In order to prepare a business for
advanced stages of growth, the owners
of many privately held organizations can benefit from opening up their boards and
their operations to outsiders.
“Once a company reaches an advanced
stage of growth with a number of different
stakeholders, it should consider adding a
layer of independent oversight,” says Mitch
Bryan, partner in the litigation practice
group at Levenfeld Pearlstein, LLC.
Smart Business spoke with Bryan about
the significance of including independent
oversight in the management of privately
held second-generation companies.
Why should growing companies include
independent directors on their boards?
The advantages include access to business
experience, insight and contacts that can
enhance a business’s ability to grow and
help them reach the point of going public or
simply transforming into a larger entity.
Also, unless the top managers in private
companies are very well-disciplined and
have a broad skill set, they may not have all
areas of the company running optimally.
Outside directors hold top management
accountable for its actions and force management to focus on the areas where the
business isn’t strong or may be at risk of
changing market conditions. This often
includes elevating the level of internal controls over financial systems.
Establishing independent board seats
will also enhance decision-making and succession planning. Independent board
members provide a check and balance
when managers promote outside contracts
that serve their self-interest but not the
best interest of the company. If company
management includes family members,
independent directors can help avoid
intrafamily arguments and enhance development of a strong, favorable and objective exit strategy based on what’s best for
all stakeholders.
What are the challenges of working with outside directors?
The economic and organizational benefits of adding independent members to a
board of directors ordinarily outweigh the
costs. Companies will need to invest in a
more formal structure and consistency to
board meetings, which will put additional
responsibility on the accounting and
finance departments to ensure correct and
current operating reports and other key
documents. Top managers will also need to
relinquish some of their autonomy. But
over time this increased professionalism in
management will only improve the credibility of the organization and the strength
of the working relationship between managers, minority stakeholders and third parties, such as lenders and regulators.
How can companies find the right board
members?
To achieve the goal of objectivity, executives should look for potential outside
directors through purely business contacts, such as lenders, bankers and
accountants. These people understand the
business and can connect owners with
other successful, responsible individuals in
their industry or a similar industry. These
truly independent candidates will examine
a company carefully before accepting an
invitation to the board. They will want to know that they can offer something and
gain something of value through the time
they invest.
Why should companies form an audit committee?
Forming an official audit committee within a corporate board establishes a norm
and a center of responsibility for getting
financial data collected and analyzed consistently throughout the year. This verifies
the reliability of operations, allows businesses to take advantage of opportunities
and establishes proper internal controls.
This official process will also highlight
areas where businesses should establish
risk management procedures.
This committee should consist of some
combination of the CFO, controller, a financial expert and independent directors.
These individuals can create a specific
structure that encourages continuity, efficiency and integrity in financial reporting.
Why is a compensation committee beneficial
for businesses?
The immediate goal of most executives is
to extract as much profit as possible from
their companies, which might not serve the
best long-term interest of the business. A
compensation committee, including a
financial expert, compensation consultant
and independent directors, can help objectively evaluate the appropriate compensation for executives and keep the welfare of
the business in mind. Independent decision-makers can offer a practical perspective on the performance of the company
and the marketplace value of the executives’ performance.
One or more independent directors on a
compensation committee create a healthy
tension that balances companies’ treatment
of dynamic individuals who occupy positions of respect within the core management group and will help motivate them to
better serve the company as a whole.
MITCH BRYAN is a partner in the litigation practice group at
Levenfeld Pearlstein, LLC. Reach him at (312) 476-7553 or
[email protected].