Boards Redux

By Warren D. Miller, MBA, CPA–ABV, CMA, Beckmill Research, Lexington, Va.

A year ago in this space, I wrote a three-part series entitled “The Board of Directors in the Closely-Held Business.”¹ The series hit a nerve out there: I got e-mail requests and phone calls for reprints from 28 states, South America, and Europe.

In the interim, however, several correspondents have questioned whether outside directors for closely-held companies are a good idea after all. They expressed several concerns. This article aims to respond to those concerns and allay them.

Question #1: Why would anyone really knowledgeable want to serve on my Board?

According to the ones to whom we’ve spoken, there is little that gets the juices of retired CEOs going like getting back in the action. Serving on the board (or advisory council) of a small company seems to be a real tonic for them. They don’t need the money (though if this market downdraft continues, they might!), they have the time, and they enjoy the reward of being part of a smaller company’s success.

Question #2: If outside directors don’t know me or my company or my industry, what possible benefit can they bring?

It never ceases to amaze me that otherwise savvy owners, who wouldn’t hesitate to engage a headhunter to conduct a search for a key employee with certain qualifications, credentials, and background, turn quasi-xenophobic when it comes to outside directors. Knowledgeable professionals don’t have to know you, your company, or your industry to deliver value. They may not know your business, but they know business. Knowing the latter, they can learn the former.

Yes, there are differences across industries and across competitors within a given industry. Except in technology or R&D-intensive industries, however, those differences are not great. Besides, all industries have certain common blocking-and-tackling issues: marketing, operations, logistics, HR, finance, accounting. The differences are at the margin. Don’t succumb to the myth of OBID.²

Those who have been successful elsewhere can be valuable to your company. But you should define your company’s needs for directors just as you would for any key employee. Then conduct a disciplined search. Outside help experienced in this arena can add valuable perspective.

Question #3: I don’t think I can afford to pay these folks what they’re worth. Or can I?

You may not be able to afford what they’re worth. But they’re in this for something other than money. Let them decide if the opportunity you offer is enough.

As a practical matter, you can probably get the people you want for about $1,200/day. Some markets will be lower. We know of one in Texas where it’s $600/day.

Will you get Warren Buffett or Jack Welch for that? Probably not. But if you’re aiming at retired professionals and an academician, $1,200/day (plus expenses, of course) should do it.

You get a bang for your buck, they get good feelings. To them it’s worth it. Don’t worry about it.

Question #4: Should I put my banker, my attorney, my CPA, and/or my insurance agent on my Board?

Only if you want them to retire on your payroll. We believe that the single best way to discourage competition for your banking, legal, tax, auditing, and/or insurance business is to put one of those specialists on your Board. Don’t.

Remember, too, that the trait most treasured in a Board (Council) member is independence. Council members (or directors) have to be willing to tell the owner that s/he’s dead wrong when the circumstances call for it.

Professionals with an existing business relationship with your organization are apt to have more trouble doing that. We don’t say that they’re incapable of independence. But why confuse their roles and put stress on the relationship by adding them to your Board?

Question #5: I’m worried about being on the short end of a majority vote to do something dumb. Should I be?

The more likely scenario is that you’ll be on the short end of a majority vote not to do something dumb!

Outside directors in publicly-held companies have fiduciary responsibilities to a large group of shareholders. The legal ramifications of such responsibilities tend to make them more activist, if only to protect themselves and their reputations. Usually the activism compels them to do the right thing. But not always.

In the closely-held business, in contrast, the shareholding constituency is usually small. In fact, it’s often one person. Therefore, directors’ focus is narrower. If they share the shareholder’s (s’) vision, as they should have before they agreed to join the Board, then formal, recorded disagreements should be few. Directors (Council members) are unlikely to ‘turn cowboy’ in the closely-held business.

To be sure, they have a vote and a voice. On occasion, the owner might well be outvoted. In our experience, that happens. But we have never heard of outside directors of a privately-held company banding together to defeat an owner who wanted to do something smart. Replacing the directors is always an option for an unhappy owner.

Question #6: I’m planning to sell my company to a much larger one in this industry a few years down the road. Do I need outsiders on my Board?

Absolutely. If you intend to cash out to a “much larger” company, such a company is probably already public, or is apt to be by the time you’re ready to sell. The fact that you already have an independent system of corporate governance will make your company more attractive to such a buyer. The fact that your senior managers are accustomed to outsiders asking tough questions of them will enhance value, make the transition to new ownership easier, and shorten the learning curve in the large-company environment. All of those will be big pluses for you.

Question #7: I’m still not convinced of the value of outsiders. Can you prove it?

We can try. For one thing, the Securities and Exchange Commission strongly encourages the boards of public companies to have outsider majorities.

For another, a substantial number of the hostile takeovers that occurred in the last twenty years targeted low-performing companies. These targets included some once-independent names—Cities Service, Beatrice, Combustion Engineering, Revlon, Gulf Oil, Bendix, AMF, ABC, CBS, RCA (which owned NBC), and AMP, to name just a few. Most of these companies’ boards were insider-dominated.

To be sure, closely-held businesses don’t face the sort of discipline that leads capital to its highest and best uses. But outside directors can help nudge owners of closely-helds towards doing what’s best for their companies. Over the long term, that will be what’s best for owners and their families, too.

Finally, as companies grow, their external relationships become more important—and more complex. A major benefit of outsiders is that they can tell insiders what different courses of action are apt to look like to suppliers, customers and communities.

Yet another form of value may occur in the wake of tragedy. If the owner dies or is disabled, the outsiders will be a source of calm, stability, continuity and reassurance for employees, customers and suppliers. That is merely an extension of the primary responsibility of any Board, public or private: To hire (and sometimes fire) the CEO.

¹For Parts I, II, and III, respectively, click on www.aicpa.org/pubs/cpaltr/jan2000/supps/busind3.htm, www.aicpa.org/pubs/cpaltr/feb2000/supps/busind4.htm, and www.aicpa.org/pubs/cpaltr/apr2000/supps/busind3.htm.

²Our Business Is Different—it’s not.