Navigating Governance Options in a Private Company
July 19 2013 by Chas Klivans
What do Julius Caesar, Steve Jobs (during his first try as Apple CEO), and Paula Deen have in common? Each leader saw nothing negative in themselves or in their organizations, yet each had their empire crumble due to crises they helped build.
This overconfident pride and self certainty, or hubris, is present in all of us. When it affects private company executives, the complacency it causes can kill a business. This is why the existence of private company directors gives a firm a critical edge in its competition for market share. The best boards remove complacency and blind spots of the leadership team, and replace them with a clear determination to stay ahead of competitors no matter what changes are necessary.
Benefits of Private Company Directors
A private company board, through discipline and accountability, helps the management team grow to the next level. It is responsible to all the stakeholders including owners, other investors, employees, customers, and suppliers.
Board meetings are designed to make the CEO perform better in his job by giving him support, oversight, and accountability, which elevates results and builds the CEO’s confidence.
In addition, the company can hold board meetings at company facilities in locations away from the corporate offices. This allows board members to meet key local people, see how operations work at ground level, and get direct input from managers at satellite locations while avoiding the bureaucratic haze that often envelops headquarters. With this input, directors can add value to the company by understanding the business at a granular level and leveraging their independent operating expertise.
Private Board Composition
Outside directors are widely used in private companies to guide and support the management team. When determining the size and composition of a board of directors, the CEO needs to be clear on why he or she needs such a board, identify appropriate members, and determine how the board will function.
More effective private company boards have a higher number of outside directors who shepherd the firm with their “heads in and their hands off” operations. Outside directors have propelled some of the world’s largest family firms, such as the Swedish Wallenberg family, to expand their business empire through multiple generations and several world wars. Wallenberg’s conglomerate usually has one family member on the board, yet interestingly retains majority voting power on large dollar decisions.
Golden State Foods is another good example of this governance gold standard. The company, which services 25,000 restaurants with 4,000 employees, has nine board members including four outside directors and five family members (who are/were senior executives with the firm).
Try to avoid placing service providers, such as the company’s accountant, lawyer, or banker on the board for two reasons. First, this violates the governance practice that outside directors be independent. Second, these service providers usually do not have an operating background with big company management experience, and middle market or small business turnaround expertise. When the company needs legal or M&A advice, rather than putting these service providers on the board, a good idea is to purchase this expertise by the hour.
Lastly try to recruit directors who will serve your business as connectors with exceptional people in the world, who can improve the company. Great board members have wide-ranging relationships that can open doors, sometimes worldwide, that the management team would not ordinarily be able to do.
Align Contradictory ROI Needs
In privately held companies, the owner may be elderly and need cash to fund retirement now, the CEO may have a growing family and needs cash in the next two years, or a very young family member in the company may want to buy an expensive car. A private equity director may want to let his money grow in the business for three more years.
These different time horizons naturally create conflicts of interest among various directors, whose different timeframes result in different agendas on deploying company assets. Actions that are best for the common good can get overridden by what is best for a director or cluster of board members.
Trouble arises when this elephant in the room is not resolved. Full disclosure begins with each board member putting their return on investment (“ROI”) and time horizon needs on the table for the group to address. Good boards force agreement on a single timeframe with one set of financial metrics the CEO can implement. This is so important to building trust among directors that lack of full disclosure is grounds for dismissal from the board. Blending these different time horizons for the common good sets the right tone at the top.
Review Director Performance
Regularly reviewing director performance identifies ways board members can perform better. All companies can formally do this, and the four kinds are director self evaluation, review one another, CEO evaluates all members, and directors review the CEO. There is no board of director police but the more evaluations the better.
Director Stock Ownership
Some private businesses demand that all senior executives and board members purchase company stock. This really enlists the heart and soul of company executives and board members, plus encourages decision-makers to act as owners.
The company will need to align the directors’ stock interest, the management team’s stock, and stock held by other employees. The more ownership interest held by a higher percentage of company decision-makers and employees the better. For example, Golden State Foods with 4,000 employees has 100 employee stock holders who act like owners.
