What Most Businesses Need Before an Outside Board

During the professionalization phase, a founder wants a good mechanic—not back seat drivers.

By Donald J. Jonovic

“No way” the chairman told me when I suggested creating an outside board for his electronics distribution company. We were working on a number of leadership transition issues with him and his two partner brothers. It was going along smoothly until the chairman dug in his heels in opposition to the idea of a real board.

I was not surprised. In fact, I had suggested a board only to remind him of the ideal: Many specialists—myself included—believe that family businesses benefit in the long run from having a formal board composed of a majority of outside, risk-taking peer directors. Like many business owners, however, my client instinctively resisted creation of a formal board.

I agreed with him. Although he and his brothers had a large company employing more than 100, neither they nor the business were ready for outside directors. What we created instead was an advisory board, which has now been operating successfully for two years.

I was long a proponent of outside boards, which I considered the most effective source of review for the majority of closely held companies. While I still believe that such boards ultimately have a powerful role to play, I no longer see them as the primary, or most effective, body for most companies.

In my consulting experience, I’ve found that most family businesses require significant evolution before they can benefit from a board of directors. A board does not become important or potentially effective until the company is well through the “threshold” transition between entrepreneurial venture and professional management. To respond to business and family needs during the transition, an advisory board, or advisory council, is more useful.

Family businesses usually go through a difficult period when they have grown beyond the founder’s direct influence but have not yet professionalized management. Some companies take longer—perhaps generations—to cross the threshold, and size appears to have little to do with how quickly the transition occurs. Even large organizations can function for some time in this twilight zone.

The essential milestones that a company must pass in evolving toward professionalism are:

1. Adequate, formalized shareholder agreements.

2. Agreement on goals and objectives for the business as an investment (growth objectives, tolerable risk levels, returns expected, and so on).

3. Timely, accurate accounting information, in a form that facilitates planning, operational decision-making, and performance review (for example, operating and capital budgets, and regular key-results reports).

4. Strong, coordinated middle management, motivated by an incentive compensation plan that is geared to achieving performance goals.

Most business founders require some professional or technical advice from the beginning, if only to draw up partnership agreements and satisfy tax reporting requirements. The need for this kind of expertise continues to grow as the business evolves.

For the most part, however, the typical entrepreneur has tunnel vision when starting out; he relies on drive, adrenaline, and persistence to punch through barriers and reach goals. True outside review, by contrast, is inherently analytical, critical, questioning—in clear conflict with the entrepreneur’s style.

In a perfect world, such conflict in style could be intellectually stimulating. In the real world, however, survival is a white-knuckle thing, like barnstorming. The entrepreneur feels he can study the fine points of flying later. What he needs now is not back-seat instructors. Just give him a good mechanic or two.

Eventually, however, the business owner’s afterburners begin to sputter, and he looks around for suggestions on how he can power up for the next phase of growth. He needs a brain to pick, a sounding board.

At this stage, he or she usually looks for advice from professional advisors, consultants, or peers in the industry. In most cases, these people have in-depth knowledge of the workings of the business and the specific characteristics of the owner’s industry. That is not what one normally looks for in outside directors, who are supposed to be knowledgeable about business in general but not be in the same industry. Outside directors are there to provide an objective view of the company, not to confirm the owner’s assumptions and biases. Instead, through the threshold phase, most owner-managers can get more benefit from technical professionals or industry peers. (In some industries, groups of CEOs who get to know each other form review groups that periodically descend upon a member to evaluate his or her business.)

Still, important issues arise during the transition period that require specific expertise rather than objective review. For example, the company usually needs help in bringing the shareholders together in agreement on goals and objectives. Shareholders must separate their combined roles as owners, directors, employees, and family members before they can discuss common strategic goals. Frequently, they develop formal agreements that define their expectations of one another, and they outline procedures to handle disagreements.

The family also needs intensive help in planning the management succession. They face questions about successor competence; the rights and benefits of family managers; selection of future key managers (along with avoidance of nepotism); and a sensible, secure retirement plan for the present owner. Different family cultures and multiple blood relationships are often major factors in these decisions. The process of selecting new leaders must be managed in a way that is integrated with everything from compensation systems to projections of future business value. Outside directors rarely have the time or expertise for such hands-on work.

Along with a succession plan, the family needs to achieve agreement on the transfer of ownership. This is not merely a question of estate planning. There are also questions to be answered about the ownership structure that will be put in place, of who will have voting power and control, of what capitalization strategies and buy-sell agreements are appropriate.

Although outside review can help in carrying out this work, the issues can seldom be decided without guidance from professionals in law, accounting, insurance, and family business management. Few outside directors have the necessary training, experience, or inclination to offer advice on these matters. And until the basic questions are resolved, few businesses or families can address strategic issues—the outside director’s meat and potatoes—effectively.

Gradually, the need for such professional advice declines in the threshold period as the management team takes shape. Ownership issues have been settled; operating issues are increasingly analyzed and tested internally, and the next-generation leaders begin to take charge.

Only then, well into the transition period, as management develops a strategic focus, does the business begin to have a significant need for the kind of independent, long-range thinking that an outside board of directors can provide. Up to that point, however, professionals working with the owners—and one another—can do a much better job of laying the track for the transition. The advisory board may consist of an accountant, an attorney, the senior owner-managers, perhaps an industry consultant, and possibly a representative of non-participating shareholders.

Few experts would argue that non-participating shareholders are appropriate for outside boards. But through the threshold phase, the support of these shareholders is often essential. Their membership on an advisory board is natural and acceptable; it also offers an opportunity to educate them and gain their support.

Further, through the threshold transition, a family business consultant can help resolve family issues and acquaint family members with their roles in the new structure. This involvement can be short-term or long-term through the transition, depending on the need.

Perhaps the greatest worth of an advisory board during the threshold phase is to ensure continuity and coordination. Too often in family business transitions, experts are allowed to give advice in compartments and the process moves by fits and starts, because there is no formal organization to oversee it. By setting up an advisory board that meets regularly, with agendas and minutes, the owners ensure continuity in attention to the issues, coordinated action, and implementation of decisions. The owners also become comfortable with the notion of review by outsiders, which paves the way for the long-run ideal of a true board of directors.

 

Donald J. Jonovic, founder of Cleveland’s Family Business Management Services, is the author of Someday It’ll All Be Yours...Or Will It?