The role of the nominating and governance committee on family business boards, Q&A with director Dennis Cagan, private company director appointments and news.
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Private Company Q&A: Dennis J. Cagan
[Editor's note: the following is the first installment of our Private Company Director Q&A series. We will continuously update this section with responses from different directors of private companies covering a wide range of topics.]
Dennis J. Cagan
Boards: Acorn Technologies, Copper Mobile, Prista, Heart Stories, Tavros Technology
What makes private company board service different than public company board service?
There are of course a myriad of governance specifics that are the same between public and private companies. The differences primarily stem from the shareholders, and to some degree the financial objectives. In terms of the shareholders, the owners of a private company are usually very identifiable, much smaller in number and with much more concentration than a public company. Typically this simplifies the job of determining exactly to who the boards’ fiduciary responsibility is. While the private board agenda no longer has to include the regulatory requirements of exchange listings and public shareholders, they are replaced with all the politics and emotions tied to partners, family members, and large shareholders (including controlling interests) versus minority holders. In terms of financial objectives a public company is usually focused on shareholder value, which is typically measured in share price and dividends. With a private company there can be a variety of complimentary, or even conflicting objectives that have to be factored into the governance equation. Is the company being built to go public or be merged or sold? Does it, or will it, require additional capital infusions to meet its objectives? Is the firm being run to simply provide income to the shareholders over a long period of time, as in a multigenerational family business? Is the enterprise employee owned, as an ESOP or partnership, and therefore needs to provide for the build-up of value for individual shareholders in order to provide enough liquidity to buy them out at retirement? Is the cap schedule such that the returns to shareholders are severely skewed, as when controlling employee owners take out a disproportional share of the excess capital in the form of compensation? Or, is it skewed in the other direction, as when controlling non-employee owners take out a disproportionate share of the excess capital in the form of dividends or distributions? All these things can uniquely affect the responsible exercise of a private board’s fiduciary responsibilities.
What are your biggest challenges in executing your role as a private company board member?
In my experience the biggest challenges in executing the role of a private company director is understanding the unique ownership structure of the company, clearly understanding who you owe your fiduciary loyalty to, and faithfully and responsibly keeping on that path within the boundaries of reasonable understanding and a strong ethical foundation. One note here is that this job can be made easier of much more difficult depending on the relationship of the CEO to the controlling (or majority) of owners/shareholders. To what degree is the CEO part of the controlling ownership structure, or simply a hired manager? Sometimes getting to the truth in certain circumstances is challenging.
Tell us about your first board experience. How have things changed for you since then?
In my case that is a little bit of a trick question. My first board was a software company I co-founded in 1968. In that case the board was only the three founders. It was relatively informal and the meetings were less about governance than they were about operational, technology and growth challenges. Strategy, risk assessment, best practices, and other concepts common now were non-existent. Today my boards are somewhat more organized, somewhat more formal, much more involved in higher-level issues like strategy, risk mitigation, and best practices. All are comprised of 50% or more independent directors. Even the one company where I was one of four co-founders, only two are left on the board – one is a VP and I am not an employee at all. The remaining directors are our non-founding CEO, our largest investor (non-executive chairman), an independent world-renowned academic and Fortune 100 director, and an independent high level technologist/operating executive. The board is very congenial, but all business and by the book – I set it up that way from the start in 1998.
How important is gender diversity on private company boards?
This is an interesting question since I authored an article of diversity in the current issue of Private Company Director – When Is Board Diversity Actually Diverse? The piece covers it in much more detail that I care to here, but when asked ‘How important is gender diversity on private company boards?’ My answer is somewhat provocative; it all depends, but perhaps gender is not important at all. Allow me to point out the extremes. If the company employs all women, sells it products to only women, and has only women shareholders, then I would argue that they in fact should not have any men on the board. Of course the reverse is also true. A man owned, man run, male employee-only company selling products only to and for men, does not really need a woman on the board. However, to whatever extent the stakeholders of the enterprise are both men and women – the shareholders, the employees, the management, the customers, any strategic partners, etc., I believe that the best performing board would be a capable mix of gender. The same goes for race, age, skills, domain expertise, and demographic and geographic knowledge. The best board is one that is balanced, containing all the key knowledge that the business requires, that which is not adequately represented by management.
