Top Ten Private Company Board Best Practices

Introduction and Overview

Now, more than ever, private company Boards of Directors are being called upon to provide leadership and skills that go beyond traditional governance activities. Boards and individual directors are becoming “activists” with involvement in strategic leadership, organizational leadership, interim management, and industry representation, in addition to classic governance activities.

According to a 2019 McKinsey Quarterly survey, seventy percent of privately held company boards are involved in core performance and value-creating activities (an increase from 59% in 2018). However, only 43 percent of respondents said their boards and members are effective in “REALLY” enabling” an increase in the enterprise value.

When operational efficiency, scalability, innovation, and exit planning all become focus areas of the “partnership” between boards and management, the long-term wealth-generating probability for the enterprise drastically increases.

Company Boards are ultimately responsible for maximizing shareholder value, not performing day-to-day activities, or monitoring the day-to-day operations of the business (a common and critical mistake made by institutional investors). 

This article serves as a set of “Best Practices” for directors, including highlighting those “Best Practices” that enhance the Board’s effectiveness and add “value to all stakeholders”.

How To Identify common problems and when Corrective Action Will Maximize Value?

While it is obvious that the timeframe of a business in its lifecycle will have a significant impact on the type and nature of the governance required, every business, whether in the development, growth or mature phase, faces numerous challenges.

Company Boards and their leadership team often lack a “holistic” insight into the issues facing the business. Too often, when management does seek assistance, consultants are hired to solve a specific leadership or functional problem. However, solving singular functional problems commonly provides only temporary performance improvement. Ninety percent of the companies we have worked with over our 22+ years have at least one significant operational issue plus a major strategic and management deficiency. 

Value creation arises from solving both the operational and strategic issues, as well as aligning and balancing stakeholder interests. A holistic approach that directly impacts both near- and long-term performance and strategic positioning are therefore imperative.

A company can have the best product/service in the marketplace and still not succeed if effective corporate governance does not “synergize’ the company.

An effective Board is required to overcome these complex challenges:

• Vague value propositions, which generally are difficult to “message”

• Shortage of management talent and leadership

• Higher investment return expectations, generally due to institutional funding

• Emphasis on short-term results

• Cut-throat competition

• Chronic change in direction and/or the lack of ineffective governance & ineffective governance process

Let us be clear: it is NOT the duty or responsibility of the Board of Directors to handle or “meddle” in the day-to-day activities of the business. Those responsibilities belong to the operating officers and management of the company. However, it is the role of directors to support, augment, and enhance the capabilities of management, not “BE” management!

Top Ten Best Practices

Best Practice #1: Timely & Decisive Action vs Complacency

The number one mistake made by Boards of Directors is complacency. Time is rarely an ally in today’s business world and complacent boards often lose sight of their role as change agents, preferring instead to hold onto the status quo due to the concept of hope. We must remind ourselves that: “Hope is not a strategy!!”

Symptoms of complacency come in the form of general under performance of expectations. Business is good, but the company just plods along and never seems to take off. Operating metrics and profits are at less than acceptable levels, but the sales staff is optimistic. The business provides a great service that customers should buy, but for some unknown reason, it has not really caught on. Simply said, the company is not achieving relative to its market opportunity!

In examining whether performance is up to par, ask the following questions:

• Are milestones being missed?

• Are financial and business targets being met?

• Is the competition gaining market share and brand equities?

• Is there a technology substitution threat on the horizon?

• Is there consolidation activity and why are we not being approached?

• Has growth stagnated?

Does management really have the skill set necessary for consistent and defined success?

Especially with our current political and unfavorable economic conditions and regardless of the governance process or member capabilities, identifying the barriers to success and assertively developing and implementing improvement processes and programs is required. Waiting too long to take decisive corrective action is inexcusable, and too often the root cause of company turnarounds and restructurings.

Best Practice #2: Align Strategic Market Positioning

Quite often, a company can have great technology, great people skill, or impressive operating history, but still fail to produce expected results over the very near and long term. This is a typical problem where generally the financials will not expose the issues, because the problem is not in the execution of the business so much as in the firm’s strategic and product positioning.

Often, the problem is the Board’s perception of the marketplace, which can be overly influenced by management, or the board members are “just too busy” or simply lack the skill necessary to effectively evaluate the market dynamics. Since customer requirements shift and change, the niche a company occupies needs to be refined or even redefined to create sustainable and long-term value. This happens frequently in mid-market service businesses where it is not unusual for customer needs to change as their markets change, thus resulting in their own business model being altered in response to market conditions.

Best Practice #3: Highly Define the Business Model

A business model, by definition, provides a blueprint that defines how a firm translates its ideas into services or products to create shareholder value. A valid business model delivers utility, and brand equities to the customer, while a refined and transformational business model provides a sustainable competitive advantage. The more defined the business model is, the easier it is to manage, govern, and execute.

