compensation packages for each director."

Determining Who Should Be On The Board
Bill Reece, the chief executive of HealthGate Data, thinks that a board should, at a minimum, have three members: a financial person, a good strategist and a strong operations person.

"These need to be people who have been through the fires and have the real 'in-theater' experience to help guide management through times of growth and through rough times," said Reece. "Most importantly, these directors must be independent thinkers and willing to press issues and argue points with management while still being supportive."

Benefits Of A Good Board
It is often the case that startup companies feel they really need to focus on growth and product development, not such things as internal controls and reporting. After all, aren't these for public companies?

Reece says this is a fatal mistake. "I feel that the most important role of a well-constructed board for a startup company is one that demands the type of financial and reporting discipline from management that will be required by a potential M&A partner or an IPO," said Reece. "Setting this discipline early is important from both a cultural standpoint and to minimize degradation of value in a liquidity event for shareholders."

Access is also an important benefit of a board. Board members can open doors for new customers, strategic partners and personnel. And they can be crucial in getting investors. "When you're a startup company, the board of directors can play a big role in the company," said Bill Flitter, the vice president of marketing and founder of Pheedo, which develops technologies for Really Simple Syndication. "And a lot of the board choice is linked to how you go about getting financing."

Consider Advisory Boards For Specialized Areas
A board of directors has clear legal responsibilities, such as voting on key corporate decisions (such as accepting outside capital). In a sense, they are part of the management of the firm. An advisory board, on the other hand, does not have legal responsibilities and is typically less formal. Yet an advisory board can be quite valuable for an early-stage company.

This has certainly been important to Oversight Systems, which develops compliance software to help companies deal with such complex requirements as Sarbanes-Oxley. Customers include such biggies as SAP (nyse: SAP - news - people ) and Oracle (nasdaq: ORCL - news - people).

No doubt, this is a specialized area, and that's why the company's CEO, Patrick Taylor, thought it was imperative to form an advisory board. "We felt the need to connect with industry thought leaders who would help direct our product development to meet the future demands of the market," said Taylor. "For our market of SOX compliance and financial controls, we reached out to accounting professors who are experts in risk management and corporate governance." His group of advisers includes Dana Hermanson of Kennesaw State University, Joseph Carcello of the University of Tennessee and Mark Beasley of North Carolina State.

"These professors connect us with future developments of SEC policies and work to push emerging technology solutions for industry adoption," said Taylor.

Tom Taulli has founded several companies, including Web-hosting firm Hypermart.net, which was sold to InfoSpace, and has been an adviser to startups. He currently operates VetTheDeal.com , a resource for investors and entrepreneurs, and is an adjunct professor at the University of Southern California, teaching corporate finance and corporate law. He has written several books, including The Complete M&A Handbook and Tapping into Wireless. He can be reached at tom@taulli.com and has a blog at Taulli.com.