There are many reasons why board governance is essential for private business owners, ranging from selling the business to protecting what has been built.
Entrepreneurs are typically determined and assured. Therefore often the idea for them to need to work with a board of equally strong-willed directors can be overwhelming. However, whether it is elevating a business or taking advice from an experienced business owner, a board of directors can be invaluable to a business and does not have to be an arduous experience.
Here at BoardPro, we have compiled a guide to board governance to help you understand and build a practical and essential part of your business in the simplest, most straightforward manner.
What is board governance?
Board or corporate governance is the framework that organises the board and how it operates.
It ensures that management runs the business smoothly and successfully. It balances the interests of the company’s stakeholders and ensures that the organisation functions in a way that makes everyone happy.
Corporate governance provides the framework for enforcing the company’s core values; therefore, it encompasses every sphere of management.
There are three different elements contributing to board governance:
- Approving strategic planning
- Identifying legal, financial, marketing and operational risks to the organisation
- Holding the CEO accountable for the execution of the strategic plan
Poor corporate governance may cause the company’s mission, vision and core values to misalign, casting doubt on the operations and hurting the business’s bottom line. Ultimately, it is in place to show investors that the company will carefully follow the plan and ensure the business and board’s integrity.
Boards that provide corporate governance oversights are called governance boards, which are much more accountable than advisory boards that only provide advice. In addition, compared with operating boards, governance boards are more objective because operating boards mix strategic oversight with the actual running of the business.
To be listed publicly, a company needs a governance board. Conversely, private companies and non-profit organisations have a mix of different board types according to what they need.
Why does it matter to private businesses?
For private businesses, corporate governance ensures objectivity and accountability. It allows stakeholders to envision the company’s direction and gives them an idea of the organisation’s integrity.
- Objectivity: This is achieved by adding directors to the board who may not be tied to the interests of the organisation. Directors should also be clear about not meddling in operational management. This ensures that the organisation’s risk assessment, strategy and performance can stay objective and not lean towards any specific party’s interest.
- Accountability: This is achieved by the board making and approving plans and then measuring results. This helps to ensure that the management executes the final decision. As mentioned before, directors should not meddle in the everyday operations of the management. That should be left to the management team, which should be held accountable for their decisions and actions.
- Integrity: The board’s objectivity ensures integrity – the state of being whole, undivided and having honest, strong moral principles. This involves the board making sure that all the different stakeholders’ interests are followed and balanced.
Corporate governance is particularly beneficial because when a business develops and matures, its operations get more complicated, and succession planning becomes an increasingly important priority. On top of that, having strong corporate governance provides all stakeholders with confidence, clarity and performance. In this way, it ensures more success for the business and the owners and stakeholders.
Does board size matter?
The truth is that a small-scale firm consisting of the owner and another staff member is likely not to need a board of directors. If the owner of a business of any size, big or small, takes the time to assess opportunities and risks, plan strategy and succession, as well as hold themselves accountable, it is safe to say that they are still executing good corporate governance, perhaps just on a smaller scale.
However, the larger the company becomes, the more decisions must be made. There could therefore come the point where the owner simply needs the help of a board to gain objectivity and guidance.
Ultimately, it is more important to look at business goals than the size of a company when deciding whether or not a board of directors is needed.
It may also be the case that some smaller-scaled technological start-ups have a board of directors. Again, this is the best way to demonstrate to investors that the company has an objective element to its overall operations and guidance, while ensuring that the owners are accountable for achieving the results they have committed to as well.
Trends in the field
Often, organisations start adopting corporate governance practises when they seek external funding or prepare for an exit. This is because owners have identified that investors and funders appreciate it when they can display their company to have the values of objectivity, accountability and integrity. Strong governance provides just that. Therefore, it is no surprise that private businesses with solid governance are worth more in the market.
According to a 2014 study by McKinsey & Company, over 75% of investors are ready to pay a premium of 18% to 30% for a well-governed business. Having proper corporate governance is attractive not only to funders but also to the owners.
Trends show that when older business owners start to retire, more corporate governance takes place because the goals are to attract buyers and maximise the valuation of the company; therefore, selling owners do their best to ensure that their company looks profitable to the market.
