Should a Private Company Have a Board of Directors?

When a company is not publicly held, there is generally no legal reason why it should have a board of directors. Yet, there are plenty of private companies that have boards. In fact, I happen to sit on the board of a private company.

So, the question must be asked: When should a private company have a formal board of directors?

Dynamics That Encourage a Board

There are various reasons why a private company should have a board. For example, if there is a family feud, the family’s legal advisers might insist on an independent board.

Also, if the company in question has substantial debt, its creditors might insist on a board of directors. Additionally, if there are venture capital or angel investors, the company might very likely be forced to have an independent board of directors.

Therefore, the reasons are numerous why a private company might have to have a board. However, what about the situation where there is little or no outside financing and no outside investors. Is it likely that such companies might have a board?

Independent Companies Having Boards

I have seen plenty of cases where very profitable, privately held companies with no debt and no outside investors have a board of directors. In fact, I know of a very successful privately held company whose majority stockholder assembled a competent and varied board.

Why did he do this when there was no legal need for an independent board? He wanted objective input as to the strategic direction of his company, as well as to other corporate matters. The company in question continues to grow and prosper.

I also know of another privately held company that just filed for Chapter 11 bankruptcy. It was in existence over 10 years, and the founder and majority stockholder brought it from a small healthcare company to a regional powerhouse with sales of more than US$500 million per year.

Unfortunately, as brilliant as the founder was, he surrounded himself with employees who were afraid to criticize him and who made him feel that he was infallible. An outside board of directors would have, in my opinion, tremendously aided this company not only to stay out of debt, but also to grow and prosper.

That said, there are plenty of small privately owned companies that do quite well without a board of directors. It really depends upon the individual running the company and the complexity of the business.

How to Choose a Board

The following are categories that I feel are essential if you are to assemble an effective board:

1. Legal representation. Today, more than ever, I believe that it will behoove you and your company to have some legal representation on the board. Choose an ethical attorney, preferably with experience in the industry in question.
2. Financial representation. By choosing someone with financial experience — preferably a certified public accountant — he can serve as a financial watchdog, advise the board if anything improper is happening with the company’s books, and aid you in SOX (Sarbanes-Oxley Act) compliance, if you ever decide to bring your company public.
3. Technical representation. It is important to have someone serve on the board who is totally familiar with the workings of your industry. This person preferably has important contacts in the industry and can assist the board and management in any technical and strategic decisions.
4. Marketing. I feel that it is quite important that you have a marketing person on your board who can help you grow. This person should know the industry from a marketing perspective and should be able to strategically advise the board as to new marketing directions, including new products and services.
5. Public relations. This person is usually a prominent individual who connects with the community at large and thereby brings comfort to stockholders, customers and the general public. Besides being a highly visible person — at least in your immediate corporate community — this person should have impeccable ethical standards. I’m sure that you are aware of prominent people who have retired from corporate or government service and have been chosen to serve on a board. A highly regarded board member really helps with the public perception of your company.
6. Other. This position can be filled by someone who is highly respected in one of the following fields:
• Environmental issues. This would apply if your company’s products have an environmental impact.
• Stockholder relations. This person has the expertise to deal with touchy stockholder questions.
• Labor issues. This would apply if your company is unionized and needs an inside advocate who can help you deal with the unions.
• Regulatory matters. This applies if the company is in a highly regulated field, for example, nuclear energy.

Corporate Governance

The above listing, when you add the stockholder(s), will fill about eight seats on your corporate board. The number in and of itself is not that important. What’s important is that you have a real board that can rein in management if they see it’s going in the wrong direction.

Some boards are thinly veiled rubber stamps for management. Anyone who gives such a board more than a passing look can quickly determine that the board is there just to do management’s bidding.

Perhaps your company isn’t ready for a board, or perhaps it is. In any event, it’s good to know the key elements that go into forming a board. Good luck!

Theodore F. di Stefano is a founder and managing partner at Capital Source Partners, which provides a wide range of investment banking services to the small and medium-sized business. He is also a frequent speaker to business groups on financial and corporate governance matters. He can be contacted at [email protected].