Family Business Boards: The role of the nominating and governance committee
In a family-owned business, it’s all too easy for the family and the management to end up on opposite teams. But fortunately, a well-run board with a solid committee structure can do a lot to make sure the two groups are informed about each other’s work for the good of the business as a whole. It’s the board’s job to make sure the family has the tools and support needed to make it is the best possible partner for the business, and that management is free to do their jobs without unnecessary interference from the family.
A nominating and governance committee can play a vital role, expanding the board’s ability to serve both the family and the business. First, such a committee manages succession for the directors and key leaders. It also can look at overall governance, and smooth out the functioning of the board. It can help mentor and guide family employees, particularly those who want to have a more involved role in the leadership of the business. And the committee can mentor and guide family members who want to become qualified director candidates.
Not all boards have formal nominating and governance committees. There are times when a formal committee may not be active, even though all the committee’s functions need to be managed. Often, if a family member is chairman, he or she will do all these activities as part of their day-to-day job. But when the family or the business becomes more complex, the board has to match that complexity. They have to meet that challenge by developing a more formal structure, which often includes both outside directors and committees.
A formal nominating and governance committee gives the chairman some cover to have difficult conversations with family members particularly. It’s easier to have frank conversations with someone who's not a sibling, or a daughter or son. When a family chairman, for example, gives a family member feedback, the ramifications go beyond the individual. Such conversations can cause family conflict if they’re not handled well. A nominating and governance committee allows the chairman to bring guidance to specific family members only when it’s been validated by third party.
Composition of the Committee
Even if a family member is the chairman, the board may still want a family member as the nominating and governance chair. In fact, if there is a family member who is aspiring to be the chairman in the future, it's a great training ground for them to understand governance and work with the outside directors on a more frequent basis. A family member leading the nominating and governance committee can make sure that the family's values and vision are being carried out in succession plans. With a strong family member in this role, the rest of the committee can be made up of outside directors. Outside directors are best able to provide that cover for the chairman that is so important, and also ensure that family leaders are validated by an impartial third party that has a fiduciary responsibility to the shareholders. Of course, every director has a fiduciary responsibility, but outside directors are perceived to be more impartial than family directors. They're not going to put people in leadership roles unless they’re qualified.
Often the board will bring in more outside directors, and those outside directors will be well matched for the direction the business wants to go strategically. A lot of those outside directors can contribute on committees, like the audit committee, compensation committee or the nominating and governance committee.
Outside directors are particularly suited to leading the compensation and audit committee because a third-party perspective is useful when it comes to the financials and the compensation structures for management. But family businesses should consider having a family member as chair of the nominating and governance committee, particularly if the family doesn't have a family member as chairman of the board.
Most nominating and governance committees are merely concerned with the succession of key leaders within the company’s management and the board, or they’re focused on the board’s overall composition. There’s no question that these areas are important, and within the committee’s purview.
But in most cases, the nominating and governance committee should be focusing on helping the family be the best possible partner for the business. The family can have as much influence on the success or failure of the company as the management or board does, and it’s the nominating and governance committee’s job to make sure the family’s involvement is a net gain for the business.
The success of key individuals within the family can greatly influence the success of the business, and also impact retention of both management and board members.
Any family members who are employed in the business should be discussed with the nominating and governance committee, to make sure they're adding value and being a good representative of the business. But the committee’s focus should be on those individuals who aspire to executive leadership roles. The key issue here is to ensure that all family members in leadership are qualified. Otherwise, retention of non-family management can be challenging because they realize that they will be surpassed by an individual with the right heritage, rather than the right credentials.
Not only should family directors be qualified to be a leader in the family business, but they also need to represent the values of the family. They need to have the right credentials to satisfy the needs of the family and the requirements of the board. The nominating and governance committee can act as mentors for these individuals to make sure they're successful, and give them the feedback they need to achieve their goals. This should be in addition to the family council’s education and development program. The nominating and governance committee can provide some meaningful advice and feedback, but this should not be the only source for an individual aspiring to become a qualified director candidate.
