Independent boards of directors curb dysfunction, force accountability

Many closely held companies, especially family businesses, are reluctant to establish boards of directors that include unrelated parties. Recruiting accomplished directors or domain experts who have no prior personal relationships with the family shareholders is even more difficult for family businesses to consider.

When a family business does take the step to add non-family board members, commonly its board configuration will include some or all of the following: the family’s estate planning lawyer, a long-serving accountant and/or a close family friend who is a retired CEO from his or her own family’s business or a large corporation.

While these individuals may all be trusted and trustworthy, it is unlikely that this type of board of directors will best serve the business or its shareholders. Why?

Because pre-existing friendships or professional service relationships will severely inhibit these directors from calling out family dysfunction, voting against poor business decisions and making obvious but uncomfortable observations about the current state of the company or its future prospects.

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Family businesses should avoid establishing non-fiduciary advisory boards. These are typically not worth the costs and burden of hosting meetings because the advisers have nothing at risk (they have no fiduciary liability for acting irresponsibly) and nothing to gain (they are not adequately compensated and won’t take the advisory responsibility seriously).

If you are serious about getting actionable input from professionals who are not beholden to your family and who can actually make an important contribution to the growth of your organization, then you should establish a fiduciary board with a majority of independent directors. If you are not satisfied with their performance, you can (and should) replace them. Your family controls their election. But be prepared to hear them point out the things that you know deep down need to get done but are too painful for you to do on your own. Expect to be challenged and expect to feel uncomfortable. These are the signs that you’re on the right path.

A familiar pattern?

If you have been experiencing any of the following in your boardroom, you are already late in acting to improve the quality of your board:

• Absence of a rigorous process in defining a long-term, forward-looking business strategy.

• Poor communication between the company’s owners and its professional managers.

• Significant turnover among the second layer of the company’s senior executives combined with very long tenure by the top layer of senior executives—conditions that have not been accompanied by strong business performance over the past three to five years.

• Board meetings that are too comfortable and always follow a familiar pattern: Nobody challenges anyone in the board meeting on any topic that is material.

• Everyone sitting at the board table is a family member, longtime family accountant, family estate lawyer or close friend.

If so, you have a governance problem now, or one is coming.

The biggest mistake family-controlled companies make in establishing a board of directors is not being comfortable bringing on directors who will challenge the family to step outside their comfort zone in charting the path forward. This is because they populate their boards of directors with friends and people who are in some way beholden to the family.

To some business owners, being held accountable by a group of experienced outsiders is a scary prospect. But having an independent board is actually not a scary thing.

If you know where you want to go and have the courage to acknowledge that you are not going to get there by maintaining the status quo, putting in place an independent board should not inspire fear. Conquering your fear of change is the first step toward positive change.

Lack of accountability among family members, whether they are passive shareholders or active members of the business management team, is a root cause of dysfunction in many family businesses. An independent director can do a number of things to shift members of the ownership group into a different level of accountability than they’ve been accustomed to:

• Establish a compensation committee, composed entirely of people outside the ownership group.

• Define the job descriptions of any owners who are also employees. Those owners should report directly to the CEO if they are senior-level employees, or to the appropriate level executive if they are junior members of the staff.

• Require a formal, written review of each family member’s performance twice per year that begins with a written self-evaluation. The purpose of the mid-year review is to make sure the family employees are on track or to identify problems and fix them before the year-end review.

• Conduct a rigorous review of owners’ expenses and set clearly defined expense policies that are enforced by the CFO or CEO if necessary.

• Devise a process that has teeth in it and is controlled by independent directors that can lead to the dismissal of the owner as an employee, and by the majority of the shareholders as a director, for poor performance or for cause (legally defined).

Finding the right independent directors

Directors are best found through a formal search process that clearly identifies disqualifying criteria as well as qualifying criteria. At the top of the “no go” list you must stipulate that the search should exclude people the family knows as friends.

A good independent director of a family business is respectful of the various family members while not being shy about expressing his or her opinion, knowing that this opinion will often be at odds with the viewpoint of one or more family members. It is important for that director to have plenty of experience working on other boards so that he or she can bring an informed perspective to the table. Ideally, the director should be a domain expert in some aspect of the company’s business or have expertise in an area in which the family company is weak. Operational finance is often a relevant weak area.

An outside director should also be respected in the relevant business community. The director should bring the strength of this reputation to bear on the board to help send the message to the larger community that the family business is willing to rise to the next level of professionalism. Insularity is not a best business practice.

In many companies, either there is a dual CEO/chairman or the chairman is the retired CEO. I feel strongly that in family-owned companies, the chairman should not be a family member and should be different from the CEO, even if the CEO is not a family member.

Why? Most importantly, because the chairman must be able to communicate freely with different shareholders—and often these shareholders, especially in family companies where there are multiple adult generations and multiple factions within them, are not on harmonious terms with each other. Because the chairman sets the agenda for the board meeting, the chairman must be able to reach out to management, to family members who are both owners and employees, and to the other independent directors, and communicate freely with all of them. The chairman must find out where there are areas of agreement—and disagreement—as part of setting the stage for the meeting. The board chairman plays a very delicate role. An independent director who carries the least amount of baggage and does not have a hidden agenda is best able to fulfill this role.

Characteristics of a good board meeting

All directors should receive a full agenda and all board material—in writing—at least one week prior to a board meeting. Meetings should not be excessively long and should not be devoid of substance. All directors should be fully engaged, properly prepared and respectful of each other’s time during board meetings.

The chairman should welcome and invite differences of opinion at board meetings, and should successfully resolve these differences of opinion in a timely manner. The chairman should not coddle or yield to directors who engage in emotional outbursts during meetings.

Board members should communicate well in the boardroom and outside it, through informal conversations and formal committee meetings in between board meetings.

Directors should understand the meaning of conflicts of interest and should be able to separate family matters and conflict from the business of running the family business professionally.

Another key element to a healthy board is that it refreshes itself through turnover in an orderly manner. Many studies have found that family business boards have very low turnover. Succession planning should be built into the structure and fabric of the board itself. This is easily done by enforcing time limits for board service, for both family and non-family directors. For example, allowing no more than two consecutive three-year terms will force turnover. People will welcome the freshness of cycling off, even if they come back on the board after the year off. And if not, you’ve fixed your problem.

Based on my 23 years of professional board experience, I believe that the biggest mistake made by every board, public or private, startup or multibillion-dollar corporation, for-profit or non-profit, is the presumption that board consensus exists on a given matter when, in fact, it does not.

Before every board meeting, every director should ask himself or herself the following question: “Do I actually know how each of my fellow directors feels about important question X, which I have a strong feeling about and want to act upon?” If the answer is no, the director should speak with the board chair, or contact each of the other directors in advance of the meeting, to socialize the idea. This will significantly improve the overall board process. Directors will know whether there is a consensus view or whether they are going into a knife fight.

Pascal Levensohn is the founder of Levensohn Venture Partners (www.levp.com). He advises family offices and institutional investors on corporate governance challenges. He currently is a managing director of Dolby Family Ventures L.P. and represents a select group of family offices as chief investment officer and strategic adviser. He is also chairman of the board of directors of C. Mondavi & Family Inc., chairman of ShotSpotter Inc. and a director of Mixed Dimensions and Cure Network Dolby Acceleration Partners LLC.

Copyright 2016 by Family Business Magazine. This article may not be posted online or reproduced in any form, including photocopy, without permission from the publisher. For reprint information, contact bwenger@familybusinessmagazine.com.

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