Should You Have Outside Directors on Your Private Company Board?

Stock to Employees—Not Always Such a Good Idea!Whether a company is private or public, good governance begins with the board of directors. A board has oversight duty, decision making authority, and fiduciary responsibilities. Many private companies desire a board with a strong skillset to handle these duties and  responsibilities, which often leads to looking outside the company. Independent directors bring accountability, outside knowledge, and leadership development skills. Each of these areas is important, but one may be more important depending on the type of company and the plan for the future.

For example, a private equity-owned company may be interested in the outside knowledge that an external director can bring from their
own industry and past experiences. The plan for this type of company may be a sale in the near future, which would require different types of expertise on the board such as strategies to increase the sale value and past experience with acquisitions. Companies in this situation should determine the desired qualifications of their ideal board, analyze the current skillset of their board members, and identify gaps in the desired vs. current skills and knowledge.

On the other hand, a family-owned business is usually looking to the next generation and beyond for their future. While a private equity-owned company may be focused on the short-term shareholder value, a family-owned company wants it to thrive for their children, grandchildren, and beyond. The company may have strong leaders in place now, but succession planning and leadership development are critical for ongoing success. If the next generation isn’t interested in
continuing the family business, bringing in outside directors to help groom the next leader can be vital. Even if the next generation is interested, having an independent board making succession decisions will remove many of the personal issues around selecting a leader from within the family.

Finally, outside directors help to keep the leaders of any type of private company accountable. The board brings a fresh perspective and assists the company in making more well-rounded decisions. When other organizations (such as lenders, customers, and suppliers) notice independent outsiders on the board, they may feel more comfortable that the company is a reputable organization and will be sustainable over the long-term. As the company grows, an outsider may be able
to notice more quickly if the owner/CEO’s role is changing and provide assistance in developing the strategic direction for the company, including hiring more executives and implementing new processes.

However, some private companies hesitate at the idea of bringing in outside directors as it may be seen as a loss of control over the company. This truly isn’t the case for the majority of companies. In the typical reporting structure, the board reports directly to the company’s stock/shareholders, as their primary responsibility is to protect the ownership interests. The company’s executive team reports to the board of directors. Without outside directors, the executive team would report to the owners. In a large percentage of private companies, the executive team and the owners are the same individuals, which means the board is then reporting to the executive team, leading to no loss of control. When the executive team and owners realize they aren’t losing any control but instead are gaining fresh and innovative ideas as well as the skills mentioned above, adding outside individuals to the company’s board becomes a win-win situation.

Katie O. Galaska can be reached at kgalaska@kmco.com or 215.441.4600.

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