Private Company Governance 101
Hard-earned lessons for private company owners and directors.
During my career, I participated in over 500 meetings of Fortune 100 boards and a substantial number of meeting of boards of closely-held companies, including one family-owned firm. I frequently concluded that I had seen everything—only to be reminded unceremoniously that I hadn’t. Probably the strangest thing I witnessed was a hostile takeover attempt involving two very large corporations where we each wound up owning a majority of the other firm’s stock. In spite of such experiences, a disproportionate share of the troubles I encountered were with closely-held firms, not Fortune 100 firms.
The good news regarding closely-held firms is that they suffer less external compliance. The bad news with closely-held firms is that they suffer less external compliance. The latter places far greater demands on their board members.
The first lesson for a governance board of any genre is to be certain that the CEO and other top managers are individuals of the utmost integrity. The greatest risk in serving on a board is reputational, not financial. The second rule, especially for closely-held boards, is to be certain that the strategic objectives of the owners are clear, consistent, compatible and documented. Governance becomes an insurmountable challenge when some of the owners (especially family members) decide they want to liquidate and the others are there for the long haul.
In large public companies, the owners are generally relatively detached from the governance process, whereas in closely-held firms they are often very close, a circumstance that can create great challenges if the board is to govern effectively and fairly represent all shareholders. In fact, the extent of this challenge appears to be inversely proportional to the square of the distance of the board from the owners! For example, in closely-held, especially family-owned firms, it can be particularly perplexing for a board to select the senior management, let alone fire it.
The Board’s Responsibility
Probably the most common mistake of boards, other than electing an incompetent CEO or, worse yet, a CEO possessing flexible ethical standards, is to fail to recognize that the board’s responsibility is not to provide good management. Rather, it is to assure that good management is provided. The difference is immense.
Another of the essential ingredients of good boardmanship, particularly for closely-held firms, is to select board members who have “been there”—people with lots of scar tissue. Trying to save money on board compensation is very expensive (although the best board members are often ones who are not motivated to serve because of the financial compensation). Further, all board members should be selected by the board itself, with the concurrence of the CEO, not the other way around—no golfing buddies. The board should set its own agenda, again with the input of the CEO, and all boards should engage an independent audit firm.
A key part of the role of board members is to be willing to “tell the emperor he has no clothes” (Warren Buffett once indicated to me that this was the most important lesson I should teach my students when I was in the “professor” phase of my career). “Single-issue directors” should be avoided (individuals with unique skills are to be welcomed, but the director who sees every issue through the same, narrow lens is not likely to serve the firm well—or to fairly represent all shareholders).
The Board’s Ideal Size
Most large, public corporations seem to be best served when governed by boards with around 11 or 13 members whereas closely-held firms seem to function better with boards having only 5 to 7 members. Finally, having a majority of independent directors is, in most instances, highly desirable. (In the case of the board of the family-owned business on which I served, it was only through the efforts of the independent directors that a family business dispute was able to be resolved.)
With all the oversight, bureaucracy, certification and investigation that was imposed after the Enron implosion, it is my view that the most valuable requirement that was added was also one of the simplest: Boards should meet at regular intervals without members of management present.
Finally, it is critical for the owners of a closely-held firm to delineate whether they are seeking an advisory board or a governance board. The difference in their respective roles is about as great as that between the canonical pig and chicken at a ham and egg breakfast (“the chicken is involved; the pig is committed”). Similarly, the disparity in the members’ legal liability is equally distinct. With regard to the latter matter, the best advice I ever received came from Jack Byrne, then the CEO of Fireman’s Insurance: “The best way to avoid being sued as a director,” he said, “is always to vote last…and with the minority!”
Norman R. Augustine is the retired chairman and chief executive officer of the Lockheed Martin Corp., the nation’s largest defense contractor, and a former undersecretary of the Army. He is a former member of the board of directors of ConocoPhillips, Black and Decker, Procter & Gamble, and Lockheed Martin, and has served on a number of private company boards.