Why Privately Held and Family-Owned Businesses Should Have Independent Boards of Directors

by FEI Daily Staff

In 1990, John Bachus and three executives of World Airways Inc. left their company and founded US Order, a start-up with the concept that a phone could be used to do such things as check stock quotes, bank and purchase groceries. Bachus helped the firm grow to $50 million.

It might have been a home run, however, in those days US Order wrongly thought people would use phones rather than computers. It was the right idea with the wrong platform for that time. Bachus, now managing partner of New Atlantic Ventures, said in a recent Washington Post interview that he learned an important lesson: “If you are a hard-charging young company with blinders on, you need to have outside advisers to see the big picture.”

Privately held or family-owned businesses are not bound by the same rules as public companies and are therefore not required to have an independent board of directors. Nonetheless, independent directors with a successful business background can play an invaluable role by offering an outsider’s perspective on a company’s operations. The board can act as industry experts when needed, financial experts when internal or external auditing concerns arise and contacts to gain new customers or funding sources. Importantly, businesses transitioning through various stages of development can alleviate growing pains by relying on individuals who have “been there and done that.”

Independent directors can help in transitioning an entrepreneur and owner from being a doer to a manager and, ultimately, a leader. A main benefit is having an independent voice to balance the sometimes myopic decision-making that can often plague privately held and family-owned businesses, especially as they deal with emotional overlays of personal relationships.

Running a privately held or family-owned business has been described many times as a lonely job. There is rarely time for reflection and long-range thinking in the daily events of the chief executive officer. These tasks or challenges have not been eliminated; they just may consume much of the CEO’s time and do not get the required attention.

As the business grows, the need for information, dialogue, knowledge-sharing, planning and delegation increases. An independent board can offer much-needed guidance and assistance in developing the company’s short- and long-term strategies.

Though not beneficial for every privately held or family-owned business, there are various reasons why an independent board would be effective. If there is substantial debt, lenders may view a board as a positive factor. If there are significant outside investors, representation by those investors may be required. And, disparities among family members may be resolved more easily with independent evaluation of issues.

Overriding all of these is the fact that the top managers — who may also be the business owners — have effectively become accountable to others.

There are clear examples of very profitable privately held or family-owned businesses — with no debt to lenders or outside investors — that have independent boards of directors. Those chief executives apparently want objective input as to the strategic direction of the companies, as well as other corporate matters. There are examples of failed companies — with brilliant CEOs who surround themselves with employees who are afraid to criticize or make them feel infallible — which could have benefited from an independent board.

Clearly, there are examples of private companies that are quite successful without an independent board. This is a function of the individual CEO and the complexity of the business.

Composition of the Independent Board

The composition of an independent board is crucial. The configuration of an effective board is a function of the chief executive officer’s vision and should include individuals who are familiar with the industry from both marketing and technical aspects to provide perspectives on technology, strategic and marketing change. It is also useful to have legal and financial representation to understand what actions may require regulatory considerations and the financial impact of decisions. Other individuals who would be beneficial are those to provide customer contacts, marketing expertise and business strategy. Overall, an independent board can provide: - Substantial value through relationships; - An outside perspective on the company; - Good governance practices; and - Accountability of management.

These are a few of the benefits of implementing appropriate governance structures, such as a board of directors. If implemented correctly, the result will be a more effectively operated and profitable company, with management’s efforts being more focused on matters that drive the company to the next level. Carl Kampel ([email protected]) is director in charge of professional standards at Ellin & Tucker Chartered.