Why Have an Independent Board of Directors in a Privately Held Corporation?


Formal Corporate Meeting RoomEvery corporation – public or private – legally has to have at least one director. Most state laws on incorporation require three or more directors. Therefore, there is technically a board of directors in almost every corporation, no matter how small the company. The board is elected by the shareholders, and board members elect the officers of the company, approve by-laws, and otherwise govern the corporation.

But in privately held companies, the role of the board of directors, beyond these minimal legal requirements, depends on what the shareholders want. In a family-owned business, the family shareholders may want only family members to serve as directors. In these cases, the board will not be independent of management and may not bring any outside expertise. That is how most small corporations start.

Other closely held businesses – whether owned by a single family, by a small group of unrelated partners, or by a few outside investors – may want independent directors who can offer financial, technical, and/or strategic advice to the operational officers of the company. In these businesses, the owners and managers in the firm have experts to go to on a regular basis, people with some knowledge of the firm’s operations.

Even if the business is not a corporation, but is a partnership or LLP or LLC, it might be a good idea to have an advisory board that serves the same purpose as the board of directors for a corporation.

If you are the owner of a small, privately held business, why should you consider forming an independent board of directors? Because it is unlikely that you and the other managers running your company have the breadth and depth of experience that today’s business environment requires.

Here are a few examples:

  • First, most businesses operate in a heavily regulated environment. Whether it is food safety rules, or environmental impact, or financial disclosures, or labor relations and employment law, or licensing requirements, the law impacts every business. Perhaps the business could benefit from an attorney on the board.
  • The financial and securities industries have come under increasing scrutiny since the recession in 2008. Even if your business isn’t in these industries, you are likely to need financing as you grow, or perhaps you are considering a public offering or other means of raising capital. You might need someone with strong financial acumen or who is familiar with borrowing opportunities in your region or industry.
  • Every successful business suffers growing pains over time. Perhaps your employee base is increasing faster than your existing managers can handle. Perhaps you have ideas on how to expand, but don’t know how to handle the logistics of your growth – IT systems, people systems, sales channels, etc. Maybe you need someone with experience doing what your business is about to do.
  • Or maybe you know you need to grow, but aren’t sure what the best opportunities are. Perhaps it would be helpful to have someone to walk you through a strategic planning exercise, and then figure out how to bring the best growth options to life.
  • And lastly, perhaps the owners or key managers in your business are ready to retire, and there is no good succession plan in place. Again, outside directors could help your company through a selection process and the transition to new management.

In the examples outlined above, it would be possible for a business to hire consultants or contractors for a well-defined assignment. Or perhaps there is an employee with the skills to help the ownership of the business through the issue.

But there is an advantage to having people with an ongoing knowledge of the business available on a regular basis to provide input to management. The challenge is to use these advisors well. Even in large public companies, this is difficult, as a new McKinsey study points out. Directors need to have the time and the skills to provide the right assistance to the corporations which they serve.

The novel I am writing deals with a family-owned business in the throes of change. Its directors have been family members, but the business  is at the point in its growth cycle where it probably needs outside assistance. Its current leadership will have to grapple with this among many other issues.

For more information on the role of directors in privately held businesses, see articles such as:

The Responsibilities of a Board of Directors for Privately Held & Publicly Held Companies, by Derek Dowell, Demand Media

What Are the Responsibilities of a Board of Directors Within an Organization?, by Bonnie Conrad, Demand Media

Should a Private Company Have a Board of Directors?, by Theodore F. di Stefano, E-Commerce Times, February 8, 2008

Why Your Privately Owned Company Needs a Board of Directors , by Janet B. Fierman, Sheehan, Phinney, Bass & Green PA, Thursday, October 28, 2010

Why Privately Held and Family-Owned Businesses Should Have Independent Boards of Directors, by Carl Kampel, Financial Executive, November 2012

Outside Directors: Do You Need Them and Where to Find Them?, by Joe Hadzima, reprinted from Boston Business Journal

Startup Voice: Private Company Board of Directors FAQs, by Inna Efimchik, White Summers Caffee & James LLP

Are there other advantages to having an active, independent board of directors in a private company? What are the disadvantages?

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3 Comments

Filed under Law, Leadership, Management, Writing

3 responses to “Why Have an Independent Board of Directors in a Privately Held Corporation?

  1. Pingback: Happy Holidays! I’ll be back in 2016 | Sara Rickover, Behind the Corporate Veil

  2. Pingback: How Trends in Corporate Governance Vary for Smaller Firms | Sara Rickover, Behind the Corporate Veil

  3. Pingback: Blog on Hiatus | Sara Rickover, Behind the Corporate Veil

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