Many business models have been developed over time and continue to evolve, for example:

• The “shopkeeper model,” which started in ancient times, evolved into FW Woolworth, Sears, and Wal-Mart, more recently morphing into today’s present world companies of Dell Computer, Netflix, eBay, and Amazon.com;

• Gillette’s "razor and blades” business model has been followed by Hewlett-Packard (computers, laptops, printers, and ink) and Adobe (free word processor reader, expensive word processor writer);

• Business service models based on transaction processing, first used by companies like American Express, and now used by Kinko’s, ADP, and Latin American Card Services;

• The “hub and spoke” delivery model pioneered by FedEx has been used to upgrade and revitalize the service of mature companies like UPS; and

• Community models such as Starbucks have been picked up by social nets such as Facebook, YouTube, eHarmony, and LinkedIn.

New business models are continually being created: for example, Uber, Airbnb, and Ally Bank: which exponentially grow and built brands, while others languish by the wayside. It is well-known and understood that faulty and poorly defined business models grow up to be bad businesses (for example, the dot-com bust was a result of poorly thought-out business models).

Does your business model provide customer utility, brand equities, and competitive advantage for your company? Will it survive the long-term test of time? It is the Board’s responsibility to ensure that the answer to these questions is “YES.”

Best Practice #4: Rely on Processes & Measurements

With business, as in sports, the difference between mediocrity and greatness is a matter of inches. Daily execution and refinement of business processes must become a perpetual activity to achieve consistent performance. Incorrect or insufficient measurements and inadequate process definitions are the primary causes of poor execution.

Boards must insist that management create and implement an effective measurement and metric system around defined, effective business processes, which result in increases in productivity and scalability and the best utilization of human capital. When measurement and metrics drive the organization, decision-making is decentralized, communication permeates bottom-up and top-down, and performance is transparent. Defined processes not only ensure quality, productivity, and cost containment, but are critical components in the valuation of the business.

Measurement and metrics can also serve as an early warning indicator of changes in customer satisfaction or market forces. By pinpointing issues before they become viability issues, Boards have time to take timely and decisive corrective action before it is too late.

Best Practice #5: Focus on Operational Effectiveness vs Only Revenue Generation

One of the costliest mistakes a company can make is adding revenue without a client “retention metric” and scalable business processes and technology to handle the increased volumes of activities. Revenue for “revenue’s sake” without strategic and tactical clarity has failed many times and is the most common mistake we observe from venture-funded companies and venture professional-oriented boards. However, the recent trend of SaaS and Technology companies where the enterprise value metric is revenue has mitigated this problem in recent years.

Operational effectiveness commands that revenue growth comes with a focus on implementing efficient business processes and monitoring quality. Defining and measuring these processes will indicate where efficiencies can be gained, costs reduced, and quality improved.

Toward these goals, metrics, and key performance indicators (KPIs) can be used to identify the twenty percent of customers who are driving eighty percent of the profits. By focusing on providing better service to these customers, the customer relationship can produce better returns, lead to more referrals, and thus generate more revenue and lower customer acquisition costs.

Increasing revenue is the answer only when all functions are aligned, and management has the people, processes, and systems in place to effectively grow. Otherwise, more revenue is likely to cause more harm than good and potentially put the “invested” capital at great risk. Therefore, it is the Board's role to ensure “no harm is done”!

Best Practice #6: Exit for The Right Reasons Or AT THE Right Time

Knowing when to exit is the most misunderstood issue facing Boards and/or their institutional investment partners today. An exit should be the result of a strategic initiative to seek a realization that is planned, process driven, and effectively managed by the Board, and not the result of factors that make an exit imperative. Further, if an exogenous opportunity to exit materializes, the rush to close often becomes the overriding interest. However, as research reveals, companies that spend six to twelve months optimizing their business model as part of an orderly disposition create enhanced shareholder value.

While waiting for market timing or a trigger event is the norm, it is generally not the appropriate answer. What is needed is to manufacture the outcome through planning and execution governed by the board. It is a priority of every Board to manufacture the exit outcome by positioning the company to be strategically valuable for the right reasons, to the right buyers, at the right time, and at the right valuation.

Best Practice #7: Align Board Membership to Situational Requirements

Too often, the Board of Directors lacks an appropriate mix of strategic, product, domain, and operational experience. An effective Board must illustrate the experiences and professional ability to understand the business, create a platform based on a sound business model, evaluate and hire suitable executive management, ensure that effective execution occurs and provide the company with prudent resources to implement its objectives.

