Happy Owner, Happy Board: The Strategy of a Private Company Board of Directors

Defining the Strategic Role of the Board of Directors in Private Companies

Strategy has been defined as the art of finding an unfair competitive advantage in the marketplace. It is implemented through defined objectives, plans and tactics. Whether public or private, driving strategy is how boards create value. Public companies tend to have well-staffed strategy groups, of which M&A is one component. The strategic role of a private company board of directors tends to be simpler.

Private companies greater than a few hundred million dollars in revenue move along an evolutionary path resembling public company strategy functions. But most private companies are smaller than $100 million revenue, and have no formal strategy function. They are focused on surviving, and hopefully prospering, in a single market.

The goal of a public company is to maximize shareholder value, which today means increasing the stock price. The quarterly treadmill drives behaviors. Private companies can invest for longer horizons, so their strategic horizon is typically much longer than that of a public company.

What is the Role of a Private Company Board of Directors?

The primary functions of a private company board of directors include:

• Strategy
• Succession planning
• Capital structure
• Risk management

Strategy and succession planning are the responsibilities that a board manages to create value, while capital structure and risk management are more often seen as ways to protect the enterprise.

The Strategic Role of the Board of Directors

Private company board strategies should be crafted around answering the question, “What do you want to do with your business?” Private companies do not answer to outside parties, except their lenders and the IRS. Since there are typically only one or two opinions that matter, if the owners are happy, that is good enough.

I submit that effective board strategies can be overall summed up in the following three questions:

1. What are the Owners’ Goals for the Business?

Defining the owners’ goals usually happens through a visioning exercise: What do you want the company to look like in five years? This usually turns into a desired set of financial statements, some market share and product descriptors, and a few qualitative statements (e.g., “most desired employer”).

There is a well-understood process for moving from a visioning exercise to a full strategic plan to achieve the goals of the business. From the board’s perspective, such a strategic plan needs to address these questions:

• Does the Board have a plan on how to allocate profits between funding growth, paying down debt, tax distributions and spendable distributions to owners?
• Are cash balances disproportionately high compared to monthly fixed costs?
• Does the dividend policy meet the needs of the owners?
• Do the external capital sources (the bank) support your capital structure?
• Does management have a strong grip on growth opportunities in adjacent markets?
• Is there an open discussion on how much risk the Board and ownership will accept?

If the owners do not have significant experience outside of their own business, they may not know they need to comprehensively both ask and answer these questions. That is why it is common for outside directors to lead on these issues in a private company board of directors.

2. How Do You Translate the Owners’ Goals into the Budget, Dividend Policy and Capital Structure?

Many companies have completed thorough strategy exercises that produce a nice report, which are then put on the shelf. If management behavior is not itself managed by the board, market forces will drive management behavior instead. Capital should be allocated to the highest and best uses to achieve the owners’ goals. Performance incentives need to support the corporate goals. Setting priorities means killing pet projects that are outside any private company board strategies designed to usher in success on a larger scale.

Outside directors often need to be the “adult in the room” when it comes to forcing the budget to reflect priorities. This usually does not happen naturally.

3. How Do You Measure Progress Towards the Owners’ Goals?

Budgets alone are not enough to measure progress in pursuing a strategy. A board needs to develop measurable metrics (e.g., key performance indicators (KPIs), dashboard, etc.) that best speak to progress on strategic imperatives. Budget numbers and financials are not sufficiently indicative for this purpose.

These metrics should be developed with management to assure their full buy-in for what they will be held accountable. A well-run, private company board of directors will have an end-to-end process that drives management and staff behavior to be fully aligned with ownership goals, with accountability set in place.

Good leadership will translate these KPIs from the company level, to management performance appraisals, and finally, down to staff appraisals. They should already be tied to the budget and capital expenditure program. Once developed, these KPIs need to be the live-or-die metrics going forward. This is a primary method for boards to hold management accountable.

Assessing Strategies for Maximum Success

If you serve on a private company board of directors, you should be working to understand, evaluate and improve the company strategy. This is one of the ways you demonstrate your value as a director.

If you are considering joining a private company board, you should evaluate the strategic role of the board beforehand to understand how the board functions and its impact on the business.

The transparency of the public markets drives the accountability which is often lacking in private companies. This is where outside directors often make the difference in private company governance.

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[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: The Role of the Board in a Private Company, The Effective Board and The Good, The Bad and the Ugly: Planning and Running Effective Board Meetings. This is an updated version of an article originally published on February 19, 2018.]

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