The Benefits of a Board of Directors and How to Measure Its Effectiveness

A Board of Directors is not just a sign of growth and maturity in your company. It’s also an essential key to growth.

by Jana Matthews
Founder and CEO, Boulder Quantum Ventures in EntreWorld.com

You’ve always relied on the advice of friends, family, peers and your management team. But if you want to grow, you need to start thinking about establishing a Board.

Consider starting with a Board of Advisors. Although informal, a Board of Advisors is established to provide advice to you. It can consist of your current brain trust, but consider adding some outside voices as well for balance. They are simply advisors, and do not possess any formal or legal responsibilities to the company.

Ultimately, as your company grows, and your responsibilities and commitments to shareholders become great, you will need to create a formal Board of Directors. The Board of Directors will also provide advice, but they provide a needed legal and fiduciary responsibility to the company’s shareholders. They will also unlock opportunities and solve problems for you and your company.

Some entrepreneurs are reluctant to appoint a Board of any kind. They think a Board is a bureaucratic hindrance or a threat to their control of their company.

Control is a significant issue for many founding entrepreneurs and some have difficulty delegating or sharing decision-making with others. To avoid that perceived loss of control, some entrepreneurs will not appoint a Board of Directors at all, or they populate it with friends and family who won’t give the founder a hard time, or ask difficult questions. With no Board, or a mere rubber stamp, those entrepreneurs gain little value.

But just as you need to find and hire people smarter than you, you also need to find Board members who complement your weaknesses and can help you grow your company.

The right Board of Directors can open new doors for you and can help you avoid trouble. However, you’ll need to invest some time and effort to make sure you choose the kind of Board members who can add value to your company. You need to learn to work with and learn from your Board members. It’s also your job to manage the Board and avoid creating a bureaucratic headaches or dramatic shifts in leadership and management of the company.

As one entrepreneur said to me, "I don’t know why I waited so long to appoint a Board of Directors. The company has grown by leaps and bounds since we did it. I’m not saying it’s always easy. It’s not really fun to go to meetings and have smart people challenge your assumptions. But the Board has saved us from several bad decisions, bad deals, and has helped us develop a killer strategy – so I can say it’s definitely been worth it. I’m finally learning how to learn from the Board members and how to manage the Board. It’s been a great experience."

The Benefits of a Board of Directors
A strong Board is an invaluable asset in building company value. Well-chosen members have experience and wisdom that complement a CEO’s energy and enthusiasm. Board members who have been through the growth process can provide sound business advice and lessons learned from past experiences. Through their involvement with other companies, they can share many valuable lessons about how to avoid the edge of disaster, and how to grow successfully. Board members can help you navigate fast growth and get from one stage to the next without capsizing.

Good Board members can also open doors for you. They have contacts and connections and can put you in touch with lawyers, accountants and consultants who have the expertise you need. They can introduce you to potential employees, clients and customers, and help you find additional sources of financing.

A great Board will build your company’s credibility. It will send a clear signal to your employees, your investors, your customers – and even your competitors – that you are serious about growing your company and becoming a competitive force.

Building the Perfect Board

We’ve noted that you need "good" Board members and should try to build a "great" Board. How do you create such a Board for your company?

Take a step back to your business plan. Where do you want to take the company? What help do you need to get there? What kinds of people and what kinds of expertise and experience will help you get there? Answering those fundamental questions will point you towards the right people for your Board.

Your Board members should possess compatible values and share your vision for the company. They should support the kind of company culture you are creating – or want to build. They should also be willing and able to spend the time needed to help you build the company. If they don’t fit these criteria, they will not be a good fit for your company’s Board of Directors, no matter how much knowledge, experience or expertise they have.

Collectively, the Board of Directors can compensate for your weaknesses and your lack of experience. They can help you develop strategy and open up new markets. To find people who can do all that, you need to be honest about your strengths and weaknesses and be open to learning from these Board members.

