By: Jacob Jeifa
Just about every large company you know of has a board of directors. A publicly-traded company is required to have a board that meets stringent standards, and most statutes governing corporations require one that meets much looser standards. Even without a statutory or regulatory impetus, there are many ways in which your growing business can benefit from a board of its own.
what is a board and what does it do?
The board’s job is to maintain the health of the company by overseeing management on behalf of its owners. The board serves as an independent level of accountability for management, particularly in areas of company finances, compliance, internal policy, and strategic planning. Typically, the board retains the authority to set the salaries of, as well as hire and fire, senior management, and usually must sign off on any transaction involving a major company asset.
The board of directors is made up of a group of individuals called directors. Directors tend to have extensive business, policy, or other administrative backgrounds, and generally don’t leave their day job when joining a new board. The size of the board may vary, but a typical privately-held business is likely to have 5 to 8 directors. Directors are chosen by a vote of the holders of the company’s stock (or stock-equivalent) or, for non-stock entities (like LLC’s and partnerships), by a process set out in the company’s operating agreement.
experience & expertise
A board gives management a handful of individuals to tap for advice and guidance. A good board has a diversity of experience, expertise, and perspectives. The needs of your company, in the present as well as the future, will play a role in helping you determine the right mix for your board.
Not every board member needs to be an expert in your industry or business. The directors with technical expertise have a role to play, both in pressing management and assuring that the other directors understand. A well-rounded board, capable of engaging in and understanding the business’s financials, operations, and strategy is an indispensable asset for an entrepreneur as their business grows and faces a new set of challenges.
accountability
A good board holds management accountable by monitoring and evaluating the business affairs. To be sure, management is tasked with running the day-to-day business operations, but the board plays an important role in setting the company’s strategic course, establishing benchmarks to measure progress, and ensuring that management is answerable to missteps and missed expectations. A budget that must be approved by the board is just one mechanism by which a board exercises this authority, as well as the power to set executive compensation and remove the chief executive.
risk management
A key function of the board is risk management. One area where the board can actively mitigate risks is in ensuring the company’s compliance with legal and regulatory obligations. As a company grows, so does the list of such obligations on the company. Meanwhile, an entrepreneur is typically not attuned to these looming concerns. A board comprised of experienced individuals who have “been here before,” is an invaluable tool for ensuring regulatory blind spots are attended to while freeing management to perform their day-to-day functions.
A board can also play an important role in settling management and/or ownership disputes without resorting to litigation. Independent directors – generally, those that have no relationship with the company besides their seat on the board – are viewed as particularly well-suited to play peacemaker, given their disinterested position.
Owners of small businesses may run a particularly high risk of being held personally liable for the company’s debts. Owners of a corporation, LLC, or LP typically seek the limited liability protection these entities provide, and there is a strong presumption in favor of ensuring that a judgment against the company does not touch the personal assets of its owners (beyond their investment in the company itself). However, this presumption is not absolute. There are certain circumstances where a court will allow a company’s creditors to “pierce the veil,” and collect outstanding debts from the personal assets of its owners.
Different states have different standards for determining when piercing the veil is appropriate. Generally, the key consideration in the court’s analysis is whether the company acts like a company which is deserving of limited liability protection. A company which ostensibly acts as the mere extension of one or several individuals – such as commingling assets, paying personal expenses with the businesses funds, or failing to keep adequate records of business decisions – runs the risk that a court will deem the company’s status as a limited liability entity a sham and allow creditors to ignore it. In making this determination, the court will ask whether the company follows corporate formalities. A board can help mitigate this risk by holding annual meetings, maintaining proper minutes, and ensuring the company’s officers act in accordance with the bylaws or operating agreement.
credibility
A company with a board comprised of respected, experienced, and engaged directors demonstrates that it takes the business of being a business seriously. Your business will not only benefit from the personal networks of each director, but the formality alone can provide valuable reassurance to potential investors, lenders, and strategic partners (provided that it’s performed adequately). Every business that chooses to work with yours is taking a risk, and a board with a reputation for ensuring internal accountability will make it easier for them to pick your business to engage with.
This may mean, for example, maintaining clean and understandable financial statements, and having ready answers for why certain things are recorded as they are, should the company need to raise capital.
should i have a board; do i need a board?
