Many of the privately owned companies I represent seldom, if ever, have Board meetings. When I suggest that they have annual meetings, they ask "What for?" Generally those clients' owners have given little thought to selecting people to sit on their Board of Directors and making good use of those people. They appoint family, friends, themselves and/or their management to sit on their boards. Yet, a good process for identifying, selecting and preparing outsiders to sit on their Board, in and of itself, can be very helpful to these businesses. Once a useful Board is in place, the company, its owners and managers will understand "what for."
What Are Directors Supposed to Do?
Directors are selected by the company's owners to manage the business' affairs, subject to any limits imposed in the company's articles of organization, by-laws, operating agreement or shareholders' agreement (formation documents). The Directors' primary duty is to the corporation itself, although they owe a contractual duty to the owners to conform to the rules in these formation documents.
The formation documents should establish the company's processes for setting short and long term goals, making major decisions, hiring management, insuring accountability, handling change and addressing issues of owner liquidity, continuity and succession. It can be time consuming to work out these "process" issues when setting up the business and many business owners don't think about them until they hit a problem. After start up, if those issues have not been discussed, with assistance of their counsel the owners can and should take the time to consider these issues and amend their incorporation documents and/or shareholder agreement(s) to reflect their decisions.
Directors should provide overall business strategy, oversight, continuity, recommendations on major decisions and special skills that would benefit the business. They should ask management for and should review financial reports, operational reports, business plans, new product or service proposals and other documents that they and management agree are significant to the overall operation and life of the business. They should commit time and effort to the business and its venture(s). While management is enmeshed in getting and retaining customers, producing goods and services, managing employees and vendors, and keeping the business operations going, properly selected directors identify opportunities, keep an eye on performance, ensure compliance with legal requirements and help with the inevitable bumps in the road.
Why Bring In Outsiders?
Most corporations are owned and run by the same people (or person). In this situation, independent board members are invaluable. They look at the forest while the business owner/operator is surrounded by trees. Outsiders contribute, for example:
- perspective (dispassionate review of performance, economic conditions, potential opportunities)
- experience (running their own or a similar business, going through business cycles)
- suport (been there, done that, it's ok)
- sounding boards (for ideas, proposals, options)
- differing skill sets (lending, accounting, export/import, marketing, IT, human resources)
Business owner/operators who force themselves to explain and account for key business data and issues to independent third parties, force themselves to take the time to consider the past, present and future performance, needs and goals of their business.
Sometimes, business owners are reluctant to open decision making to outsiders who are not stakeholders in the business. However, there is no need to forego the benefits of independent strategic advice and assistance. Articles of organization, by-laws and operating agreements can impose a wide variety of limits on directors' authority. For example, owner/operators can require shareholder approval of directors' recommendations on key issues. Some owner/operators set up boards of independent advisors either to assist a board consisting of stakeholders or to meet termporary needs (revised website, entry into social networking as marketing, major refinancing, relocation, establishment or purchase or sale of a business). There are many solutions, which, with legal advice, can and should be tailored to meet the needs of each business.
Many companies are "family businesses" in which one or more family members run the business while a larger group of family members own the business, sometimes with differing degrees of ownership. Questions of management qualifications, business performance, transparency, accountability and transfer of ownership or control can acquire an emotional charge that interferes in business operations and prosperity. Here again, independent board members can add to the mutual confidence between owners and management while providing supplementary skills to the business.
Family shareholder and/or governance agreements often create a board of both family members and independent members in various combinations. Such agreements specify which matters simply require board awareness, which require board recommendation, and which, if any, require board approval. The independent board members can become buffers between family management and family owners and may play a role in family dispute resolution, as the independent members are knowledgeable both about the family business and about the family.
In any case, it is wise to have outside directors (or advisors of any kind) sign an agreement covering key issues such as duties, compensation, confidentiality, termination and, in some situations, non competition.