Your Board can supply the specialized knowledge you need, such as in-depth understanding of your industry sector, customers, funding sources, products and technology). When reviewing your business plan, consider where you think the company will be in three to five years and what it will take to get there. Board members can lend unique experience and expertise to the big decisions ahead: finding angel or venture capital, negotiating strategic alliances with large companies, acquiring and merging one or more companies, selling your company or going public. Select members with those potential events in mind. Of course, you will also benefit from people who are leaders in their own right with a broad understanding of the challenges of your industry, entrepreneurship, and growth.

Select three to five outside Board members to complement two inside Board members. In addition to you (the CEO), the other inside member should be a member of your top team such as your Chief Financial Officer or Chief Marketing Officer.

One thing to avoid when selecting your Board is a "yes-man." A Board is not there to rubber-stamp your decisions. Their purpose is to review, discuss, and even challenge your thinking, plans and recommendations. You want experienced people to help you avoid making bad decisions – and to understand the implications of decisions you do make. Look for people who ask hard questions about your company, your culture, your plans, markets, and strategy. Common goals and shared vision are important, but you need checks and balances to your decision-making. Select people who share your values and your vision, who will challenge you, but will also help, coach, support, and encourage you to achieve your goals and grow your company.

The Board Meeting (and Beyond)

How often should the Board meet and how involved should they be between meetings? When a company is growing, it’s useful for the Board to meet on a quarterly basis. However, if a company is growing rapidly or the market is changing dramatically, it may be essential for the Board to meet more frequently, as often as every four to six weeks.

With the talent and experience available on your Board, you may find other opportunities to involve members even more closely. In some situations, Board members may get actively involved from start-up. Your Board can help create or shape company strategy, define new markets, and build the management team. Be sure to talk about the amount of time you think you need from each member, and ask about the amount of time each person is willing to provide. Whenever Board members play a hands-on part, you need to clearly define their roles and responsibilities to avoid confusion and conflict between Board members and your senior management.

The Roles and Responsibilities of the Board

While every Board of Directors will face a different set of problems and opportunities depending on the company’s stage of development, and the market environment, all Boards have a core set of responsibilities.

The Board has a fiduciary responsibility to the shareholders of the corporation. Even if you, the CEO, are the majority shareholder, the Board still carries that responsibility! The Board is also responsible for hiring and firing the CEO and the officers of the company and for setting their compensation. The Board should support the company’s leader and senior management as long as they are performing, learning and improving, operating within the approved plan and achieving expected results.

Your Board of Directors also needs to be prepared. Board members should review reports and advance materials and be ready to participate in Board meetings. They should provide their best professional judgment and share their experience, ideas, and networks of potential customers and sources of financing.

Your Roles and Responsibilities to the Board
Just as you have expectations for Board members, the Board will have expectations of you and your team. They expect you to have a clear vision and mission for the company. The Board expects you and your top team to formulate the business plan, to discuss it with them, to take their comments into consideration, to execute and manage according to the plan, and to report back on outcomes.

You and your team should provide regular reports to the Board on your progress toward plan. If you have deviated from the plan, provide reasons for doing so. If things are not going as planned, or if something has gone wrong, be sure to tell the Board. Board meetings work best when the "no surprises" policy is in effect. Standard reports should be supplemented with updates between Board meetings as necessary or prudent.

Treat your Board members with respect. Hold Board meetings on scheduled dates. Last minute cancellations aren’t just rude, but they may prompt your Board to suspect you are hiding something! Provide materials in advance so members can prepare for Board meetings. Don’t Fed Ex six inches of materials two days before the Board meeting and expect Board members to stay up all night reading the materials. Remember that when someone agrees to serve on a Board, that person assumes certain risks and responsibilities, and agrees to work on behalf of the company– often for little personal gain.

Be open with information. In order to be effective in their role, Board members need to understand what’s happening in your company. Give them free access to your management team as well as outside experts and specialists such as accountants, attorneys, and bankers.

Don’t just be open; be honest and straightforward when assessing issues and problems with your Board. Trust is a very precious commodity – and so easy to destroy.

