“Good Governance in Private Corporate Ownership,” as seen on NACD Private Company Direct

December 2020

Good Governance in Private Corporate Ownership

Private company directors must achieve a balance between considering what is best for the business while respecting what is preferred by the owner.

Public companies ask the board to serve in a governance role with authority over management of the business and strategic decisions. It is expected that public company directors will use their authority to focus on increasing the value of the business.

Private companies typically want a board composed of individuals with relevant expertise and experience who represent a sounding board for the owner. Those advisors, as with public company directors, are expected to help increase the value of the business. The fundamental difference between public and private companies is that private company advisors do not have the authority vested in public company directors. Instead, private company ownership, rather than the board, is vested with the power to make decisions.

The difference between being a public company director and a private company advisor can be immaterial or unnoticed until there is a major difference of opinion on a sensitive or important issue. Every private company advisor has the responsibility to provide sound guidance while acknowledging the owner, with ultimate authority, can accept or ignore that advice.

It is natural that owners value the autonomy which enables them to work in their preferred manner, including who manages the company, how it is run, goal setting, investment decisions, acceptable risk levels, etc. The board of advisors fulfill their obligation by providing the best advice possible. The owner’s “privilege” is to choose to ignore that advice. Public company boards find ways to work through differences of opinion when decisions must be made. Private company directors learn to acknowledge that a consensus may not be achievable.

Once the private company owner understands the board’s recommendation, the private company board can conclude its obligation. For clarity and mutual respect, the advisory board can ensure clarity with statements like “This is our recommendation and, while we do not agree with, or condone your recommendation, we acknowledge that this decision is yours to make.”

Private company advisory board members can anticipate high owner sensitivity around the following business issues:

1. Executive leadership. Succession planning is an ongoing responsibility of public company boards. Engaging in succession planning with owner CEO’s often provides boards with their foremost challenge. Achieving a sound succession plan may be more likely if done during a period of company success, positioned as a best practice for emergencies, and when the process commences with impersonal criteria.

2. Board of advisors. Creating a board or replacing board members can lead to difficult decisions. Public company boards focus on developing the appropriate skills matrix and on recruiting independent individuals with those skills. Public company board composition is determined by the board, not by the CEO. In contrast, private company CEOs often determine the composition of their boards. When private company directors are selected for reasons other than relevant expertise, experience, and independence, the potential capability of the board of advisors is diminished.

3. Growth versus profitability. Company value is typically dependent on the growth of both revenues and profits. Increasing the rate of growth often requires increased investment in R&D, marketing, and/or the sales force, potentially reducing profitability, at least in the short term. Public company boards can design management incentives to motivate behaviors that drive growth. Private company owners are often dependent upon the company’s cash flow. Private company advisors can avoid developing conflicting expectations by objectifying the valuation impact of alternative growth initiatives relative to the effect on owner’s cash flow.

4. Capital investments. Acquisitions and other capital investments that require owner funding can lead to a difference of opinion between well-intentioned advisors favoring a business alternative and the owner, who must provide the capital required.

5. Risk tolerance. Private company advisors and owners may have different perspectives on acceptable levels of risk. Making explicit the risks associated with a business decision can facilitate a more objective discussion of the fundamentals of the alternative being considered.

6. Sell vs. retain. Advisors may become involved in deliberations regarding whether the company should be sold. Objective analysis can indicate the relative value of divestment versus continued ownership. However, owners may have personal, non-quantifiable reasons for selling or retaining the business. Private advisors will need to address the owner’s personal preferences in addition to the business aspects of a transaction.

Private and public directors require the same business expertise. Private company directors also need to be capable of identifying and incorporating the owner’s preferences to reach effective consensus.

R. John Fletcher is the managing partner of Fletcher Spaght, a strategy consulting organization, which he founded in 1983, and managing director of Fletcher Spaght Ventures, a venture capital fund. Before FSI, Fletcher was a senior manager at The Boston Consulting Group. John currently serves on the boards of Axcelis, Clearpoint Neuro and is Chairman of Koru Medical and Mebaolon. Previously, he served as chair of Spectranetics during its turnaround and subsequent sale to Philips NV; for this work, he was selected in 2018 as the NACD Director of the Year.

Link to original article here.