- Are you required by law to have a board?
- If your company is organized as a corporation, it’s likely that you’re required by law to have a board and maintain adequate board records.
- Do you have investors, or plan to seek outside capital eventually?
- Large investors will often demand a seat on the company’s board in order to protect their investment.
Short-Term Considerations
- How experienced is management?
- Is the company’s management made up of seasoned professionals, or could they benefit from experienced oversight?
- Why do/don’t you want a board?
- Would your business benefit more from a board member or employee with that particular skill set/experience?
Long-Term Considerations
- Where is the business going?
- Is your company looking to expand into new and unfamiliar businesses?
- Where is the industry going?
- Is industry consolidation forcing you to look toward acquisitions?
- What is your exit plan?
- Whether you plan to take the company public, sell it or keep it within the family, a board can play a crucial role in readying the business for your eventual exit.
Personal Considerations:
- How much authority/money are you willing to part with (now)?
- A good board is unlikely to be free and requires real authority. (see note on advisory boards.)
- Who else is involved in making this decision?
- Does your company have other owners who must provide their consent?
Recruiting tips
Look For:
- Character & ethics – At the end of the day, do you trust them?
- Board experience – Do they have board experience? If not, what experience do they have which would make them a good fit for your board?
- Availability & Willingness– Will they be able to commit the time necessary?
- Interest level – Are they interested in helping your company reach its goals?
- Value – What unique value would this person bring to the boardroom?
- Conflicts of interest – Does this individual have business or personal relations that are, or may prove to be, at odds with your business?
- Compensation – Does this individual have expectations for compensation? If so, are they agreeable?
What to Say
When pitching a prospective director, be direct and upfront with your expectations for the board and its members. This may include providing answers to:
- What are your plans for the company?
- What authority will the board have?
- Why do you want this particular person on your board?
- How much of a time commitment do you expect from your board?
- How will the board be compensated?
- What role do you see this person playing?
seek diversity of representation
When recruiting possible directors, one should not confine their search to only those individuals with direct industry experience. It is undoubtedly the case that this experience would prove useful to your growing business and may certainly be worth reserving room for on your board, but good directors and boards must bring more than technical expertise. However, a good board is also capable of supplying expertise in areas where management is either lacking or unable to give it the full weight of attention. For instance, if you operate in an industry that is rapidly moving from retail to e-commerce, it may behoove you to add a board member with IT and cybersecurity experience.
Social Diversity (gender, race, nationality, age, sexuality, religion, etc.) and Idea Diversity are also important for one’s company culture and success. Boards benefit from diverse perspectives which provide valuable insights and views. Those that lack diversity miss out on the ability of a diverse board to problem solve through multiple angles and collective experience.
a note on advisors & Advisory boards
An entrepreneur that is uncomfortable with the idea of ceding authority to a formal board of directors, or simply does not have either the resources or impetus to build one, but still wants to tap the experience of others can opt instead for an advisory board. An advisory board can be formal or informal, lend credibility to the company, and be a valuable source of insights as the company grows.
However, while its members may play a role in pushing management, an advisory board should not be viewed as a substitute for a board of directors. A board of directors operates as an institution within the company, and it is the formality of this relationship, combined with the specific authorities conferred upon the board, which provides real value to the company.
To search for local business advisors, see here.
Jacob Jeifa, at the time of this post, is a second-year law student at Penn State Dickinson Law. He is a graduate of the University of Delaware and is interested in corporate law. Prior to law school, Jacob ran a property management company and was a research assistant with the Weinberg Center for Corporate Governance.
Sources
https://insights.som.yale.edu/insights/even-small-businesses-need-corporate-governance
https://www.cfainstitute.org/en/advocacy/issues/small-company-governance
https://www.sba.gov/business-guide/manage-your-business/stay-legally-compliant
https://www.sba.gov/business-guide/plan-your-business/fund-your-business#section-header-5
https://www.uschamber.com/co/start/strategy/how-to-create-a-board-of-directors
https://www.score.org/blog/directors-and-officers-understanding-roles-corporate-management
https://smallbiztrends.com/2016/09/board-of-directors-for-a-small-business.html
https://www.uschamber.com/co/start/strategy/board-of-directors-nacd-steven-walker
https://www.sba.gov/local-assistance