The worst misalignment of member skills to board requirements occurs when too much reliance is placed on members with financial backgrounds. While finance experience is critical expertise for any Board, Boards that are heavy in financial expertise are often deficient in operational expertise, revenue and customer acquisition, and/or specific customer or industry knowledge or some other critical requirement.

Because the Board of Directors is ultimately responsible for the success or failure of the company, it is important that members have a mix of backgrounds and skills. Boards that do not have a well-balanced mix of expertise miss the depth of insight and leadership that such wide-ranging experience can bring. We at the Ephor Group strongly suggest “some grey-haired” experience on every board. We likewise recommend that planned Board Member “turnover” should be a role of the company Chairman to ensure that the company always has the “right mix” of skill and experience on the Board. Too often we observe “good-ole-boy” oriented Boards. Experience consistently outperforms intelligence and arrogance!

Best Practice #8: Board Members MUST provide Leadership

In some companies, the Board of Directors’ role in developing strategy or evaluating company management is insignificant. When this happens, it is often because the Board members do not have the operating experience, industry knowledge or leadership characteristics required to play a strong role in the leadership and direction of the business.

Traditionally, leadership planning and development at the company level is left up to the CEO and other C-Suite Executives. There is, however, little leadership planning and development for board members who must acclimate to these responsibilities without the same level of attention, guidance, and development given to operating constituencies.

It has been proven repeatedly that effective and appropriate governance leads to higher valuations. Evaluating management, driving corporate culture, and setting strategic direction are all board responsibilities and are critical to maximizing shareholder wealth. Therefore, board membership is a responsibility that goes beyond the bounds set by listening to management presentations and routinely getting through board meeting agendas.

Effective Board Directors are all about Leadership and Stewardship!

Additionally, effective Directors mitigate risks. Supervising Enterprise Risk Management (ERM) includes:

• Monitoring the impact of the significant changes that the Trump administration is having on American businesses,

• Preparing for increasing compliance and governance requirements,

• Implementing variable compensation or taking corrective action on misaligned pay practices,

• Mitigating reputational risks, while increasing brand equities, and

• Continuously assessing both upside and downside risks.

Best Practice #9: Have an Outside Unbiased Perspective

Boards are often composed of Investment or Financial Professionals with their own individual investment timelines, fund influences, equity requirements, and constraints. This dual role as an investor responsible for his or her fund requirements and those of a board member responsible for the long-term interests of the company often results in conflict. This is most frequently evident in second, third, and later stage growth financings where institutional investors/board members “wire in” put rights and other equity protections that can be severely burdensome to the company, particularly at a later stage if additional capital is needed.

While these protections are often rewarded at the fund level as prudent, from a company, management, and board perspective, they can often be disastrous if they create circumstances where additional capital is blocked by liquidation rights or other provisions that make new investments unattractive. This stakeholder "imbalance: in Ephor's 22+ years of governing, advising, and investing in small emerging businesses has proven to be detrimental to many founders’ equity interests.

From the Founder's CEO Entrepreneurs perspective, board members (who represent institutional funds) often cannot objectively separate their fund responsibilities from their board responsibilities, bring an unproductive bias to their board-level decision-making, and potentially may naively suppress opportunity and value.

Best Practice #10: Set a Governance Process & “Outsider” Influence

Most private companies lack independent or true “outside directors.” We at Ephor strongly suggest that, in most situations, the Board hire an effective Chairman, or Executive Chairman, who is empowered, experienced, and has a proven governance process that creates accountability in Board members, and the knowledge and experiences to govern the company. We also strongly recommend “outsiders,” or independents, as directors who can prevail with unbiased perspectives, create new insights, and facilitate among multiple constituencies.

Independent board members are harder for operating executives to “manage upwards” and are quicker to recognize management deficiencies and strategic misdirection precisely because they lack preconceived notions of how the business should operate and know when to seek required outside help. Experience, and unbiased perspectives, married with a solid governess process always improve the probability of success!

Conclusion

The role of the Board of Directors is drastically changing and becoming more demanding, especially in the service sector of the economy due to: globalization, technology substitution, economic & political disruption, complex marketplace & customer requirements coupled with more regulatory requirements.

All directors and shareholders must make the changes necessary to ensure that their organizations prosper in these challenging times. Moving beyond traditional governance activities is “uncertain ground” for many boards and board members.

Therefore, by deploying and executing these “Best Practices” the company and its stakeholders can enjoy a “higher probability of success” in achieving the organization’s objectives and outcomes.

We at Ephor having governed some 20 companies in our 22+ years as well as our Strategic Practice Lead, Garry E Meier as a 9-time Chairman, have learned a lot and accomplished a lot. This experience and knowledge have allowed us to be most proud of the fact that 22 of our current and past clients have been “recognized” by high-growth publications such as INC Magazine and Forbes.

As such we are happy to share our experiences with you.