The Board of Directors in the Closely Held Business

In the previous two installments in this series, we covered a wide range of issues related to outside directors (or a "council of advisers") for a closely-held business. In this concluding piece, we discuss why the owner(s) should be in a voting minority, the mix of insiders and outsiders, committees within the board or council, advantages and disadvantages of outsiders, and corporate governance itself.

Majority Owners in a Board Minority?

If the group of outsiders is to make a substantive contribution, there must be enough of them to outvote the owner(s). Therefore, the owner(s) should be in the minority on the board or council. That might be difficult for those who are used to having their own way.

Why? We have observed many owners, especially those with long tenure, who confuse having rights with being right. Opposing a majority on one's own board offers the possibility that what is often a benign dictatorship heavily dependent on the vision and viewpoint of one person may, in fact, evolve to become a company that survives for generations.

Few do. The failure to initiate an independent system of corporate governance is a major reason. After all, the first responsibility of any board of directors is hiring (and, on occasion, firing) the CEO. Outsiders can usually make that decision more objectively than a founder/owner who has nurtured his/her "baby" through thick and thin.

Cynics will argue that owners can always call a special meeting of shareholders and vote in new directors. In our experience, however, that won't happen if the owner is committed to the process and if capable professionals who aren't golfing buddies or next-door neighbors comprise the cadre. Those who have built their own businesses (and have the scars to prove it!) can be invaluable.

The Right Mix of Insiders and Outsiders

Equally important is the number of people on the board or council. It should be as small as possible, but it should be an odd number to avoid tie votes. In our experience, five or seven are numbers that work well. Three is too few, nine is too many.

Including one (and only one) close friend of the owner is desirable. This is the person who can speak candidly to the owner on the golf course, at the gym, or just sitting out in the backyard. We have a client whose second-generation sole shareholder chose to activate a full-blown independent board. But he wanted one close friend on it. The friend, a successful fellow who had built and sold several businesses, has turned out to be the key board member, the one who can talk to the shareholder in ways the other directors cannot.

The temptation for some owners is to stack the board with close friends. We discourage that. The best board members are independent, unencumbered by previous ties to the owner. That independence allows them the freedom to ask the questions that need to be asked and cast the votes that put the business ahead of the family. It is when the family takes priority over the business that family businesses go astray.¹

Committees and Meeting Frequency

Depending on the size of the company and of the board or council/panel, the group might need to create special committees to address particular needs and issues. Those are often ad hoc; in larger private companies, an audit committee and an executive committee are common subgroups of the board of directors.

Most private boards meet quarterly for a day. One meeting annually might extend to a second day, depending on economic volatility, capital spending, and the like. Top managers, especially would-be successors to the top job, should make occasional presentations to the board or council/panel. This familiarizes the second tier of managers with the board (or council) and vice versa. Over time, the twin notions of independence and professionalism become part of the company's culture.

Tenure and Terms of Office for Directors (or Advisers)

The directors of most public companies serve for three years. In the wake of the hostile-takeover wave of the 1980s, many companies revised their bylaws to provide for staggered terms for directors. Private companies are not subject to hostile takeover, per se, though problems servicing large debt loads can result in lenders' "workout" professionals, in effect, taking over the management of a company.

Nonetheless, we see real benefits in staggered terms for boards of directors or councils of advisers of closely-held companies. For one thing, a director/advisor not attending or making substantive contributions can be eased out at the expiration of her/his term without undue embarrassment. For another, we recommend term limits for directors/advisers. Some readers may wonder why.

On its face, the twenty-second Amendment to the U.S. Constitution mandates a maximum of two terms for our nation's president. However, the Amendment also provides for how to count tenure when a vice president succeeds to the presidency. So long as a vice president does not serve more than two years of a president's unexpired term, she/he can be elected to two full terms (in addition to the two years). A president can, therefore, serve for as long as ten years.

It is our strong belief, which is also supported by research,² that what is good enough for the CEO of the largest, freest, and most prosperous nation history has ever known is a worthy guideline for American business, too. Accordingly, we recommend a limit of three three-year terms. Writing that into the corporate bylaws allows for orderly transition, recruiting replacements, and avoiding bruised feelings and wounded egos. It works.

Benefits and Drawbacks of Outsiders

Non-family outsiders offer pluses and minuses. The benefits include external perspectives, viewpoints different from the owner's, financial independence from the owner, experience in arenas where the company is weak, and the ability to speak to the owner as a peer. The absence of hierarchy in the latter is especially important.

However, it takes time for a board of outsiders or a council of advisers to achieve effectiveness. Developing familiarity, confidence, and trust among outsiders who might not know either the business or each other takes a while. In more-insular company cultures, long-time employees may be threatened by, or resentful of, a group of outsiders whom they don't know. Such outsiders will raise questions that insiders long ago quit asking. Their queries will be disruptive—and needed.

Closing Words

A group of outside advisers, whether on a board of directors or a council (or panel), can be invaluable to a privately-held company. This group is a key aspect—some might argue the key aspect—of corporate governance, a topic that gets short shrift in many closely-held businesses. But those who want their businesses to survive beyond one generation must deal with it. Sooner is better than later.

Remember, the higher the growth rate and/or the faster the rate of change in the company's industry, the more such a group is needed. In times of crisis, members provide continuity and stability. They also provide guidance for that most important of questions in any business, family or public—succession.³

For more information, contact Warren Miller via e-mail at wmiller@beckmill.com or phone 540/463–6200.

¹Family-driven succession disasters at companies such as Wang Laboratories and Crown Publishing are key chapters in the how-not-to-do-it archives of family business history. So, too, are the protracted intra-family courtroom dramas between the Kochs of Wichita, the Dorrances of Campbell Soup, the Binghams of Louisville, and the du Ponts of Wilmington.

²See "Stale in the Saddle: CEO Tenure and the Match Between Organization and Environment" by Danny Miller, Management Science (1991), Vol. 37, pp. 34-52. This is a fascinating study about how the "fit" between organizations and their environments deteriorate as CEO tenure lengthens, and the declines in organizational performance that result from that deterioration.

³For an interesting case study, see my article, "Siblings and Succession in the Family Business," Harvard Business Review, JanuaryFebruary 1998, pp. 22+.