Effectively Creating and Leveraging a Board of Directors for Privately Held Companies

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1 Effectively Creating and Leveraging a Board of Directors for Privately Held Companies Background The board of directors is a term that strikes fear into the hearts of most management teams. It is the group responsible for making the big decisions of the company and the one responsible for calling management into account for both success and failure. Many people view a board of directors as something that only large companies utilize. It invokes images of publicly held Fortune 500 companies and their prestigious board members sitting around a mahogany paneled conference rooms. But the reality is that if done the right way, assembling a board of Directors can provide incredible value for a small to medium size enterprise. The Board of Directors, Defined A board of directors is charged with oversight of a company s operations. Its members are typically elected by stockholders for a specified period of time, and are empowered to the extent as defined in the by-laws in a company s articles of incorporation. When establishing a board for a company the amount of power given to the board vs. that which resides with the shareholders of the company is a decision made at the discretion of the shareholders. Some of the duties conferred upon a board of directors typically include but are not limited to: Working with executive management to develop and define the strategic direction of the company Establishment key policies of the company Establishment of the ethical tone of the company, and ensuring that management is operating setting an appropriate tone at top for the company Selection of the executive management team Setting of expectations for the company s overall performance and holding the management team accountable for those results Monitor the performance of management Setting executive management s annual compensation and any performance based bonus plans GALLINA LLP Effectively Creating and Leveraging a Board of Directors for a Privately Held company [ 1 ]

2 Approval of operating budgets Approval of significant transactions including purchases, mergers, and lending agreements Meet with external auditors to approve their audit plan and the results of their audit The legal responsibilities of the board will vary significantly with the nature of the organization, and the level of authority granted to the board from the company s by-laws. For publicly held companies, many of the board s responsibilities are defined by regulatory bodies and are much more rigorous and complex than for privately held companies where there is a substantial amount of discretion as to the role a board will play within an organization. One of the board members will be selected to be the chairman of the board. In smaller companies, the chairman will frequently be the majority shareholder. As allowed in the by-laws, this person will be responsible for running the board meetings and sets the tone for the board. Fiduciary Responsibilities By law, board members have a fiduciary obligation to the company. In that role as a board member, you are legally bound to take actions that are in the best interest of the company. All board members need to have a thorough understanding of their fiduciary duties as a board member, and it is a best practice that all board members have a discussion with their legal counsel to properly understand this role, and the serious implications it can have. Many professionals join boards for the prestige or further develop their professional network. With this in mind, it is critical that everyone that sits on a board realize that the decisions that they make can have a profound impact on the company. At the end of the day, the board is accountable to the stockholders and to outside stakeholders in the community. By not taking the role as a board member seriously or by not fully understanding the matters being voted on by the board, a member can be placing not only the company, but themselves at risk. A board that is engaged and well informed of the issues at hand will be the most effective in managing a company. GALLINA LLP Effectively Creating and Leveraging a Board of Directors for a Privately Held company [ 2 ]

3 Qualities An effective board should ideally have members that are from a diverse set of backgrounds that are relevant to the company. For instance, a manufacturing company may want to have one or more board members that have expertise in manufacturing, while at the same time have other board members that have their expertise in finance, law, or marketing. Having input on issues from a variety of differing perspectives can provide unique insight into the issue at hand. This is the role of a board that many private companies will find most useful. Having an assembled team of trusted advisors involved in key decision making processes can help in vetting the various strategic opportunities that present themselves to the company. Of course it is critical that the team you assemble for your board has the experience and vision necessary to assist in this role. Assembling a team of mediocre advisors will generally produce mediocre results. Turnover There are benefits to a company in having a board of directors with a stable membership that have served the company for a substantial number of years. The members of the board will be well versed with the history of the company, the competing personalities of management, and the overall strengths and weaknesses within the company. However, a certain degree of required turnover may be beneficial as well. Bringing on a new board member can bring new perspectives and insight to issues, and without much of the historical perspective, such members can question many actions the company taken by the company and uncover issues that had been previously overlooked. Accordingly, many by-laws include term limitations on board members to ensure the positions turnover periodically. Difficult Decisions Sometimes tough decisions need to be made. Management may come to the board for approval of a significant transaction that will impact the company s future for years to come. It is the board s responsibility to review such proposals, provide candid feedback to management on the proposals, and in the end to approve or reject such proposals. The board should challenge management and ask relevant questions to gain a fully understanding of the risks and benefits of the proposal, as opposed to rubber stamping the requests of management. GALLINA LLP Effectively Creating and Leveraging a Board of Directors for a Privately Held company [ 3 ]

