When Should I Bring Outsiders Onto the Board of Directors?

When Should I Bring Outsiders
Onto the Board of Directors?

by John B. Elstrott, Ph.D.

Emerging new ventures and even long-established, closely held family businesses sometimes struggle with the decision of when and why they should bring outsiders onto their boards of directors.Public companies are required to have very active and accountable boards of directors, but privately owned companies have a choice regarding how active and involved they want their boards to be.A company is least likely to need a proactive board when it is 100% owned by one shareholder and is unlikely to experience rapid growth.

If a private company has multiple shareholders or is going through a period of rapid industry growth or change, then an outside board can often be a valuable asset to the CEO and the shareholders.It is best not to ask your company’s banker, lawyer, or accountant to be on your board.You are already benefiting from their advice and they may have a conflict of interest.In most cases you also don’t want non-shareholder managers on the board.You may invite key managers to participate in appropriate parts of the directors’ meeting, but there will often be times when it is best not to have them present.

Family owned businesses present special challenges.It is often counterproductive and awkward to have all shareholding family members on the board, whether they are active in the business or not.If there are many family shareholders, then it is usually best to establish a family council that includes all family members.The family council then can fill a pre-determined number of seats on the board to ensure broad family input and control.

Directors do not manage the company, but they ensure that the company is well managed.They represent the interests of all stakeholders, but primarily those of shareholders.The directors’ main objective is to protect and maximize shareholder value.In a closely held family business it is sometimes better to recruit outsiders to a Board of Advisors.This reduces the outsiders’ liability and they can focus on providing seasoned, unbiased advice, as the shareholders are in a position to represent their own interests.

Recruit directors whose skills complement those of the CEO and the shareholder managers who are already on the board.Assuming there is not a competition conflict, recruit some directors who have achieved something significant in your industry or a related industry.You are looking for directors who can make a long term commitment, as it will take some time for them to learn about your business and industry and to develop a good working relationship with other directors.

Forming an active board that includes experienced outsiders is expensive but provides good long term value.Depending on the size of your company you should expect to pay directors $500 to $5,000 per meeting, for meetings lasting a day to a day and half.Generally you meet four to six times per year.In addition, experienced directors expect, and you want them to have, stock incentives or incentives linked to long term growth in company value.You expect directors to enhance shareholder value; give them incentives to do so.

In most cases it is not necessary to purchase Director’s and Officer’s Liability insurance, unless the company is public or there are a large number of shareholders not represented on the board.

Forming committees that meet between director’s meetings is usually productive.It is common to have committees for Finance and Audit, officer compensation, and sometimes growth and acquisitions and recruiting new directors.One of the most delicate, demanding duties directors have is to evaluate the performance of the CEO.Directors should always be prepared to execute a succession strategy should they have to replace the CEO.

It takes a great deal of effort for a CEO and his management team to adequately prepare for a director’s meeting.A packet providing recent financials and background information on key issues should be delivered to directors one week prior to each meeting.Though it requires both time and money to recruit and develop an active board of directors that includes outsiders, it is wise investment in the growth and value of your business.