Family directors, too, need to have a rigorous credentialing process. They need to represent the whole family and all of their interests as a fiduciary, and they need to have the experience required for them to make shrewd decisions about the company’s direction. It's difficult to get a family director the outside experience they need, because most are not qualified to serve on other boards. Many boards want C-level executives for their director pool, and few family directors have that professional background. That’s why other training and development opportunities must be provided by the family council’s development and education committee to allow family director candidates to grow into the role.
Management Oversight and Retention
The nominating and governance committee also keeps an eye on management succession. The committee oversees succession of key leaders and communicates with the compensation committee about issues they've observed or successes. If the governance committee has seen big progress or great improvement in an individual, there would be a brief dialog on management succession issues.
For example, in some cases the nominating and governance committee may be thinking eight to 10 years ahead. If they see that retention is a key issue and it’s crucial to keep the same person in place, the compensation committee needs to play a role. Vital individuals need adequate compensation to reflect their importance to an organization, so compensation must be in alignment with the overall goals of the business and with plans for succession.
Board Oversight and Succession Planning
Lastly, the nominating and governance committee also looks at board succession and composition. They're aware of the strategic objectives the company wants to achieve over the next 10 years, and making sure the talent and the experience of the board fill those needs. It’s important to look at corporate strategy and make sure the board composition suits it—not the other way around. The composition of the board shouldn’t drive the company’s objectives, the way a board with a technology background might push the company toward more advanced technology than is going to make sense for the business.
But strategic objectives are the perfect yardstick with which to measure the skills of the board. If a company wants a third of their growth to be in Europe, then they’d want somebody on their board who had robust experience in international expansion. The talent on the board must match company strategy.
There are a number of ways to measure board composition. Some committees conduct a skills assessment, mapping everybody's skills and experience on a spreadsheet to see where the gaps are based on the company’s strategic objectives. Some conduct an evaluation of board effectiveness, not only how the board works as a team, but how effectively the board and management identify opportunities and things they need to think about.
One of the benefits of doing board evaluations is that it makes it easier to communicate with family members if there's an issue around performance. It's very difficult, without doing evaluations, to talk with a family member who is not performing or not preparing for board meetings. If a board does evaluations, there is a fallback with real data over a period of time, showing clearly when an individual was not performing well at the board. Data show what's lacking, and allows the family to help somebody improve. I met one family that had a red-yellow-green light evaluation process. A red or two consecutive yellows on the annual evaluations was cause for requesting the individual to step down from the board. This also provides a way to have an ongoing discussion about director performance and expectations.
Mentoring family director candidates is an essential role of the nominating and governance committee. The committee can manage those individuals who are doing family internships—not the high school summer job internships, but serious internships for adult members of the family who are trying it out to see if they want to come work for the family business. The nominating and governance committee can help provide feedback on the design the internship program to make sure it’s good for the individual and gives them what they need to make a really good decision about employment with the family business.
Once family employees come on board, it’s also the committee’s job to monitor their progress, and mentor those who aspire to top leadership roles—including any family members who aspire to become CEO or chairman of the board.
Even if a family doesn’t have a formal nominating and governance committee, the chairman should ensure that all of the above activities are accounted for. If a family has outside directors, they can be great sounding boards and provide valuable insight into managing family, corporate, and business succession.
For the past eight years, Meghan Juday has been the IDEAL Family Council chair and a director on the IDEAL Industries board of directors, a primarily independent board. Meghan has worked as a business analyst and Project Manager at CSC and as a next-generation leader of the IDEAL Industries family. Meghan was one of the first graduates of the Family Business Stewardship Institute at the Loyola Family Business Center. She has a B.A. from St. John’s College in Santa Fe, NM, where she graduated in 1994 with a concentration in mathematics and philosophy.
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Riverbed chairman and CEO Jerry Kennelly announced the deal making the company private.
Riverbed underwent shareholder struggles for most of last year and was pressured by investors. IN September 2014, Kennelly said it was restructuring the company in hopes of cutting $25 million from expenses. A review by the board of directors eventually led to the sale in December 2014 too Thoma Bravo and Teachers’ Private Capital.
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