Going From Smaller to Larger
For resolution of long term needs, a formal board of directors is an excellent choice.
However, if the private company faces a short-term emergency that requires an immediate solution, conducting a deep dive is a good alternative. This is usually done by a former Corporate Co-Founder/President on the board, or for a business without a board the Co-Founder/President can be recruited from outside the company.
This Co-Founder/President will need to have successfully completed similar engagements in large public companies and private businesses your size, which gives him or her the sensitivity and sensibility to fix the business half and people half of each company challenge.
The deep dive is a carefully orchestrated exploration of the internal company functions department by department – but is also a thorough exploration of how your company relates to and is viewed by customers, suppliers, industry thought leaders, and trade association heads. When done carefully, it will show the company in detail the exact steps needed to create higher sales and profits.
On assignment, the President visits divisions and plant locations away from headquarters to interview key personnel, managers, and executives. Then he interviews customers (the “good” repeat ones, the “bad” lost customers, and the “ugly” never got prospects), suppliers, trade association directors, and other sources. If the company uses a lot of technology, he interviews several university professor thought leaders who know ahead of the rest of us and ahead of the media if new industry technology will make the company’s product/service obsolete or if imported into the company will propel the firm to jump ahead of competitors.
The deep dive will illuminate how to create products and processes that jump the curve, doing things 10 times better not just 10% better. Most companies stay on their curve with minor improvements. True innovators jump to the next curve of innovation to delight customers, while being the only game in town.
With the information gathered from the deep dive, the President creates a Weekly Scorecard the CEO can use to profitably expand the whole company. This Scorecard benchmarks each line item on the company’s Income Statement and Balance Sheet to industry firms which only achieve top 25% percent ranking for fastest growing sales and profits, but does not use industry trend data or public company financial statements, which are known to have inherent weaknesses.
The project unearths hidden industry trends ranging two to four years into the future, which your industry rivals never see, because it reveals what trend setters like the largest universities, the biggest companies, and the most cutting edge start-ups are already planning as the next big market moving products.
To prepare a company for the dive, the CEO must shape the employees’ perception of the assignment to focus on making improvements that will elevate financial results and make everyone more successful. He reveals that the assessment will review the business as an interlocking system, and states that he will protect every employee from payback or punishment for giving unvarnished input to the President during this company-wide review.
The President weights internal leader input 25% and external expert input 75%. He then synthesizes all the input into a practical expansion plan, which the company CEO presents to his board. External expert input is derived from six independent perspectives (e.g. customers, suppliers, distributors, university professors, trade association directors, and larger similar company C-level leaders). The reason the internal management team recommendations are weighted only 25% is because these are the same people that created the problems. If they had adequate solutions they would have fixed the problems. Almost always the internal team is very loyal and well intentioned, just tapped out of new solutions.
Hubris is commonplace and far more destructive than people realize because it creates unintentional complacency in many companies. The antidote to hubris consists of two choices.
First, recruit a formal corporate board made up of outside directors who have track records as operating managers in large companies and have turned turnaround middle market and small businesses.
- Ask yourself honestly, “What is the purpose of this business?” If the purpose of the business is to expand to a much higher level of wealth to serve the interests of the owner, employees, and outside investors – then an effective private company board is like an insurance policy that keeps the risk of failure low.
- To determine the best director candidates, a private company can start with the end in mind. Half of the board ideally are outside directors.
- To set the right tone at the top, the directors need to openly blend their naturally different time horizons for return on investment, reaching agreement on executing one timeframe with one set of metrics for the CEO to implement.
Second, and equally good, particularly if the urgency of the problem is high, find a good fireman, who is a former Corporate Co-Founder/President, to put the fire out. This operating veteran, who may or may not sit on the company’s board, conducts the deep dive with the blessing and support of the company CEO.
A private company board, through discipline and accountability, helps the CEO turbo-charge sales, gross margin, and after-tax profits – while increasing his confidence.
Drawing on 28 years of management experience as a co-founder and CEO, Chas Klivans launched The CEO’s Navigator in 2001 and created the business solution of Innovation2 (www.InnovationTwo.Us), which increases financial results and at the same time builds management into an A team.