Private Company Governance: Is it an Oxymoron?
With all the noise about ENRON, WorldCom, Tyco and the myriad other corporate governance disasters that motivated Senators Sarbanes and Oxley to rewrite many of the laws affecting corporate accountability, private company owners have been asking what, if anything, this means for them. The answer is nothing, and a lot. From a legal and regulatory perspective, Sarbanes-Oxley has little impact on the governance of privately owned businesses. But the recent media attention does bring to light what always has been true: that effective corporate governance can significantly impact the performance of any commercial enterprise.
Craig Aronoff, who founded and runs the Family Enterprise Center at Kennesaw State University, claims: “The potential positive benefit of effective corporate governance is the most overlooked opportunity in private companies.” Aronoff has conducted extensive studies of the longevity of private companies, i.e., what it takes to survive long-term, and he concludes that one of the three unmistakable factors correlated to long-term success for family businesses is effective corporate governance.
From my not-so-scientific sample, which entails working with about 50 closely held businesses a year, it appears that private-company corporate governance is an oxymoron. Aronoff believes that only about 10 percent to 15 percent of private companies have effective governance mechanisms in place. That may be generous. It is rare indeed to find a privately-held company that has a functioning board of directors that provides the accountability mechanisms envisioned by legal scholars. Most private boards are simply legal versions of the management committee empowered to make decisions requiring board approval. Or, if they include any “independent directors,” the most common suspects are the spouse of the owner or the company’s lawyer or CPA.
One of the privileges of owning a closely held business is that you do not have to be accountable to anyone. Unfortunately, this privilege comes with a price: some accountability is a good business practice. As Aronoff observes, “Despite what some may think, all the wisdom and insight in the world is not generally contained in a single individual.” He notes that effective boards are crucial in setting strategy, planning growth and monitoring performance. Besides, as any private company owner knows, it truly can be lonely at the top. There always will be decisions for which a CEO can’t seek counsel from his or her underlings, and it is nice to have someone who is familiar with the company to provide objective advice.
My personal experience bears out the admonitions of Aronoff. In the cases where I have served on private company boards as an independent director, the companies made significant strategic decisions that otherwise would not have been made if only owners, managers or family members served as directors. In one case, the board consisted of three members: the two 50 percent owners who founded and ran the company and myself. (I wouldn’t advise taking such a position.) One of the owners wanted to sell the company, but his partner wanted more for his share than it was worth at the time, so I was asked to help them position the company so it could eventually be sold at a more attractive price.
At the first meeting it became apparent what was behind the divergent views of the two owners. The owner who was opposed to selling also objected to the strategic initiatives that the company needed to undertake in order to improve its performance to justify the higher price he said he needed. My role quickly became one of convincing the reluctant partner that in order to achieve his target price, he would have to make some changes in the way the business was run. The other owner, who had been anxious to exit out of frustration with his partner who was stuck in his ways, soon gained a second wind as we started to implement the reforms needed to fuel growth and reduce overhead. Three years later the company was sold to Mohawk Industries at a price that was pleasing to both owners.
In another case, involving a much larger company, I served as one of five independent directors on a board with 12 members. This employee-owned $350 million global engineering firm recognized the value of outside counsel, but wasn’t willing to turn over control of the board to non-employees, which is understandable. The other independent directors included a four-star Air Force general, the highest ranking woman of a Fortune 500 company and the former head of a major strategy consulting firm. Each quarter issues arose that resulted in outcomes clearly different than what would have been experienced if the board were simply an extension of the management committee.
On issues ranging from forcing a reluctant CEO to establish a succession plan to persuading the company to find a new bank that would better support its growth than the home town institution, the outside directors were instrumental in building consensus around initiatives that otherwise would not have made it past first base. And the decision to eventually exit a consolidating industry before it was too late would undoubtedly not have been made without the influence of unbiased outside directors.
It takes a secure CEO to establish an accountability mechanism. When I was responsible for corporate governance policy for the first Bush Administration, I met a lot of CEOs of large public companies who resented board oversight. And they did not even own a meaningful share of their company’s stock, as is the case with most private company bosses. Self-imposed accountability is contrary to human nature. But at the same time, an effective sounding board, whether in the form of a formal board of directors or an ad hoc board of advisors, is invaluable.
If you are progressive enough to assemble a functioning board, here are a few tips:
Some CEOs, like Sherwin Glass’s son Greg, who now runs Farmers Furniture, have found organizations like Young Presidents Organization (YPO) or The Executive Committee (TEC) invaluable resources. These organizations can be extremely beneficial because they provide many of the benefits of a board. But if you want all the benefits of a board, there is no substitute for having one.
Michael Jacobs, Author
Michael Jacobs is the CEO of Jacobs Capital and Professor of the Practice of Finance at The University of North Carolina at Chapel Hill. He's the author of several books and a certified speaker.
© 2018 Jacobs Capital. All Rights Reserved.