Care and Feeding of the Board of Directors

You need to take care of your Board legally, financially, and professionally. Provide indemnification insurance as appropriate and consult with your lawyer about ways to protect your Board from inappropriate litigation.

Work out fair compensation for your Board’s time. The spectrum ranges from a flat fee per Board meeting to stock options set at a certain strike rate to a grant of a certain number of options for every one they buy. You also need to reimburse members for travel and other expenses incurred in connection with their roles and responsibilities as Board members.

The greatest compensation an entrepreneur can offer a Board member ultimately is to make their time on the Board a rewarding experience. Engage them in projects that are interesting. Value and respect their advice, counsel and opinions! Great Board members truly crave the satisfaction of helping a company grow and a fellow entrepreneur be successful.

Final Thoughts

If you’re still concerned that if you appoint a Board you’ll lose control – or be replaced, there is always that risk. The best ways to avoid that risk are also some of the best ways to grow your company. Develop a sound business plan. Build a team that works well together. Listen to your Board. And keep growing the company.

The last thing the Board will want to do is kick you out of the company. They want to see you succeed and they want to help you succeed! They would much rather keep you than replace you. Of course, without a good plan, or you’re not achieving expected outcomes, or you have a dysfunctional top team, if you are at war with your Board, then they can – and should – take action. They should begin with a warning – and they may ultimately have reason to replace you – because they have a responsibility to the shareholders of the company. However, in most cases, the company’s goals, your goals and the Board’s goals will be totally congruent, and focused on growth and success.

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Measuring The Effectiveness of Your Company’s Board of Directors

by Andrew J. Sherman
Senior Partner, McDermott, Will and Emery

Recent corporate scandals and accounting fraud has lead to federal and state legislation, as well as an outcry from the general public, for more accountability by and among corporate executives, Board members and their advisors to shareholders and employees. Recent corporate governance policy goals include more objectivity in the composition of Board members, more independence and autonomy for auditors, more control over financial reporting, stiffer penalties for abuse of the laws and regulations pertaining to corporate governance, accounting practices and financial reporting, new rules to ensure fair and prompt access to the information and current events which affect the company’s current status and future performance.

Yes, companies of all sizes – both public and private – and in a wide range of industries are truly entering a new age of scrutiny – an era of validation and verification. The role of the Board and its committees are being redefined, re-examined and re-tooled. A new set of best practices, procedures and protocols are being written as we speak, and this process will continue into 2004 and beyond. Owners and managers of entrepreneurial companies need to make sure that internal controls and systems are designed to ensure compliance with the new best governance practices, and managers must be held accountable for enforcement and results.

The Corporate Governance Best Practices Audit

A natural place to begin the review and analysis of current corporate governance practices would be a legal and strategic audit that focuses on compliance with current laws, as well as the adoption of new procedures to ensure that systems and internal process are in place to comply with the new laws and regulations. The legal audit should include recommendations for the improvement of governance systems and communications channels, and it should provide a series of compliance training programs for officers, directors and managers with significant financial or reporting responsibilities.

Among the issues and topics to be examined and discussed during the Corporate Governance Best Practices Audit included the following:

* Size and composition of the Board and the relationship of its composition to the performance of the company. (The definite trend is towards smaller Boards with higher ratios of outside directors.)

* Independence and objectivity of the Audit Committee, which must meet the new Sarbanes-Oxley requirements.

* Knowledge, skills and discipline of the Compensation Committee (Note: Many predict that the members of these committees will be next in line for the "hot seat" and be forced to meet the more stringent independence requirements that audit committees already face.)

* Overall structure of Executive and Management Compensation and Stock Option Plans (pay for performance, fairness issues, linking reward with the meeting of strategic objectives, the reduction of excessive perquisites, the Board’s ability/willingness to stand up to the CEO, and so on are all current issues which will require examination.)

* Internal control processes to ensure that the Board is fully and promptly informed, adequately performing its oversight role, and that "red flags" are addressed properly and in a timely manner. (It is now critical to have a written statement of corporate governance policy in place.)