Directors Owe the Company a Duty of Loyalty
Directors, by law, have a "fiduciary relationship" with the corporation. They must act with loyalty to the corporation and in a manner calculated to serve the best interests of the corporation. In so doing, they may consider the interests of the company's employees, suppliers, creditors, customers, long and short-term economic conditions, community and societal concerns and the long and short-term interests of the corporation and its shareholders. Directors' decisions do not have to be correct, but they must be made without self-interest and in what the directors reasonably believe is the best interests of the business.
It is possible (and, in fact, usual) for the corporation to "indemnify" its directors — that is, to agree to defend the directors against any claims made against them based on their actions (or failures to act) as directors, so long as they were acting in good faith and without self-interest. The companies buy "directors and officers" liability insurance policies to cover their directors for any such claims (and take care of the indemnification promise). Most outside directors will not serve on boards without indemnification and most prefer that there be directors and officers liability insurance coverage in place while they serve.
A director has a "conflict of interest" in a matter when s(he) has a material interest in the matter — either personally or through a member of his/her family or through an entity in which s(he) has a financial or management interest. Where there are potential conflicts between the business' interests and those of an outside director (or any director) the director must disclose the material details of the matter to the business. The director should not participate in any discussion of or vote on the matter. If the matter involves a transaction, a majority of the disinterested directors must approve the transaction and the transaction must be fair to the business. When conflicts arise, it is wise to consult counsel to be sure that the resulting decision is valid.
Setting up a Board of Directors
Set up a process that suits your business. Here are some suggestions.
A. Decide what kind of board suits your business. How many people do you want? Will they serve staggered terms (for continuity)? How much decision-making authority should they have? How many independent members do you want? Amend your organizational documents, if appropriate.
B. Spend time defining what types of people and what mix of people would help your business. What would their professional skills, business and personal experience, personal skills, and history look like? Develop a brief, written job description for each position.
C. Cast a wide net. Have a brief narrative description of your business to circulate with the job descriptions. Don't just send the package to people who might qualify for the positions. Ask referral sources and contacts for referrals. Be clear about minimum qualifications and time commitment requirements. Set prequalification standards for suggestions that come in. You will be surprised at the number and caliber of the referrals and the people who would like to sit on your board.
D. Be thoughtful about your selection process. Who will do the initial screening/prequalification of the pool? Who will interview and in what sequence? Include all major stakeholders in some way. Have a list of questions to ask each candidate and be sure each interviewer has opportunity both to interact with each candidate and to observe each candidate interact with others.
E. Be sure your picks can work with the owners, management and each other. Board meetings generally should be fun. A joint meeting of proposed board members prior to final selection may be valuable to assess the group dynamics and to discuss orientation materials and activities.
F. Be sure your director candidates have, and are willing to commit, enough time to the job to be useful. Discuss confidentiality, non disclosure, non competition and liability issues before extending offers. Extend offers in writing (with advice of counsel) and get signed acceptances.
G. Don't be penny wise and pound foolish. Offer compensation. It does not have to be a lot of money but compensation shows that this is important. Get directors and officers insurance coverage.
H. Orient new members. Be sure the orientation includes an understanding of your goals and vision, your customers, employees, products and services, your financial situation, and operating and capital budgets. Ask new members what materials they would like to receive. If you don't have the information they think is important, don't be defensive — they can explain its importance and help you develop it. Depending on their skill set, they may want to meet the company's key personnel, accountant and/or attorney, and to see the company's facility and/or products.
Conclusion
Recently a client told me "I wish I had done this ten years ago. I have great people and already they are making fabulous suggestions and helping grow the business." The initial work required to set up a well-functioning board of directors is well worth the time and effort. What are you waiting for?
Janet is a shareholder in the law firm Sheehan Phinney Bass + Green, a business law firm with local, regional, national and international clients. Her practice serves privately owned businesses, including family controlled businesses.
This article is intended to serve as a summary of the issues outlined herein. While it may include some general guidance, it is not intended as, nor is it a substitute for, legal advice. Your receipt of Good Company or any of its individual articles does not create an attorney-client relationship between you and Sheehan Phinney Bass + Green or the Sheehan Phinney Capitol Group. The opinions expressed in Good Company are those of the authors of the specific articles.
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