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What is the ROI for a Private Company Board of Directors?

The Value of Developing a Private Company’s Board of Directors

Successful firms view their boards of directors as competitive weapons.

Boards influence the most important business matters. And, since they are expensive and consume substantial time, a board of directors’ involvement needs to be effective.

When properly constructed and thoughtfully led, boards of directors create significant value for shareholders. Boards should focus on high impact matters, including:

  • Oversight
  • Strategy
  • Succession planning
  • Capital structure
  • Enterprise risk management

Choosing to avoid formal governance structures is a popular way to bury nonperformance and other unpleasant topics. But these problems don’t go away on their own.

Noses In, Fingers Out

Great directors operate with the motto of “noses in, fingers out, sensors on.”

If you have a board of directors, how do you determine its ROI? The benefits tend to be intangible, but the costs are real. If your business does not have a board, creating one may be a dramatic change.

So, what’s it worth?

What Are the Benefits of a Board of Directors?

Highly effective private company boards focus their time on key issues. Using a sports analogy, boards have playbooks for both offense and defense.

Offensive plays include developing effective strategy, succession planning and managing capital. Defensive plays include oversight and risk management.

Public boards have these same priorities, in addition to broader responsibilities set by their regulators.

Strategy

A high-performing board helps management formulate and execute a strategy to achieve the owners’ objectives. Many private businesses lack this kind of formal planning process.

Outside directors can bring a systematic approach to developing business strategy, allocating resources and providing accountability. Outsiders typically bring relationships to help deploy the strategy.

A common reality with private companies is that so long as the bank and the taxman are happy, it’s easy to become complacent. But if the owners are committed to growth, the directors should be working to make it happen.

With a reasonable multiple, this additional growth should be worth significant value. It is not uncommon for owners to look for 10-25% increase in value, depending on their opportunity set.

How does this compare to the cash costs of running the board?

Capital Structure

Shopping for a new bank loan to shave a few points is what any competent CFO can accomplish. But if the owners want to grow the business to create significant value — what is the best capital structure to support the growth strategy?

Sometimes, traditional bank financing may not be the best solution.

Many private companies don’t have the experience to look at financing options (even if they better suit a company’s future needs). Examples include:

  • Private placements
  • ESOP
  • Leveraged recapitalization
  • IPO
  • Strategic partnerships
  • Spinning off non-core assets

A board with experienced directors can assure the firm’s capital structure does not limit growth. Other offense-oriented board actions include:

  • Managing conflict
  • Developing compensation plans
  • Assuring accountability.

Private and family businesses sometimes struggle with these topics due to personal relationships. What is it worth to have the leadership focused on creating value, rather than debating compensation or managing irresolvable conflicts?

A high-performing board should remove the emotion from the analysis and help the principals focus on proactive decision-making.

Succession Planning

This topic includes both:

  • Contingency plans for planned transitions and unexpected loss of talent, and
  • Developing a pipeline of future leaders to execute a growth strategy.

What would happen to the value of the business if the CEO became incapacitated? Who inspires confidence with customers, employees and creditors?

Having a succession plan for the top layers of management doesn’t create a profit, but it preserves value during turbulent times.

There is no other way to hedge this risk.

Enterprise Risk Management

The board is responsible for assessing, understanding and managing enterprise risks. The board of directors should decide to accept, avoid, transfer or mitigate these risks.

For risks which are accepted or mitigated, the board needs to allocate resources and talent and assure compliance.

Certainly, audit and other regulatory compliance functions are core elements of a strong defensive play at the board level. The value of a high functioning board is greatest for firms that suffer from poor management.

The Costs of Acquiring a Board of Directors

Some private companies have effective boards with no outsiders, but that is less common. Typically, outsiders drive effective governance. The primary concerns when bringing in outside directors are

  1. Cost
  2. Time
  3. Interpersonal dynamics.

What does this mean to a company considering bringing in three outside directors?

It is common to hire a consultant to facilitate this process. The cost to have a consultant help form the board and operate it for one year (assuming four on-site meetings plus travel) may be $100,000 to $250,000—depending on a variety of assumptions.

(This assumes about 100 hrs/yr of work by the outsiders. PE firms use different metrics.)

The time commitment to recruit and run an effective board is significant. Even if the owners hire a board consultant, reaching the first meeting may total 4-8 months of effort. The board work itself could be 1-3 weeks of work, spread over a year.

For the chairperson, managing offline discussions requires more work—as well as preparing for and running the meetings. Board members must always be aware about how their decisions impact executive deliverables.

Lastly—and maybe most importantly—how do outsiders change the interpersonal dynamics of the owners and key executives? How well will they work together? The purpose of bringing in outside directors is to effect substantial change. Management will have concerns on how outsiders impact their careers.

This is why experienced directors say, “it is all about fit.”

What Is the ROI of Your Board?

Leadership expert Ken Blanchard once said that “Feedback is the breakfast of champions.” It is true for boards as well as most other business functions.  Thoughtful board evaluations are the best way to achieve a high ROI from a board.  An evaluation may be performed on the board as a unit, and/or individual board members. There are numerous techniques to accomplish this delicate task. There is a well-established market of board consultants, who will design and execute a board evaluation process tailored to your circumstances.

Structuring the Board Evaluation Process

There are several key questions to address when considering board evaluations.

What is the goal of the evaluation?

A new board needs time to evolve to achieve its full effectiveness, and feedback is a quick way to see where it needs to grow. A mature board will have well-defined processes to be evaluated and needs to think about how to stay fresh.

Who is participating in the evaluation?

Board evaluations should include board members, key non-board executives and outside ownership. If conditions require, there could be other stakeholders that need to be heard.

Who should conduct the evaluation?

This usually falls to the chairman, outside counsel or a consultant. The facilitator must be trusted by all participants. If the intention is to give individual feedback to board members, then the leader needs to have the tact and gravitas to deliver feedback so it is accepted.

How best to conduct the evaluation?

The typical methods include questionnaires and personal interviews. The design of each is critical, but there are ample tools available to consider. An informal approach may be best the first time through. Like most board processes, they evolve over time.

There are numerous in-depth surveys regarding director compensation, but there is little or no reviewed data on private company board evaluations.  Based on hearsay, I estimate that less than 15% of private company boards use a formal evaluation process on a routine basis.  However, there always seems to be time to do this, on an ad hoc basis, after a crisis.

The decision to conduct an evaluation, and how the results are used, is a measure of the quality of the ownership of the business. Good owners will drive continuous improvement at all levels of the business, including the board. They want to know the IRR of their investment in the board, as much as they would any other investment.

The toughest decisions in business lack formulas which neatly provide answers. Developing a high performing board which creates substantial value is not a simple matter.

It takes judgment to value intangible benefits against hard costs.

The return on investment is a series of seamlessly linked and well-executed processes:

  • Formal needs assessment,
  • Critical structuring,
  • Thoughtful recruiting and onboarding, and
  • An unrelenting focus on director and board performance.

This is a path well-traveled. The value of a high performing board is obvious when the process is well managed.


[Editors’ Note: To learn more about this and related topics, you may want to listen to the following webinars:

This is an updated version of an article originally published on July 6, 2017]

©All Rights Reserved. October, 2021. DailyDACTM, LLC d/b/a/ Financial PoiseTM

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About Bruce Werner

Bruce Werner is the Managing Director of Kona Advisors LLC, which provides advisory services to owners and investors of private and family-owned companies. With exceptional experience in finance, strategy, M&A, governance, and succession planning, Kona Advisors creates practical solutions to the most challenging corporate problems. Mr. Werner is an experienced Corporate Director, leading businesses through…

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