Why Do Companies Need a Board of Directors?
Business owners will often say with satisfaction that they “report to no one.” Unfortunately, this also means that, for too many of them, no one is watching or evaluating what they are doing. No one is there to keep them on track. No one will tell them when they are making bad decisions. They also have no one to give them the benefit of their experience in business.
Some people can work very well without a boss. They will assess their companies, create a list of goals, and be disciplined about taking the necessary steps to accomplish them. They will carefully benchmark the results, taking stock and changing course when necessary and consulting experts for advice when they have problems.
Then there is the other 99% of the population.
There is a reason why most workplaces have managers. It’s because nearly everyone performs better when they have to be accountable to someone else. Owning your own company doesn’t magically change any of that. This is why so many companies choose to involve a board and fill it with experts and objective parties. It’s very easy for an owner to get caught up in day-to-day management, putting out fires instead of assessing weaknesses, focusing on goals, and implementing value drivers that will build greater success over time.
Board of Directors vs. Board of Advisors
What is the difference between a board of directors and a board of advisors? There are several key differences that make them better or worse suited for smaller or mid-sized companies. Here are the pros and cons of each.
A board of directors is a formal board arrangement with legally defined responsibilities. This type of board is typically elected by the company’s shareholders and is subject to the corporation’s by-laws. The board’s director is elected for an established term. All of these factors give the board more power and permanency. They also make it harder for the company or the owner to remove or change board members if he doesn’t like them or they don’t perform as he would want.
Furthermore, board members have a fiduciary duty to the company. They can be held personally liable for mistakes the company makes. Because of the responsibility involved, these are paid positions – often generously paid. Not every company can afford to compensate industry experts for the time they serve on the board of directors or pay for liability insurance to protect board members from claims by shareholders, employees, or customers.
In contrast, an advisory board is a much more informal arrangement. The owners or management team can choose their own advisors and add to, remove, or replace members as necessary or if they are not a good fit for the company or with the owner’s personality.
Advisory board members are not held liable for any of the advice they give or work they do in the performance of their duties, so they are not as well compensated. Usually their compensation is paid via a small yearly stipend or an equity interest in the company. Additionally, advisory board members do not have a fiduciary responsibility to the company. They do not have to place the company’s bottom line above any other interest. This means they are free to mentor and help the owner and the management team sort through any problem they have.
For many smaller or mid-sized companies, an advisory board will be the most attractive option for obvious reasons. As the company grows, it may become necessary to formalize a group of advisors into a board of directors with all of the responsibilities that change requires.
A large part of our job at Prometis Partners is to work with our clients to make their companies stronger and more profitable so that they are attractive to buyers and can survive and thrive after a sale. Establishing a board of directors or creating a board of advisors is an excellent move towards accomplishing those goals. The support and advice of natural leaders and businessmen with expertise is valuable to an owner in so many ways.
Business owners will often resist the idea of a board because they do not want their independence or authority compromised, but the exit planning process is fundamentally about eliminating codependency between owners and their companies. A board can greatly help with that. If you have questions about boards, how they work, or how to establish one in your business, please call us. We want to help prepare your company and your family for future success.
As the end of the year approaches, we would like to thank you for the time you spent reading the information we provided about exit planning throughout 2019 and wish you all the very best in 2020. Happy New Year!