Directors can play a key role in the success of start-ups and scale-ups in both the UK and the U.S. However, differences between legal frameworks and governance norms, as well as the experience and approach applied by directors in different jurisdictions, mean that the role, expectations, and benefits that come with these appointments can vary quite significantly.

Common Ground Between the U.S. and UK

As a starting point, both U.S. and UK companies can have directors that are not employees of the company. In the UK, we often refer to them as “NEDs,” short for non-executive directors. In the U.S., they are more commonly referred to as “outside” directors. Oftentimes, both of these get referred to as “independent” directors, but it is important not to confuse true independence for merely being a non-executive.

Unlike executive directors, NEDs are not meant to be involved in the day-to-day operations of the business. However, all directors in either jurisdiction owe the same fiduciary duties as directors to the company and/or stockholders regardless of their relationship to the company. The high level “job description” for modern NEDs in the UK and the U.S. is largely the same: to help shape strategy, to monitor the implementation of that strategy by the executive and management teams, to act as a mentor to other board members to leverage networks for the benefit of the business and to identify and direct management to manage risk.  

The Value of Outside Directors/NEDs

For many companies that have taken outside capital, it is not unusual to have NEDs/outside directors on a board of directors. NEDs/outside directors can add the following benefits to any company:

• veteran management experience to the CEO and other members of the C-suite;
• industry expertise, experience, and connections;
• diversity of opinions supporting management;
• objectivity (depending on their independence) in decision making;
• compliance with public company listing standards (for listed or IPO-stage companies); and
• a governance tool for key decision events that necessitate a record of an unconflicted process.

The actual value of any outside director/NED however will depend on how much they actually contribute in any of those roles. While there is ample evidence of successful use of NEDs, more often with public companies, private companies often fail to reap the benefits of NEDs and may find themselves regretting the addition if done for the wrong reasons or the wrong way.

Differences Between the U.S. and UK

While there are many commonalities in the use of NEDs/outside directors between the U.S. and the UK, there remain a number of gaps both legally and in practice. 

Level and Diversity of Experience

As a general matter, while the UK is a highly experienced business ecosystem, the modern venture-capital ecosystem remains in its first generation. Few founders or investors have actually exited yet, and as a result, the talent pool for experienced UK NEDs is largely based on carryover talent from separate industries and experiences. For example, many companies have NEDs that are from more traditional industries that are perhaps less high growth or less prone to exits. That is not to say these NEDs are any lesser individuals, but they often bring fewer relevant experiences to the table. As a result, the overall value of the NEDs is less effective than when outside directors have experience that is more on point. 

By contrast, the U.S. high growth ecosystem has a much larger number of exits and deals and the pool of experienced independent directors is thus greater. As a result, U.S. companies tend to have more opportunities to lever the experience of their outside directors.

This is not expected to be a difference for long, however. As the UK and European ecosystems mature, more companies will complete a full lifecycle and result in exits, which means more executives and existing directors will gain experience. In addition, training and networking organizations such as Boardwave have been helpful resources to allow existing and prospective non-executive directors to share experience and knowhow.

Level of Authority Granted: Chairman Role; Setting the Agenda

Many UK companies often set out to find a non-executive chairperson as an early order of business for an enterprise. While the chairman role legally has the same duties as other directors, oftentimes there is a power dynamic where management is deferential to the non-executive chair. These chair roles are frequently paid positions that can be expensive for early-stage companies. While perhaps useful at times as a means of mentoring less experienced founders, this often creates a layer of bureaucracy and expense that is burdensome for early-stage companies.

By contrast, most U.S. companies generally do not typical empower outside directors with additional chairperson titles. Even when appointed chairperson, it is rarer that a U.S. company empowers that director at the same level. As a result, outside directors tend to be more operationally involved rather than solely for governance purposes.

Compensation

Even early-stage UK companies will often provide a salary or fee in cash to non-executive directors. In addition, many will offer stock-based compensation to those NEDs as well.