What are the key governance roles?
There are two leading roles which make a private business board of directors highly effective:
- Independent directors: This is when the directors have no personal or financial ties to the business. It enables them to think and act independently compared with those who are active in the company. They provide the strongest form of objectivity, as they have no personal interest in the business. The stakeholders highly value this objectivity, providing a base for solid governance.
- Experienced board chair: This individual understands just how vital governance is and can objectively lead meetings. They will need to ensure not to impose opinions but instead facilitate discussion to elevate the business through effective strategy and teamwork.
With these two roles, boards will likely stay focused on the issues identified. However, it is important to note that to be effective the board chair must also have a trusting, respectful relationship with the business owner.
What are the best practices?
The first and most important advice would be to have clarity about the role of the Board. Defining the board’s role will impact its composition and how it operates. “The key role of any board is “to make the choices that create the future for the communities they serve,” says Steven Bowman, the founder of Conscious Governance.
Secondly, defining how the board works with the CEO is another major decision. Separating the board and the CEO’s functions is a best practice, as the CEO reports to the board and it is the responsibility of the board to monitor the CEO’s performance.
Before getting started, owners must ask themselves: Why is a governance board needed? For that reason, defining the Board’s role is essential. For example, if the owner is only seeking primary advice, then an advisory board might be more appropriate. On the other hand, if the owner is comfortable enough to let the board make decisions based on what they think is in their best interests, then a governing board can be considered.
Next is defining who is the board chair.
Once a suitable chair is identified, with their help, the next step would be to select directors for the board. The skills brought in from the board of directors should reflect their ability to manage risks and seize opportunities facing the company.
The board’s skills matrix is a simple yet effective tool for identifying expertise gaps on a board. It works by listing the essential aspects that the board needs on the top and then listing the directors on the side. The next step would be identifying what skill a single director brings to the table. In completing the matrix, what becomes apparent is what each director brings to the table, what skill might be missing from the board and what talent gaps need to be filled.
Finally, the governance process needs to be defined. Top priorities are to decide how often the board should meet, what the board meeting agenda is for the next few months and how the board will make decisions.
How big is a board?
According to a study by The Wall Street Journal, a board should be large enough to carry out the board’s fiduciary and other duties effectively and efficiently. Therefore, it seems ideal for many companies that a board should comprise five to seven board members.
Boards that are too small (fewer than three people available for a board meeting) run the risk of having insufficient expertise to govern effectively. Boards that are too large risk losing focus and becoming difficult to lead effectively. However, it is important to note that there is no correlation between business size and board size or board size and board effectiveness.
Generally, directors can be found within the company’s network of stakeholders and allies. This is the most direct and inexpensive way to attract a well-known talent profile. Another way of finding talent is through recruiting firms that specialise in board searches. There are also established online platforms dedicated to supporting boards and directors to network and connect.
It is important to acquire directors from inside and outside their networks to create a balanced, unbiased team. By looking outside these networks, boards can find directors with a larger sample of talent who are objective, accountable and have integrity. Note that even if a director has no previous corporate governance experience, it should not should limit their potential for selection.
“Focusing on acquiring talent is more important than fixating on a potential director who has not had governance experience.”
Like all employees, directors should be fairly compensated for their time and effort. Boards should compensate their directors because, in this way, they can set a higher standard for skill and knowledge. In addition, in the efforts to achieve the most objective views in the boardroom, the relationship between the business and the board members becomes more business-like by compensating directors.
Fairly compensating directors means “cause driven-directors” and “voluntary-entitled directors” are avoided. This avoids having directors who are not objective and are only being compensated parallel to the work they contribute into the company.
However, overcompensating directors should be avoided as well. By doing so, directors can be afraid of making decisions that may jeopardise their board income, and as a result they, too, are not objective.
Can the owner be the chair?
Having the owner act as the chair of the board is not recommended. Often, owners put a considerable amount of effort into leading their staff, and they are responsible for driving results. It is perfectly normal for owners to feel strongly about the efforts they have put into their business. However, this means that they are not objective.
Also, board chairs who are intimately involved in their business may influence the objectivity of the other members of the board. For example, if there are other related directors on the board, such as an employee or a family member, this may influence the owner-chair and might put them in an uncomfortable position to act or think independently.