* How closely and effectively does the Board monitor the integrity and accuracy of the company’s financial statements and reports without micromanaging the process?

* What is the compensation system for the Board members? To what extent is Board compensation influencing its objectivity? Are directors required to own, or not own, a specific amount of company stock?

* How transparent are communications with shareholders and the financial markets? Are the requirements of Regulation FD being met?

* How effective are the Board’s strategic and business planning skills? Have clear goals been set for the executive management team? How well is the team implementing these goals, and how closely is performance monitored?

* What risk management procedures are in place? The audit should include a comprehensive review of the officer and director liability insurance policies, as well as other types of risk management, such as information/data security, physical security, and so on, especially in a post 9-11 world.

* What succession plans are in place at both the Board and executive management levels?

* Do the skills of the various Board members match up well with the company’s current medium- and long-term strategy? Have any shifts in the company’s focus or changes to its business model triggered the need for new directors with a different set of skills? What procedures are in place for replacing directors that now may be obsolete?

* What proactive steps is the Board taking to maximize shareholder value, such as the leveraging of existing intellectual assets?

* Does your Board have a Nominating Committee? Are its policies and criteria clearly articulated? If yes, how closely are these policies followed? What due diligence is done on prospective candidates (and vice versa)?

* Is there a performance review process for Board members? Why or why not? If yes, how effective have these reviews been in improving individual member or overall Board performance?

* Are Board meetings held both with and without the CEO present to encourage candor and objectivity? Who selects and appoints committee chairs and committee members? The Board? The CEO? Do the by-laws allow for a non-executive chairman? If yes, have the differences in the responsibilities between the Chairman and CEO been clearly articulated? Is there good chemistry between the Chairman and CEO? Why or why not? Are periodic meetings of only the independent directors held?

* How frequently does the Board meet? Who sets the agenda? How effective are meetings? Are there minimal attendance standards? How often do the committees meet? How many committees are in place and how well do they function? Are they adequately reporting to the entire Board? Are lines of authority between the Committees and the entire Board clearly established?

* Does the Board have a contingency plan in place if the company becomes financially distressed? Does the Board understand that its fiduciary responsibilities may extend to other types of stakeholders, such as creditors, vendors, as workout plans and strategies are developed?

* Does the Board have a formal orientation program for new members? When was it last updated?

* Does the Board composition reflect gender, ethnic and racial diversity? How many international members are on the Board? What is the average age of Board members?

A corporate governance process must be put in place that restores the integrity of the company’s leadership in the eyes of the shareholders and employees, creates truly informed Board members who have the power to act based on timely and accurate information, and protects the authority and fosters the courage of the Board to take whatever acts necessary to fulfill its fiduciary obligations. In reexamining the roles, functions and responsibilities of Board members, it is no longer sufficient to merely make a periodic meaningful contribution to the strategic direction of the company. Rather directors must now be more proactive as defenders of the best interests of the shareholders and also employees, who are participants and beneficiaries of pension, 401(k) and stock option plans. Board members and corporate leaders should assume that their meetings will be in "rooms with glass walls" and that their actions will be examined under a microscope, at least until general market confidence is restored.

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The Entrepreneurial Director: An Uninvited Guest

by Michael J. Meyer

Merit Capital & Management, Inc.

Do you remember the strange feeling you had the first time you paid a visit to the parents of the person you were going to marry? You knew that at least one of the parties wanted you there – your fiancé – but you didn’t know quite what to make of the others, nor they of you. If you remember, you might have some idea of what it is like to serve on the board of directors of a company at the request of the owner or investor, but not necessarily the management team. You are an uninvited guest, a situation I have experienced several times over my 25 years of investing in, managing and serving on boards of companies.

By design, some inherent conflict exists between a board of directors and a management team. If the conflict is acknowledged, appreciated, respected and managed by both sides, it can produce extraordinary dividends for executives and directors alike, not to mention the company and its stockholders to whom both parties owe their ultimate allegiance.

