by Steve Goodman
CPA, MBA – President & Chief Executive Officer
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A private business has choices to make when it comes time to develop a board of directors. Companies organized as a C or S corporation are required to have a board. Delaware and Massachusetts law permit a minimal board consisting of one member. Most states require more than one board member. All states require S and C corporations to have a board. LLC’s and sole proprietorships are not required to have a board of directors.
Failure to have a board, even a single person board, and to follow through with meetings, resolutions, and board minutes can have serious consequences. The courts can decide that a company’s failure to act as a corporation allows a plaintiff and the courts to ‘pierce the corporate veil’ and find the company owners personally liable for company debts.
Types of Boards
Whether a company is required to have a board or not, the choice to not have a functioning board is itself a decision. Many small business owners maintain a view of corporate boards from their understanding of public company boards. Public company boards have their responsibilities defined by law and regulations. They have a fiduciary responsibility to the shareholders, both large and small. They have the authority to fire the CEO. There are requirements for independent board members. They can be held personally liable for their decisions, hence nearly all public companies purchase directors and officers (D&O) liability insurance. Directors of public companies can earn several hundreds of thousands of dollars, plus travel expenses, for their efforts each year.
Private companies have more choices in their board make-up. They can choose a fiduciary board or an advisory board. A fiduciary board has the same legal requirements to protect shareholders as a public board has, but with far fewer constraints. A fiduciary board serves as the company’s legal board of directors fulfilling the requirements of regular board meetings. An advisory board is simply that, a board of advisors. They have no legal authority and do not fulfill the legal requirement of a company to have an active board of directors.
There are numerous reasons that business owners give for not instituting a fiduciary board.
- It takes considerable time and resources to organize and maintain
- It can be expensive
- Board members may question the owner’s judgment
- They simply do not understand why they would want a board
The first objection is often true. Developing a quality board of directors can be a time-consuming process. It often begins with an education process even before individuals are nominated and evaluated. The process begins with an understanding of why a company would want a board. It continues with a statement of what the company owner(s) wants the board to contribute. Next logical steps include deciding the skills, experience, priorities, and personalities of the desired people. Then the selection and evaluation process can begin.
Implementing a new board has many similarities to the due diligence one conducts when looking at an acquisition. Is it a strategic fit? Can we afford it? What are the anticipated benefits of one to five years out? Will this acquisition fill gaps in our product lines or create new business opportunities? The amount of work that many companies conduct in evaluating acquisitions can be comparable to the effort required to develop a board. If one does not understand the role of a private company board or the benefits it can provide, then only the work and the cost side of the equation seems relevant.
Board members expect to be compensated for their time and knowledge. Lodestone Global, a consulting firm specializing in company boards, published a private company board compensation study in 2016. The presentation indicated the median private company director compensation was $36,000/year. For this money, the average board met four times a year with two additional formal teleconference meetings. The typical board consisted of six members of which three were independent. One was female.
Most smaller private company board members receive modest compensation for their participation. Company officers on the board do not receive extra pay for their board membership. Independent board members can receive as little as $6,000 to $10,000 per year, sometimes paid partially in stock, up to hundreds of thousands based on company size and participation expectations. If a board can avoid one bad decision, make one good contact, or change one strategy for the better, the costs of the board can pale by comparison.
The Lodestone Global study indicated that 87% of the privately held companies with boards saw increased revenues with 82% seeing increased EBITDA following the initiation of a board. A McKinsey study interviewed family-owned businesses to understand what they believed to be the biggest advantages of having a board. The respondents noted two benefits. The first was cost control. They found boards placed an emphasis on cost controls. The other identified impartiality in decision making. Independent directors were unburdened by the family politics that can afflict many families owned businesses.
The job of a board is not to question the judgment of the CEO and company management. The board’s job is to ensure that company management has done their homework before making a decision. Many a private company has made a poor decision based on a CEO’s impetuous decision making. Companies have handled personnel issues poorly resulting in lawsuits. Companies have missed opportunities because they failed to follow through or is-prioritized. Many senior company managers are uncomfortable challenging the CEO’s decisions. Directors recognize their role to not be ‘yes men’ or women for company decisions.
Often a board’s primary job is to educate and train the CEO to be better at his/her job. Running a company is a difficult job that includes aspects of leadership, decision making, and delegating, among many other functions. Few people excel in all aspects of the job. Private company boards, especially those chosen for their experience, recognize their roles including coaching.
Business owners who chose not to establish a board often do so as much out of ignorance than any other reason. They do not understand the role of a board. They believe that their early success in starting and growing a business is indicative of their skill and capabilities. They believe a board is unnecessary, at least until the day they trust their gut instinct a few times too many. Often, business owners are reluctant to share their proprietary information with others for fear it will become public knowledge. A simple NDA solves this problem.
