Certain ideas in business take on a certain air of mythology. The boardroom is one of them. That doesn’t mean that conversations surrounding boards of directors are always productive or useful. From Succession to drama-laden news headlines, we often discuss board construction and processes in terms that are less informative than they are sensational.
But boards serve a very important purpose in business. They deserve conversations that clearly outline their function and benefits. That starts with laying out some very basic definitions.
One of the first acts of a new corporation is to set up a board of directors. A board is an elected group of individuals that represent shareholders (the owners of the company).
The role of the board is to oversee the corporation through its mission to the shareholders. Their mandate is to protect the value of the company today and tomorrow for those shareholders. As a governing body, they typically meet at regular intervals to set policies for corporate management and oversight.
Issues and responsibilities that fall under a board’s control usually include:
The individuals selected to be on the board of a corporation have overall responsibility for the activities of the corporation but do not participate in day-to-day decision-making. The corporation’s executives and managers make those choices.
The structure and powers of a board are determined by an organization’s bylaws. The bylaws establish the specific duties and rules of procedure for the board.
Bylaws typically set certain kinds of rules. This may include:
While the law does not prescribe a specific number of board members, most private company boards range in size from 1 to 11 members. They often include an odd number of individuals to avoid ties in voting.
State law, however, often “fills the gaps.” It may provide certain provisions that the bylaws must or cannot provide.
Startups or small corporations typically build a small board. It may include as few as one to three people. Such boards usually serve as a legal formality since the shareholder(s) and the board member(s) are often one and the same.
This dynamic quickly changes from a legal and operational perspective when the company has enough owners such that economic ownership and managerial control are no longer identical. In this context, the shareholders or a subset of shareholders may have appointed or elected individuals to the board who are directed to act on their behalf.
But “their behalf” means all shareholders and not necessarily the majority shareholder or one that elected them. Board members make decisions based on their own experience and viewpoints, which may not align with the beliefs of any particular shareholder.
For mature corporations, the typical size of a board is between 5-9 individuals. That structure may grow larger if several committees (e.g., compensation, audit) become necessary. A mature board is usually a representation of both management and shareholder interests and includes both internal and external members.
The title of “director” is literally baked into the term Board of Directors. But not all directors get cut from the same cloth, serve the same role, or hold the same responsibilities. Their differences matter.
An internal or inside director is a member who has the interest of major shareholders, officers, and employees in mind. Their experience within the company arguably adds value. An insider director typically does not receive compensation for board activity as they are often already a C-level executive, major shareholder, or other stakeholder, such as a union representative.
Independent or outside directors do not involve themselves in the day-to-day inner workings of the company. These board members get reimbursed for costs and often receive additional compensation in the form of cash and/or equity for serving on the board.
Ideally, an outside director brings an objective, independent view to goal-setting and settling any company disputes. The most successful boards typically strike a balance of internal and external directors on a board.
Building a board requires a balance between business interests, relationship politics, and more. Some inclusions feel inevitable. Others need strategic consideration.
When selecting independent or outside directors, most corporations seek expertise in a specific area that they might otherwise be lacking. These qualities may include:
Other factors may play a role in board seat allocations, but these get top billing. Decisions about board seats outside this scope may invite scrutiny.
Being a member of a board gets characterized as a “resume booster” – and for good reason! In theory, you receive a seat because you bring something exceptional to the table. But that seat does not come without strings. The company expects you to deliver on several important fronts.
Corporate board members have a fiduciary responsibility to care for the finances and legal requirements of the corporation. They must act in good faith and with a reasonable degree of care.
Crucially, they must not have any conflicts of interest. This means the interests of the company must take precedence over personal interests of individual board members.
Board members set the mission of the company. That means they must affirm that all actions are related to and align with that mission. It puts board members in the difficult position of having to gauge large-scale decisions according to the agreed-upon direction.
The board can change the mission, but this should only occur after careful deliberation. Such choices tend to be rare for very good reasons. They are complex in nature, speaking to the gravity of responsibility shouldered by board members.
Big brands draw huge audiences with this particular piece of board operations. Organizations like Berkshire Hathaway livestream their annual meetings to huge audiences because their speakers represent the financial clout of the organization.
But annual meetings are more than a function of PR. They hold serious significance beyond the spectacle.
The board should hold meetings at least annually. At the annual meeting of the corporation, the board typically discusses overall company performance and may discuss the issuance of a dividend, oversee an election of corporate board members, elect or appoint officers and key executives, or amend the bylaws, if necessary.
Corporate board members have a good deal of latitude within the scope of their duties. After all, board members must be free to act in the interest of the shareholders, run the corporation in the best way they see fit, and take appropriate risks to help the company grow.
That does not mean that their choices are beyond scrutiny. Directors may be sued individually for acts or errors they commit while attempting to fulfill their fiduciary duties on the board.
Many corporations include officer and director liability insurance in their insurance packages for this exact reason. Such insurance does not cover all acts. Willful misconduct, for instance, typically gets excluded. Directors may be held personally liable in certain instances. If a director or officer is found liable for a wrongful act, their personal assets may be used to pay damages to the plaintiff.
Fiduciary mandates do not form the foundation of all boards of directors. Another type of board sometimes utilized by corporations and other business entities is a non-fiduciary (i.e., advisory) board.
While advisory boards often have the same considerations as fiduciary boards as to duties, makeup, compensation, etc., the main distinction is that advisory board decisions merely serve as recommendations rather than binding decisions. Fiduciary boards will often defer to the recommendations of the advisory board in making decisions. But they must affirmatively take the step of approving or implementing those proposals.
Advisory board tasks are usually project-based usually revolve around specific projects. This can include everything from what new product or service the company should develop to acquisition targets, what priorities the company should focus on for the next 12-18 months, and beyond. Members should and often work with C-level executives on their projects and usually report directly to the fiduciary board.
It is important to note that sometimes corporations will simply utilize committees of the main fiduciary board for a function similar to the role of an advisory board. However, that often depends on the available time and expertise of the board members themselves. In addition, how formal an advisory board functions will vary greatly depending on the size, sophistication and personality of the company itself.
The role and independence of the board expands even further when the company is insolvent or nearly so. While a detailed discussion of this issue is beyond the scope of this article, suffice it to say that generally the fiduciary duties of the board shift from representing the shareholders to preserving the company’s assets for the benefit of creditors. The shift in duties is an effort to protect creditors when a corporation enters the zone of insolvency because the creditors replace the shareholders as residual claimants on a corporation’s cash flow.
None of the above parameters should be taken as gospel. The board of directors in any company will be shaped by its founders and organizational direction. These discussions better serve as guidance for parsing the board structures of companies being considered by investors.
But they can also offer instruction. If you are in the process of preparing a company for acquisition, the variables highlighted in this conversation matter a lot. The idea of a board did not come out of nowhere. Boards of directors offer significant benefits when structured properly. That starts with understanding the language involved in their design.
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This is an updated version of an article from 2020. © 2023. DailyDACTM, LLC d/b/a/ Financial PoiseTM. This article is subject to the disclaimers found here.
Jeremy Waitzman advises his clients on significant transactions and operational issues in their businesses. Described by clients as “an essential business advisor” and “a partner in the success of my business,” Jeremy has substantial experience representing businesses of all types and sizes from inception, guiding them through significant growth, and often through ownership’s exit. His…
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