However, the role isn’t easy, and all parties must persevere to make it work. At no time in history, moreover – given the difficult economic environment, the highly publicized ethical lapses on the part of major companies, such as WorldCom and Enron, and the subsequent regulatory crackdown (can you even say Sarbanes Oxley?) – has the job of the outside director, and its inherent conflict with the management team, been so apparent and so publicly scrutinized.

Where the Buck Stops

The paramount question is this: "What is the true role of an outside director, and how can one most effectively perform in that role?" Formulating the right answer is critical, not only to the future of the companies that must make effective use of boards, but also to that of the American economy. Government regulation alone will not repair the damage done to investor confidence. The buck stops in the boardroom, and getting it right there will depend upon entrepreneurs, management teams and outside directors all understanding their respective roles and performing in their jobs well.

I would like to suggest three areas of focus for a company’s board members and entrepreneurial leader, or CEO. Openly and aggressively addressing each aspect of these focal points will improve the boardroom environment for the "uninvited guests" and the management team, and thus benefit the company and its shareholders. Specifically, an effectively functioning board of directors revolves around all participants understanding their Shared Constituencies, acknowledging their Separate Responsibilities, and creating the Proper Environment. What follows is a discussion of each.

* Shared Constituencies

With one exception, directors and officers share responsibility to the same parties, the first among them being the stockholders. Individuals or entities that provide risk capital to an enterprise deserve the consummate effort and loyalty of anyone who works for, or serves as a director of (and is thus being paid by), that company. Every decision by either the board or the operating leadership must be evaluated for its impact on shareholder value. This is not to say that decisions are easy or that managers and directors will agree. It is just that both must use their best judgment to ensure that decisions positively impact shareholder value.

Secondly, board members and managers have an obligation to employees. A place of business that is safe and professional – where employees can enjoy their work and receive frequent and open communication – is the hallmark of a thriving company. It is the responsibility of the board and management team to ensure that such an environment exists at their company.

Third, without satisfied customers, no company can survive. Ensuring a proper focus on the needs of the customer, including the delivery of a high quality, valuable product or service, is a shared responsibility. While the management team implements the strategy, managers and directors must both possess a keen understanding of the marketplace in which the company operates and the needs of the customer, as well as work to reinforce a customer focus.

The fourth shared constituency is actually the company’s adversary – its competition. Successful business leaders, be they directors or entrepreneurs, thrive on beating the competition, and thus share the responsibility for ensuring that the company is positioned well relative to its competitors. No director can help develop an effective long-term vision and strategy for a company – a prime board responsibility – without a complete understanding of the competitive landscape in the industry and a passionate desire to win.

Finally, I mentioned an exception to the shared constituency concept. It is that the board is responsible for both supporting – and evaluating – the leader of the company, and to a lesser extent, the entire management team. Herein lies the inherent, though healthy, conflict. It is the most potentially explosive of all of the roles an outside director must fulfill, and one that necessitates balancing an appropriate amount of support and judgment. I will discuss this matter further later in the article.

* Separate Responsibilities

An effectively functioning board presumes that all directors – including those who are also officers – understand that the board’s responsibilities differ in some respects from that of the management team. After all, if that were not the case, a board wouldn’t be necessary or beneficial. Let’s examine the four such areas.

The first is strategic planning. While the company’s officers develop its long-range plan, directors ask the tough questions, ensuring that management undertakes the necessary thorough research, evaluation and testing. Directors also support the strategy once it is put in place and continually monitor its effectiveness and appropriateness in what is likely a rapidly changing market.

A CEO manages the day-to-day operations of the company, whereas, as noted above, directors evaluate the performance of the CEO and other officers. Although an independent minded entrepreneur might not take to the analogy, the relationship is much like that of parent and child. The director needs to counsel and support the CEO. Undoubtedly, there will be times when stern advice or discipline is in order – best delivered, from my experience, through examples from the director’s own experience. It is vital that directors not make arbitrary or uninformed judgments or allow the issue to become personalized. Directors, especially of public companies, must also ensure that the company adheres to flawless legal and ethical standards and that accurate and timely financial information is distributed.

