Corporate governance is one of the most important aspects of running a successful business, yet it is something that many business owners dismiss as unimportant or rudimentary. In fact, good governance is more important than ever for companies of all sizes and all stages. An effective corporate governance structure can lead to (1) better access to favorable strategic transactions, such as finance or M&A, (2) improved performance of the business, (3) reduced risk of corporate crisis or scandal, (4) better shareholder relationships and investor confidence, and (5) a favorable professional reputation in the industry, which often leads to a higher valuation of the business.
Corporate governance is, simply put, a system by which a company is directed and controlled. Unfortunately, it is not a simple set of rules or a “check the box” framework. And while there is a lot of guidance regarding governance of large public companies, those rules may not always be appropriate for every company.
So how do you build an effective corporate governance framework?
1. Build a strong, qualified board
While there is no “one size fits all” when it comes to how to structure a board of directors, there are some common key elements:
- Size – Boards can consist of one member or as many as 30 or more directors (statutes will vary from state to state). A larger or more established company typically means a larger board, but that doesn’t necessarily need to be the case. A larger board may provide more voices and flexibility in terms of approving actions or staffing committees, but it also comes with more expenses, less efficiency and complex situations, including a possibly overcrowded board where a director may be less likely to voice an opinion.
Key tips: Having trouble gathering enough directors in the room for a quorum? Consider reducing the board size. Does it seem like the board is acting as a single voice? Consider increasing the board size and adding some diversity.
- Independence, Diversity – An effective board should consist of a diverse group of directors with different skills, backgrounds and perspectives, including independent directors. An independent director brings a different voice to the boardroom and can resolve conflicts of interest that may arise between the company and a stakeholder. When considering who is truly “independent,” consider how long a director has been on your board. If someone has been a board member for 10+ years, they may no longer truly be independent.
Key tips: When the time comes to elect new members to the board, consider fresh eyes, new areas of expertise, and members who are unaffiliated with the company; you may see real changes in creativity and energy in board meetings.
- Engage and educate the board – An effective board asks questions and challenges management. It does not “rubber stamp” the recommendations presented to it. So how do you engage your board members? Educate them. Provide your directors with an orientation and periodic updates that go beyond the scope of ordinary board matters, and teach them the true “ins and outs” of the business. Give them a tour of your operations. Introduce them to key management personnel whom they may not otherwise meet. Once the directors know your business, they will be even more motivated to play an active role in its success.
Key tips: Provide background materials and draft documents well in advance to your board, so that they may meet their fiduciary duties of care and loyalty to the company. When boards are educated and engaged, court tend not to intervene and second-guess the “business judgment” of the directors.
2. Clearly define shareholder rights
Do all shareholders have equal voting rights, or is one class advantaged over another? Do your shareholders have the right to approve certain transactions or activities that otherwise would go to the board? Can the board take action without shareholder approval? Have you offered minority shareholders any protections? Does your company have a policy on related-party transactions or extraordinary transactions? All of these items should be formalized and reviewed by the Board and senior management on a periodic basis.
Key tips: Take a look at your bylaws, operating agreements, and stockholder agreements. Are they accurate and up to date? Do they reflect reality? If not, then it is time to update and circulate these governance documents to directors, owners, and stakeholders.
3. Transparency, transparency, transparency
Ensure timely, periodic distribution of any material matters involving the company to your shareholders. This could include key financial performance metrics, corporate policies, ownership information, board decisions and any other important developments. Whether or not legally or contractually required, make a plan to distribute updated information to your shareholders on a monthly, quarterly and/or annual basis and communicate that plan to your shareholders so they know what to expect. Not only does this inspire confidence in the management of the company, if your shareholders understand the company’s management strategies and performance metrics, they will better understand their roles and be more motivated to help the company grow.
Key tips: Communications and investor relations are key! Keeping your shareholders in the loop will reduce unwelcome surprises and claims down the road. Take advantage of electronic dashboards that distribute various levels of information to selected groups (directors, shareholders, noteholders, etc.).
Given the potential complexities with structuring your company’s governance, be sure to consult a corporate attorney regularly to keep your governance in good shape.