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Berkonomics

Why bother with a board of directors?

I hope you enjoy this new format – with its larger type and easier navigation. – Dave

No matter what your size, if you intend to grow your business into more than just a lifestyle workplace, you should create a board of directors. If you take money from knowledgeable investors, you will be required to create a board as a part of the investment process.

Building Great Boards available at berkus.com and Amazon Kindle Singles

Building Great Boards available at berkus.com and Amazon Kindle Singles

Boards perform two important types of task. They protect the company by overseeing the expenditure of company money for expansion, acquisitions, purchases of large assets, hiring of senior management and more. A board is usually composed of a mixture of the senior executives or the CEO, at least one representative of the investors, and at least one industry expert from outside the company. The usual size of a board is five, but legally the number in most states is equal to the number of shareholders up to a maximum of three board members required by law. With three or more shareholders, you must have a three person board of directors in most states. The average board for a company taking outside investment money is five. Beyond seven members, a board is often too cumbersome to be at the most effective value to the CEO.

[Email readers, continue here…]  Each board member is legally tasked with two duties: the duty of care, and the duty of loyalty: care for the living entity that is the corporation itself, and loyalty not to the board member’s constituency, but to the corporation itself. Sometimes, these duties conflict with the best interests of

the board member personally or his or her co-investors. This could happen when a board votes to take in new money at terms that would be unfavorable to the class of investor represented by the board member. It could happen if some early investors and board members want to sell the company at a price below the objective of the later board member, where the relative returns are excellent for the early investors and marginal for the later ones.

There is no legally-mandated requirement that members of the board help a corporation to grow. But it is certainly the goal of the investors, the CEO and even the board members individually, when assuming the position of board member. Often, a board meeting is entirely devoted to issues of growth, with members chiming in to help the CEO with marketing issues or customer acquisition.

It is important to make time for the required duties at board meetings. Approving the budget and watching over it during the year, and approving any actions that would dilute ownership including stock option grants, are two examples. Much less understood are issues that address the management of risk, such as review of corporate insurance policies, adherence to OSHA safety regulations, and oversight of the terms of real estate and large equipment leases that could affect a company’s ability to maneuver in times of crisis or extreme growth.

Many entrepreneurs would rather not have to answer to a board, and resist creating an entity that could have the power to check management actions, and even to fire the CEO in extreme cases. Yet, the establishment of a proactive board is the first step toward professionalizing the company and its management. Properly handled by the CEO with adequate time allocation for individual and group board member updates, the proper use of the board will help control risk and provide resources to management that will pay back in better overall management of the company and more efficient use of its resources. More importantly, no entrepreneur or CEO can do it all alone, especially in a rapid growth scenario. Too many things can go wrong, many of which are things that one or more board members have already dealt with in their business lives.

Take the establishment and nurture of a board of directors seriously. It is much more than a legal requirement to be resolved. It is the creation of a vital part of the organization, one that could be of great help in both protection and growth of the enterprise. Great boards create value for shareholders while protecting them at the same time.

  • Great article! and great comment. A “must” read and “must” understand for all entrepreneurs! This topic is part of the MNSA 11 Commandments of Business which includes how to select one’s board.

  • Bill Carpenter

    Great article and great advice. One clarification regarding Directors’ ” loyalty . . . to the corporation itself” – which could be misinterpreted by some as doing what’s best for the company’s operations (and employees) vs. doing what’s best for the shareholders (who elected the directors to represent them).

    In good times those interests are usually aligned, but if the company becomes insolvent, the director’s duties shift to the corporation’s creditors. And sometimes what’s best for the shareholders can be to sell the company to a competitor (who may then shut down the company and fire its employees). That may not appear to management to be acting out of “loyalty to the company”.

    I know that’s not going to help sell the need for a board to an entrepreneur, but I thought it was worth reminding entrepreneurs who accept private equity that the shareholders are going to expect a liquidity event someday, and the board’s job is to get it for them.

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