Board Responsibilities and Benefits
Private company advisory boards have no legal responsibilities. Advisory boards range from formal boards, much like a board of directors but with no legal responsibilities, to informal groups of people with similar positions in non-competing businesses. Fiduciary boards have legal responsibilities. Therefore, the informal group approach is not a valid option. Though more formal, in practice the private company board acts as a hybrid between the public company board and the informal group of advisors.
Ownership of the company determines whether a board of directors more closely acts as a public company board or an advisory group. When a company has one owner, the role can be more advisory. While the board has the legal authority to fire a CEO, if the CEO has the ability to fire the directors, the circular logic nearly always works in favor of the owner. Boards run by one owner support the growth and development of the owner.
Boards run by family businesses are often called upon to consider family differences of opinion concerning company plans and activities. As independent directors, one of the roles that directors play is the referee in family disputes. It is not a role that many relishes, but they recognize as one of the reasons to have a board. Board members become knowledgeable about family politics and the thought processes of key family members. Family issues run the gamut from dividend policies to promotions to succession planning. An independent board is sometimes the only mediator that can avoid open conflict.
Boards run by companies with an angel investor, venture capital, or private equity ownership tend to run more formal than advisory. Professional investors, including many angel investors, have received training regarding their roles as private company directors. They understand the legal requirements of their positions while also recognizing their value for business introductions and business experience.
Establishing a Board
A privately-owned business with no institutional ownership has a virtual blank slate in forming a board. Several consulting organizations exist to assist a company from concept to nomination and acceptance. Starting a board begins with an understanding of the role of the board. Some CEO/owners seek a board that will focus on training and advice. Others seek a higher profile board to assist the company with introductions and stature in the business community. Still, others seek a board that will demand a level of professionalism suitable for training the CEO and key staffers for future growth.
With the role of the board confirmed, the next step is to define the skill sets, experience, temperament, and other aspects of an optimal board. Professionals advise that companies avoid considering their company attorney and/or accountant for the board. They lack the necessary independence due to having the company as a client.
When searching for board members, it is important to find people that fill gaps in the executive team’s experience. It is also important to find people with relevant experience in areas critical to the success of the business. Advisors recommend that companies look at people with the following expertise:
- Legal – a lawyer on the board can prove invaluable in a litigious environment.
- Financial – particularly someone with SOX compliance experience and funding experience if relevant.
- Technical – if your company has a large technical component, someone with technical skills can be valuable.
- Marketing – marketing plays a large role in most company’s success.
- Public Relations – PR is not marketing, though they may overlap. A respected PR presence on the board can contribute to company stature and community recognition.
- Regulatory – companies in regulated industries can benefit from directors with a regulatory background
- Industry – former executives in the same or related businesses can provide business insight.
- Other – These include labor/HR experts, shareholder relations, and environmental issues.
Given that the typical board includes only three independent directors, one must make choices when staffing a board. Many companies find it beneficial to hire an independent chair and allow him/her to work with a consulting firm to identify candidates. This relieves company management of the enormous time requirement to interview people and evaluate resumes.
Some company owners are more comfortable in an environment of peers. For these people, an advisory board may be the appropriate choice. Advisory boards can take many forms, including a board composed of family members and trusted advisors. Without legal status, advisory board members do not require D&O insurance.
The most interesting form of the advisory board is the peer group board. These are boards, typically created by an organizing body, comprised of teams of owners of non-competing businesses. These groups may meet monthly, usually for 3 to 4 hours, to discuss opportunities, challenges, and to seek mutual advice. Not unlike a 12-step program, all members pledge to protect the content of the discussions. This allows executives to open up about their businesses and encourages the sharing of experience and knowledge. These boards can become a source of friendships, moral support, and access to contacts.
There are numerous organizations who sponsor peer boards. Some CEO’s will participate in both a fiduciary board and a peer board. Interested business owners are advised to test multiple peer groups. Some are more problem solving oriented while others offer more emotional support. The wide variety of peer board organizations permit business owners to find a solution that fits their needs.
CPA, MBA – President & Chief Executive Officer
About Steve Goodman
For more than 30 years, Steven has provided insightful solutions to the challenges of business succession, wealth preservation and charitable planning, focusing on the needs of owners of closely held businesses and high net worth individuals.
He's been featured in the New York Times and is an accomplished speaker and has presented over the years to many organizations and professional groups on efficient business succession, estate planning issues and tax strategies. Steven is a CPA who was vice president of the Trust and Investment Division of JP Morgan Chase and a supervisor for KPMG Peat Marwick, and holds an MBA from Fordham University.