Board of Directors Is Key Tool for Success of Private Companies

The sudden implosion of public companies has become almost daily news. Although Enron has stolen the headlines by losing over $50 billion in shareholder wealth, Lucent and Nortel have actually destroyed more shareholder value than Enron. Other high-flyers such as TYCO, Cisco, GE and IBM have suffered setbacks due to accounting irregularities.

How could such major companies with publicly-disclosed financial statements, teams of internal and external accountants, broad coverage by analysts and significant investor oversight suddenly discover they were over-leveraged, or misstating earnings? And most important, why didn’t the Board of Directors identify and fix the problems before they impacted shareholder value? Each of these cases was created by management, but the Board, simply and without equivocation, oversees management on behalf of the owners of the company.

As the cases above demonstrate, the mission of the Board in a public company is to protect shareholders, most of whom have never seen the inside of the company or met management face-to-face. A failure in this capacity is at least detrimental, and possibly catastrophic. But in a closely-held or family-owned firm, where the shareholders typically founded the company and have a hands-on role in its management, is the role of the Board as clear or important? In fact, the closely-held company often has a greater need of a strong Board for the following simple reasons: (1) Smaller firms have greater risk, (2) more limited resources and (3) a shallower talent pool.

The Board is critical to helping a company overcome these obstacles through effective and applied oversight. Public companies, with better access to financial resources and talented management, have greater latitude in conducting their affairs. In other words, they can make mistakes and recover faster. There is usually broad business unit and customer diversification and therefore less risk, and a more open environment in which to operate, make mistakes and learn from them.

Public company employees often complain about the endless parade of meetings they must attend. But these meetings serve as informal checks and balances in the decision-making process. A pool of talent will get together to collectively determine the best course of action based on group experience before making million-dollar decisions. Yet in a closely-held company, this is a luxury that doesn’t exist. Management is often a single layer on the organization chart, and therefore the ability of the Board to add value through oversight is incalculable.

If composed thoughtfully, the Board allows successful bankers, financiers, attorneys, consultants and executives, with a wide range of industry and technical experience, to guide the company and provide oversight of management. Often this is the best, and cheapest, counsel a closely-held firm will ever receive. Board meetings can be used to assess and monitor strategy, ask questions of management concerning their execution plans and evaluate executive leadership.

An active Board of outsiders should be willing, and in fact eager, to dig for answers that management might be unwilling, or unqualified, to provide. The result is a company that utilizes all of its resources to achieve the overall goals of the organization, and a reduction in the burden that typically rests on the CEO’s shoulders.

Based on our experience working with Boards in family-owned and closely-held firms, we offer some recommendations on corporate governance practices that should be of value to your company:
  • Keep the Board small and manageable, with five to seven directors, to reduce “groupthink” and foster communication.
  • Elect directors that are professionals and leaders, willing to question assumptions. In many cases, the Board is the last line of decision-makers protecting management from making an expensive mistake, and a hands-off, “go-along” Board will fail to stop them.
  • Ensure a majority of directors are outsiders, have a vested economic interest in the company and bring diverse backgrounds to the Boardroom. If they are to serve the company well, it is best they bring something to the table that the company doesn’t already have.
  • Compensate directors based on corporate performance, through equity, warrants or similar methods to keep their attention.
  • Have directors review corporate strategy at least annually, and grant them access to managers charged with executing the strategy. They will often question assumptions you took for granted long ago. In a closely-held company, there are often few others to question how goals are being met.
  • Establish performance metrics and benchmarks for the Board to monitor monthly and yearly, and ensure they are discussed at each meeting.
  • Elect new directors every two years to keep the Board fresh and fully engaged.

Public and private companies typically share the identical objective of increasing shareholder wealth. While the public company needs a Board to provide oversight on behalf of thousands of dispersed shareholders, the private firm’s Board serves as a team of advisors providing counsel to management. But in the end, the result is the same.

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