Finally, a great owner does not guarantee a great chair. The owner may lack the experience to lead a board. Therefore, it is good governance practise to avoid complications by ensuring that the owner is not the chair of the Board.
What to avoid:
Several mistakes can be avoided if you are clear on what to watch out for. As a guide, the team here at BoardPro have compiled a list of some of the biggest pitfalls we continue to see within companies today.
- Conflicts of interest: The key aim of acquiring board members is to maintain objectivity. One of the greatest errors in corporate governance is hiring directors who may have financial interests that directly conflict with the objectives of the company. This requires careful consideration during the hiring process.
- Making the owner the board chair: Owners often have too much emotional attachment to their business to maintain objectivity while chairing and leading the other directors on the board.
- Making the CEO the board chair: The CEO should be left to run the operational part of the business and should not be given the duty of governance. It is impossible to hold the CEO accountable if they are given both duties to balance.
- Focusing too much on financial risk and not enough on external or internal risk: It has often been seen that companies have suffered due to failing to identify operational risks, as legal and financial problems follow afterwards. The truth is that market risk as well as operational risk should also be considered to avoid these problems.
- Focusing too much on risk and not looking at the potential: Although it is crucial to identify risk to keep assets safe, it is just as important to look at current opportunities.
- Focusing too much on operational risk: The board should not focus on operations; that is the job of management. Suppose the board is composed of people who are too familiar with the operations. This may lead to focusing too much on this aspect of the business while neglecting other risks, strategies and opportunities.
- Forgetting the core values and mission: A company’s mission should never be forgotten. It determines how the company acts and how it interacts with its customers.
It is argued that an owner’s most significant struggle is their fear of losing control of their business. With the board members coming into the business to make strategic decisions and assess risks, owners may feel that no one could understand the business as they do. Coupled with the feeling of losing control, the idea of reporting to a board simply does not make sense to some owners. Entrepreneurs do not report to anyone but themselves – that is often why they became entrepreneurs in the first place.
Owners may also be dismissive of strategy, thinking it is not important for them to achieve success, so why change? However, they might not be able to realise is that although their strategy might have been intuitive, there was always one in place.
With these doubts and areas of resistance, owners often prevent their private businesses from achieving their full potential.
The reasons for this might be:
- The owner is happy where they are: Having a board and scaling up was never really of importance to them in the first place.
- The strategy in place is at its limit: The strategy that had worked for many years prior needs to be changed to see potential future growth
- Leadership has reached the limit: Skills and expertise must be brought in to help the business progress to another phase and encourage additional growth.
How to overcome these issues
Many owners who implement a governance board have a successful business and fulfilling lifestyle already. Governancee boards are generally implemented because the owners would like to maximise the value of their business. Another reason would be to maximise the scale of their business.
Owners must understand that in order to achieve their goal they must do what they have always done – overcome nuances – even if this means reporting to a board.
In understanding this, they generally become more open to corporate governance. If an owner wants to maximise the value of their company, they do not have much choice but to adopt a governance-focused approach to their business. Buyers and potential investors prefer to see this type of structure as it assures objectivity and accountability.
There are several ways to exit a private business, including declaring bankruptcy, selling, transferring to a relative or going public. It is an accepted fact that the latter three are preferable as they highlight the value of the business.
Well-governed companies are worth more because future owners see the formal efforts made to bring accountability and objectivity to the business. This appreciation can be illustrated in the following ways:
- Identifying risks: Many businesses are overly focused on identifying financial risks and forget to look at environmental risk in the market and internal risk in operations. Having an objective board means that these risks should be reviewed in a fair, and balanced manner.
- Developing strategy: Companies need to clarify their core values, mission, vision and how their business appeals to customers. Annual operating plans are not synonymous with longterm strategic priorities, where as the latter creates value.
- Operational execution: Although it is important for the board not to delve too deeply into the operations of the business, it is essential to respect the company’s best interests by performing tasks such as giving feedback to the CEO.
Focusing on these areas will ensure that the business performs as guaranteed, giving future owners and stakeholders peace of mind.
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