U.S. venture-backed companies typically do not provide cash compensation to outside directors as commonly, with most directors solely accepting equity in as the basis for their compensation. 

Legal Dynamics

One of the most fundamental differences between the U.S. and the UK is the level of litigation risk. Interestingly, Delaware law in the U.S. has a tool that allows boards to take more business risk even in a conflict situation while limiting litigation risk: the business judgment rule. Delaware law provides that if a transaction in which parties are interested is reviewed by a board of directors in full light of the interests, and the disinterested majority of the board approves the transaction, the board typically gains the benefit of the “business judgment rule.” That means that if a stockholder challenges the fairness of the transaction, the burden of proof is on the stockholder to demonstrate a decision was not fair and in the best interest of stockholders. This has the effect of meaningfully deterring litigants from claims. As a result, non-executive directors that are disinterested in transactions can be a powerful tool to enhance governance and limit risk for U.S. entities.

By contrast, the UK does not have a corollary to the business judgment rule. While UK courts will look favorably on decisions in which disinterested directors approve, they do not provide the same level of protection to boards of directors. Of course, the overall litigation risk however, tends to be lower relative to the U.S.

Common Misconceptions About NEDs/Outside Directors

Practically speaking, most NEDs/outside directors in a private company are not truly independent. With a shareholder base that is compact and typically votes according to a voting agreement, it is rare that a director is truly directed wholly without ties to investors or management. 

As a result, companies often fall victim to some of the following statements when it comes to appointing a NED:

• “It’s good governance.”—This would be true if a NED was truly not tied to one of the various voting constituencies. Inevitably, the NED has been introduced and is related to some person of influence, whether a relationship with the management or founder or with the investor. While it is a useful governance tool to have a truly independent director, it is rare in a private company context that the director actually qualifies, and even rarer that the situation is actually tested.
• “I have never voted against an independent.”—A company never wants to be the first to find that out. Realistically, assume that this is just another investor board seat right unless the non-investors source and pick the relationship.
• “They will give you lots of access.”—This may well be the case, but it is important to diligence this with the potential candidate first. Are they motivated to help you, and are they connected to the right people and industries?
• “They can be a mentor for things you have not seen.”—They can still be a mentor if they are not on the board. If they will be on the board of directors though, they need to be a partner in your business in many ways.
• “You are not investable without one.”—Many, many private companies go a long time without a NED on the board. Most do not start spending resources until later in their life when they are thinking about going public.
• “You can still operate with more board members.”—This is usually said by someone that is not accountable to a board of directors and does not need to balance running a lightning-quick business and a bunch of directors that may not be full aligned.
• “We just like having the optionality.”—This is worse than having a NED actually appointed, because it means the investor might use it to add to your board of directors to change the control dynamic without you getting the benefits of potential access.
• “Don’t worry, we always consent.”—If so, then why is the seat needed at all?
• “It will protect you/us.”—This usually protects whoever has the right to appoint the NED, but it rarely creates an opportunity to protect shareholders and the company more broadly.

Conclusion

In both UK and U.S. NED appointments, it is important that board dynamics enable individuals to contribute and challenge effectively, rather than being seen as a way to balance a board for “optics.” At each stage (or investment round), start-ups and scale-ups need to work with their existing directors and advisors to make sure that the board is properly equipped to guide the company through the next phase of its development. Having an effective board can send a strong signal to potential counterparties, investors, and acquirers. Regularly assessing board composition and size is crucial as a company grows. Key inflection points for bringing in new NEDs might include preparing for a new funding round, planning international expansion, or approaching an exit.

Whether in the UK or U.S., companies should consider their current challenges and future aspirations when evaluating potential NED candidates, ensuring the board evolves in tandem with the business.

For more information on transatlantic companies and non-executive directors, please contact Wilson Sonsini attorneys Michael Labriola or Richard Goold.