The company’s CEO is its chief communicator, not only of financial information, but also all initiatives on the part of the management team. An effective tool that I encourage entails a weekly "dashboard," containing all of these so-called Key Performance Indicators, or KPIs. Cumulative information should be included as well. As recipients of the information, directors need to evaluate it objectively, while keeping it confidential and supporting management. The board’s objective is to encourage management to achieve even higher levels of performance against stated objectives concerning matters such as product development, increased market share, cash management or profit improvement.

Officers get paid for results, but stockholders need to get "paid" as well. It is the board’s responsibility to ensure a proper balance of the rewards for those who work to deliver the results – the management team – and those who provide the capital that is also vital to the opportunity to pursue a vision. In short, directors must create a compensation structure that attracts and motivates able employees while accounting for shareholders’ interests.

These areas of differing responsibilities have the potential to create a difficult and uncomfortable relationship in the boardroom. However, conflicts can be avoided, as long as board members and officers clearly understand, not only their own role, but also the role of the other party. They need to recognize that each party must continuously make difficult judgments and decisions with less-than-perfect information in an ever-changing marketplace; and they must fulfill their role and conduct themselves in a professional manner. Given all of the above, a collegial, productive board of directors can work well together in the creation of stockholder value.

* Proper Environment

Several other structural and behavioral factors have been apparent on the most effective boards on which I have served. Among them are the following points that, I believe, merit consideration.

If entrepreneurs or owners are going to make a realistic attempt at creating a legal board of directors (or even a valuable and effective advisory board), a minimum of two outside directors is an absolute must. This step helps eliminate the inherent conflicts and provides at least double the unique perspective on any given issue. A board size of five to eight members, each with a different personal and professional background, is ideal. Quarterly meetings are most frequently utilized, but I like monthly meetings if you can get the members to commit to the time required. Set aside a portion of each meeting for the outside directors to gather separately as a group.

Avoid lawyers and accountants whom you can pay for advice. Instead, recruit CEOs and other entrepreneurs who have a wealth of experience dealing with business challenges. You can probably never pay them what they are worth, but you will be surprised how willing many will be to help a fellow entrepreneur by serving on the board.

Create and work in an environment of mutual respect. The individuals you want to attract are successful business people. You will learn by listening to and respecting their opinions. Similarly, anyone willing to serve on a board should have a healthy respect for the company and its CEO and be passionately engaged in helping the company attain its goals. Understanding cuts both ways. Focus on doing your job, be it director or officer, and respect the other side by allowing it to do its job.

All board members, whether outsiders or insiders, must come to the table with radical objectivity and an open mind. Only major issues should be addressed at the board level. Each must be thoroughly presented, evaluated, analyzed and discussed. Innovative and creative thinking is required to make the right decision. Applying previous experiences to board level issues is appropriate. However, unfounded biases or irrelevant opinions have no place at the boardroom table.

Open, two-way communication is essential, particularly when bad news must be conveyed. As a director, I expect "no surprises." I want to be told early when problems arise and be given full disclosure. CEOs should expect the same from me. If I am concerned about the leader’s performance, I will tell that person, as difficult as that may be for both of us. Often, such discussions begin best in a private encounter.

Finally, directors and officers must "do their homework." The management group needs to prepare a full set of materials for directors to review well in advance of board meetings. Directors, in turn, must read and assess the information in order to come prepared. In addition, skilled directors conduct their own independent research and inquiries into the company, its products and industry, and share their findings with the full board.

When you put together a board of directors for your own company – or are forced by investors to welcome an "uninvited guest" – you might not be pleased. Should you be asked to serve as a director in this tense regulatory environment, you may even be frightened. But put your concerns to rest. If you function in a proper environment where you recognize both your shared constituencies and separate responsibilities, you will have a challenging and rewarding experience – one that benefits both your company and its shareholders.

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