4 The board should foster an open environment where ideas are freely discussed and evaluated. Positive or negative feedback on proposals should be both candid and constructive in nature. Chairman The chairman of the board is the group s leader and has responsibility to preside over meetings of the board. The chairman has the ability to set the agenda and tone of each board meeting, and to ensure that discussions at the meetings stay on track and are productive in nature. For most small businesses, the role of chairman will be filled by the majority stockholder. This will enable that person to maintain control over their company while at the same time being provided feedback by the members of the board. In situations where there is no majority shareholder of a company, the board members will be elected by proxy vote, and then the elected board members will vote on which member of the board will be the chairman. Control As previously mentioned, the board s powers are those that are given to it by the stockholders and the articles of incorporation. In public companies, this means that stockholders vote on the election of board members, and that board members cast votes on key decisions of the company. In a smaller owner-managed business, it is likely that the majority shareholder will not desire to relinquish control of the company to board members that hold minority interests. In these situations, voting rights by board member can be allocated pro-rata based on ownership interests, or board votes can merely be advisory to the chairman who would be the ultimate decision maker. Level of Involvement For many small companies that have a majority shareholder, that person is likely to share the role of chairman with the role of being Chief Executive Officer (CEO). However, many situations for smaller private companies have a board that is separated from the management of the company. When this is the case, the board must have carefully designed rules of how it operates. The ideal situation is that the CEO of the board reports to the board, but the CEO is responsible for the execution of the board s goals, as well as day to day GALLINA LLP Effectively Creating and Leveraging a Board of Directors for a Privately Held company [ 4 ]

5 decision making. It is critical to empower the CEO with this capability and give them the room to execute on those plans approved by the board. If the board becomes a micro manager of the entire c-suite of executives, it diminishes the ability of the CEO to get their team on one page and focused on executing the same strategy. Providing Information to the Board Candid two-way discussions require that management share all information with the board that could be relevant to their decision making process. At the same time, management should not flood the board with overly detailed analysis at a micro level. Traditionally, management prepares a board packet which will include the following items: Financial statements Analysis of the results in the financial statements Projections for coming period Significant matters for board approval The board packet should be summarized to the point where it minimizes the time board members require to review it, but it should be detailed enough that it contains all the relevant information the board members need to make informed decisions. It is easy to provide the board with a thick board packet that contains an overwhelming amount of data. The trap of providing excessive information can obscure the important information and make decisions harder to make. The board members should also provide feedback to management as to the contents of the board packet. If there is a certain performance metric that the board wants to review, management should respond to that request by providing that information to the board member, and then including that information in future board packets. Compensation Board members will generally want to be compensated for their services. While many board members will likely be successful and they will not be looking for compensation as the primary reason why they serve on a board, it is generally recommended that the board of for-profit entities receive quarterly or annual compensation for the efforts required to serve on the GALLINA LLP Effectively Creating and Leveraging a Board of Directors for a Privately Held company [ 5 ]

6 board. This does not just include meeting time, but should also factor in preparation time in reading key documents and travel time to attend meetings. Resources for board members The National Association of Corporate Directors is an organization that exists to provide information and resources to board members. While much of their content is targeted towards publicly held entities, they have a great deal of information available to assist with corporate governance. Their website address is This group holds information events for directors. Frequently the company will pay the membership fees for all of its board members to join NACD. GALLINA can help Building a board of directors from a panel of trusted advisors can be a strategic advantage to any company. Small to medium size companies can benefit from the expertise of a board as well. In developing your board, it is critical to make the right decisions. GALLINA can help. If you have any questions on the role of a board of directors in your company or any other accounting question, please feel free to reach out to us to discuss the right steps for you and your company. ***** GALLINA LLP Effectively Creating and Leveraging a Board of Directors for a Privately Held company [ 6 ]