Why form a board of directors… and why not?

There are many good reasons to consider the formation of a fiduciary board, traditionally referred to as board of directors, and/or an advisory board. There are however also a few risks. As the owner or leader of a private company, how well you understand both, and move forward, can have a dramatic and material long-term effect on the success of your company.

WHAT PROBLEM DOES A BOARD SOLVE?

For most people that own the controlling interest in a private company, the bulk of their knowledge comes from business press stories about the actions of large-cap public company boards. There is much more to understand.

One of the more dramatic evolutionary trends in American business over the last couple of decades has been the pressure on public companies – both regulatory and investor-driven – to upgrade their governance practices (e.g. boards). A smaller but important result has been private companies quietly moving to emulate – where appropriate – the governance practices of their public counterparts. A board completely composed of either owners or management is technically a board. However, this does not meet the true intent of a fiduciary board since it lacks a majority of independent directors, which is mandatory for a public company under Sarbanes-Oxley.

What problem does a board solve? Many would comment, “I am doing just fine without one.” When they want advice, they may rely on their attorney, CPA, or fellow business-owners. Many private company leaders are realizing that beyond licensed legal and accounting advice, the general business counsel they are getting is not worth the price. Is it really the wisest choice to rely on your informal network, or even your attorney or accountant for advice on serious strategic issues in your unique industry? Or, what about acquiring a competitor, or expanding internationally? A carefully created, balanced, and well-managed board can offer inexpensive and invaluable counsel in a broad range of critical areas. The objective is to add to the breadth of expertise beyond what is already available in the company.

In addition to strategy and practical advice, an experienced board can have other benefits, like improving your company image in the eyes of customers, vendors, bankers, and employees. A board can be a valuable asset raising capital or other financial transactions. One important by-product of a board is increased accountability of management.

WHY WOULD I GIVE UP CONTROL?

The most common comment from the owners of any closely held company is “I don’t want to give up control.” In most cases creating a board with independent directors does not cause owners to lose any control.

The reporting dynamics of a fiduciary board are that the board reports to the shareholders – or even the sole shareholder/owner – of the company. The board’s sole responsibility is to protect the interests of the ownership. One way or another all employees, including senior management, report to the CEO. The CEO in turn always reports to the board. In the case where the CEO is not the sole owner of the company, for example a public company, the reporting is very straight line – very simple. He or she can be directed and even fired by the board. But in the case where the majority owner of the firm is the CEO, there is an additional element. The CEO reports to the board, and since the company ownership elects the board, they ultimately work at the will of the CEO. As the owner, he or she will always have the final say. The board should provide a platform for a critical analysis of management’s actions, and objective feedback, but the CEO can ultimately reject their views. If that makes them uncomfortable, their fiduciary and legal recourse is limited to their resignation.

SO, WHY TAKE THE TIME AND SPEND THE MONEY?

We have reviewed the upside of forming a board. What is the downside? If things are good, one might question the need for a board. On the other hand could things be better? If that’s possible, then, why not?

Initially forming and maintaining a board is very time consuming. Ultimately it is the owners that undertake this. If the owner and CEO are one in the same, then where does the time come from? Like anything else, it has to be recognized as a priority. Yes, it will initially take valuable time away from your other management responsibilities. It is the board’s potential for dramatically upping your company performance that makes it worth the trouble.

Another issue is cost. When forming a board for a privately owned company that intends to stay closely held, it is most often not desirable or feasible to compensate a board with equity – e.g. stock options. Some form of phantom stock or synthetic equity is possible, but ultimately it boils down to paying the board in cash. In addition, there are travel expenses for attendance at meetings, the additional hard and soft costs of preparing board materials for meetings, and of course directors and officers insurance (D&O).

The biggest reason for not forming a board is usually the cost in management time, focus, and resources, and the monetary costs themselves. Beyond that, forming a board is not for the thin-skinned. If you have well-qualified and experienced directors they will be questioning your judgment. They will press you for your reasons and expectations at every turn. If you do not want anyone arguing with you, even if it’s for the betterment of your enterprise, then pass. Lastly, another good reason for not pursuing a board is simply, not understanding how they work and how the governance process, in general, is meant to build a stronger corporate infrastructure.

BACK OF THE ENVELOPE

WHY?WHY NOT?
1. Gain first-class advice from experienced experts1. Puts a strain on management time & resources
2. Get fresh innovative ideas, competitive advantage2. Costs too much money
3. Impressive optics for customers, vendors, & investors3. BOD may question your judgment
4. Best governance practices & process4. You don’t understand the BOD process

In conclusion, a good board of directors can be a powerful competitive asset to any company, but it’s not for everyone.

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