For some owners of closely held companies, installing a board of directors may seem more painful than cutting off one of their pinkie fingers.
They’d have to give up control of their business.
They’d have to share confidential information.
They’d have to waste time on the formalities of having a board.
They’d have to waste money on compensating directors.
Putting aside for a moment whether these concerns are valid (they’re not), for many owners of closely held companies, installing a board could be one of the best things they do for their companies—and their sanity.
The guidance, knowledge, and wisdom provided by a board, and the healthy separation a board creates between a closely held company and its owner(s), can be invaluable to the maturity and growth of the company.
The kinds of boards closely held companies could install
Before we go deeper into the benefits the owners of a closely held company can realize by installing a board, let’s look at the kinds of boards a closely held company could install.
On one extreme is the compliance board. Many states require incorporated companies (but not LLCs) to have boards. A compliance board is a non-functional board meant to meet legal requirements—and little to nothing else. Often, the only members of a compliance board will be the owners of a business.
One step away from a compliance board and toward a functioning board is the insider board. An insider board will often include family members of the owner(s) and members of the company’s management team. The insider board may be created by the founder(s) but is designed to involve the family and senior management in big-picture planning for the company. However, the owner(s) will retain the authority to make decisions.
Inner circle board
Moving past a board stocked with family members of the owner(s), the inner circle board contains directors the founder(s) or owner(s) know well and who possess knowledge and wisdom beyond that possessed by the owner(s) that can guide the company toward growth—and perhaps challenge the thinking of its owner(s). An inner circle board may even establish committees, such as an audit committee. However, the owner(s) will retain decision-making authority.
Finally, the most independent board structure we’re likely to see in a closely held company is the quasi-independent board. With this structure, there will be outside/independent directors who have no tie—employment, familial, or otherwise—to the company aside from their roles as directors. With no ties to the company, these directors are likely to be more objective and less deferential to ownership than their counterparts in the above three board structures. They will expect their input will be considered when decisions are made. With a quasi-independent board, the owner(s) may not retain full decision-making authority like they would with the other board structures.
Why owners of closely held companies should consider installing a board
As a lawyer representing closely held companies and their owners, I have seen firsthand the advantages a board of directors can provide.
Yes, having a board will help closely held companies comply with the laws of their states where those laws require corporations to have boards.
Yes, having a board will help streamline the process of establishing a special litigation committee (as we described a while back in this post).
Yes, (and as I mentioned above), directors bring with them knowledge and wisdom beyond that possessed by the owners. Directors’ experience and their areas of expertise—sales, marketing, operations, legal, finance, whatever—can only add to whatever experience and expertise the owner(s) and their employees are already bringing to the table.
But most importantly, a board can help the owners of closely held companies get of out of their own way. A board can provide much needed separation between owners and their businesses. Separation that is necessary for both the owners and their businesses to prosper.
Directors bring the perspective of strategic, big-picture thinkers who are not mired in the day-to-day operations of a business. They have a bird’s eye view of the business, the company’s industry, and (hopefully) relevant trends that will impact both. This separation is something owners of closely held companies are unlikely to have until they’ve scaled their business and have a management team in place to handle day-to-day operations and firefighting. Spared from having to play WHAC-A-MOLE®, directors can focus on strategic initiatives that would have otherwise been impossible to conceive and implement if left to the owners given the stress they’re under simply to keep the business running.
Equally as important, directors don’t take personally the issues that arise in the day-to-day operations of a business that owners often do.
There is a tendency for owners of closely held companies to view their companies as extensions of themselves. If something bad happens to their company, then something bad has happened to the owner too. This emotional involvement creates an unduly stressful environment in which it becomes increasingly difficult to make sound, rational business decisions.
When a customer doesn’t pay, it’s as if someone mugged the owner.
If an employee sues the business, it’s as if the owner is under personal attack.
The business’s problems become the owner’s problems—and both are worse for it.
It is far healthier and more functional to view the business for what it is: a tool. If a farmhand breaks a tractor wheel, the owner of the farm doesn’t react as though a part of them had been destroyed. The broken tool is not a personal affront; it is merely a problem that needs to be addressed.
If we apply this mindset to the ownership of closely held companies, the stress similarly begins to melt away.
If a customer refuses to pay, perhaps the business needs to adjust how it handles its accounts receivable, or change its payment structure.
If an employee sues the company, maybe the company ought to consider Employment Practices Liability insurance in the future.
Good business decisions can’t be based on fleeting passions and grievances. They should be grounded in a rational and impersonal assessment of the situation. A board can help ensure such an assessment is the norm.
Obviously, this is easier said than done. One can’t simply flip a switch and instantly separate business from emotion. But having a board of directors is tremendously helpful in creating that separation. A healthy separation between closely held companies and their owners reminds owners they are not their companies, and vice versa. Directors don’t take delinquent customers or lawsuits from problem employees personally, and their presence helps owners not take such things personally either.
Dispensing with the perceived drawbacks of a board
I’d be remiss if I didn’t revisit the drawbacks I mentioned at the beginning of this post that owners of closely held companies fear come with installing a board. I can dispense with each of them easily.
Owners who fear they’d have to give up control of their businesses if they install boards will be happy to learn that so long as they are the controlling shareholders, they remain in control of their businesses no matter how independent their boards are.
Owners who fear they’d have to share confidential information with board members can have directors sign nondisclosure agreements or choose to have only insiders on their boards.
Owners who fear they’d have to waste time on the formalities of having boards can bring in coworkers to compile agendas and materials and take notes. (The goal, of course, would be for boards to provide so much value to the owners and their businesses that any administrative costs of having boards is a small price to pay for unlocking such value.)
Finally, owners who fear they’d have to waste money on compensating directors can provide equity to their directors. (Again, hopefully the directors create the kind of value that dwarfs their compensation.)
Bringing boards aboard closely held companies
I assume that when many owners of closely held companies think about boards of directors, they envision mahogany-lined boardrooms at huge, publicly held companies filled with people in suits methodically proceeding through an agenda before enjoying an exquisitely catered dinner. They might shudder at what they believe are the time and financial investments required to install and maintain a board at their own companies.
Given what I’ve seen in my legal practice, those owners stand to lose more by standing pat than if they were to bring aboard a board of directors.
For owners of closely held companies serious about growth and increasing their revenues while also being serious about creating healthy separation between them and their businesses, installing a board of directors may be the kind of investment that provides an incalculable—and indispensable—return on investment.