Perspectives

Governance

Issues and opportunities for private companies

By Maureen Bujno, director, Center for Corporate Governance, Deloitte LLP

In today’s business environment, closely held companies can no longer afford to accept the informal governance practices that have long separated public and private concerns. Increasingly, private company executives are embracing public company style governance practices.

Overview

In today’s business environment, closely held companies can no longer afford to accept the informal governance practices that have long separated public and private concerns. Increasingly, private company executives are embracing public company style governance practices.

This increased sense of formality, even among family-owned businesses, is giving privately held companies more structured processes for addressing everything from strategy to cyber security. In a recent Deloitte survey of board practices, conducted in collaboration with the Society of Corporate Secretaries and Governance Professionals, 250 corporate secretaries from publicly traded companies identified key areas that their boards will focus on in 2015.1 What we found was that many of the same issues they raised – especially strategy, risk, and board composition – are also confronting privately held companies as they adopt more public company governance practices.

An increased sense of formality, even among family-owned businesses, is giving privately held companies more structured processes for addressing everything from strategy to cyber security.

Issues

The challenge for closely held companies is how to strengthen their governance without compromising the flexibility that many see as their primary advantage in the marketplace. While most public companies have clear rules and strict procedures to help ensure everything from regulatory compliance to risk assessment, private companies may be wary of becoming too bureaucratic or beholden to process. Many private companies, however, are finding ways to strengthen their board structures and enhance their long-term growth prospects without sacrificing their nimbleness in their existing market.

Overall, closely held companies tend to have smaller boards, with directors often selected from the company’s executive team or, in the case of family-owned businesses, relatives of the founders. Populating the board with insiders may give companies a strong sense of mission, but it could leave them unable to objectively assess risks, develop effective strategy, or adapt quickly to unexpected changes in the marketplace or customer base.

On the other hand, private companies have fewer worries about meeting the demands of the investing public and analysts and, as a result, they can focus more on the long-term growth of the company.

Further, the governance challenge of attaining the ideal board composition and size may enhance board structure at smaller boards and allow for an extension of separate board committees, where much of the “board work” takes place.

Populating the board with insiders may give companies a strong sense of mission, but it could leave them unable to objectively assess risks, develop effective strategy, or adapt quickly to unexpected changes in the marketplace or customer base.

Opportunities

By adopting common elements of the governance practices at publicly traded companies, private businesses can enhance board oversight to help their operations run more effectively.

Board composition and structure

One of the first steps is to decide the composition and size of board a company should have. Board structure should align with the company’s strategy; the composition should include the skills and experience needed to ultimately advise on the development of the strategy and overseeing its execution.

While management and directors will likely overlap more in private companies than in public ones, boards should be structured to include independent, outside directors, and meetings should be conducted in a manner that encourages fresh perspectives. By having more outsiders on the board, discussions on agenda topics such as risk, strategy, and succession may become more robust.

To determine the type of outside director a company needs, the existing board should consider assessing long-term goals and determine if there are gaps in the skills, expertise, and experience of the current directors. For example, does a company need more financial experience on the board? Should it hire a director who has a background in international expansion? Utilizing board skills matrix can help to identify current board skills and where gaps may exist. Further, independent directors should be considered for inclusion on the audit committee and other formal committees of the board, including a compensation committee that deals with management compensation.

As they expand their boards, middle market companies should consider evaluating the diversity of directors as well. Family-owned businesses may have multiple generations represented, but age isn’t the only consideration. Is there also ethnic and gender diversity? In addressing these issues, companies may want to consider their customer base and whether the makeup of the board reflects that base.

While private companies should have a separate audit committee to oversee the integrity of the financial statements, financial reporting process, and the independent audit, they have the flexibility to determine the need for other separate board committees. Consideration should be given to formalizing the oversight of compensation and governance practices with committees that include independent directors. Other committees might focus on specific areas such as risk, investment, finance, or strategy.

Finally, board structures vary among private companies. For example, many leading family companies have a board of directors with independent members, as well as a separate family council that is responsible for the family matters, which are handled outside of the board of directors. Further, some private companies also consider the need for advisory boards to provide objective, specific knowledge on certain topics or business development needs.

Strategy

In our survey, corporate secretaries listed strategy concerns as the most important topic on the public company board agenda.2 Privately held businesses, however, often can focus more closely on strategy issues because they don’t have as many regulatory and compliance issues to deal with as their publicly traded counterparts. Not only should strategy be a focus of frequent discussion, it should also be monitored by the board to ensure it is being implemented properly. The board may even propose metrics for monitoring the continued execution of strategic objectives.

While it may not be practical in every case, middle market companies may want to consider conducting strategic retreats, which are considered a leading practice for private company boards. Such retreats typically include both senior leadership and the board, allow for a day focused on the business strategy, both short- and long-term, and include a deep dive into the risks associated with the outlined strategic objectives. The retreat can set the foundation for future board meeting agendas and for monitoring the execution of strategic objectives.

Risk oversight

Boards should consider addressing risk management issues regularly, either through an audit committee, or if a company is in the financial services sector, a separate risk committee – or at the full board level. Regardless of whether risk oversight is delegated or not, the full board is ultimately accountable. Directors should decide on the governance structure that will work at their company to oversee the risk management process. The full board should be discussing the most significant strategic risks to the enterprise, while understanding that the full list of enterprise risks (whether operational, compliance, or financial) are being continually monitored, mitigated, and assessed. The board structure and committee composition will provide the basis for an effective risk governance structure to oversee risk processes and specific, significant risks.

This applies to cyber-security risk issues as well. Cyber threats against businesses increasingly are becoming a concern for companies of all sizes. Directors may want to consider whether their company needs a chief technology officer or if the company has the necessary in-house expertise and experience to manage cyber risks. There may be a need to bring in outside expertise to brief the board on cyber security, the board’s role in overseeing such risks, and being prepared with an incident plan.

Once the proper board is in place, the committee structure is determined and planning issues such as risk and strategy are evaluated, companies should examine the frequency of their board meetings and whether the board is allowing appropriate time to oversee company issues. Boards may want to consider how their practices – meetings, composition, and structure – measure up against other private company leading practices and make adjustments if needed.

While management and directors will likely overlap more in private companies than in public ones, boards should be structured to include independent, outside directors, and meetings should be conducted in a manner that encourages fresh perspectives.

Questions to consider for 2015

As the challenges facing privately held companies grow more complex, many are finding that the board structures adopted by public companies can help position them for long-term growth. While the board needs of private companies vary widely based on their size and type of business, a stronger governance structure can help companies move beyond the more insular boards that are common among family-run businesses and invite fresh ideas for building the business.

For companies of all sizes, more formalized board structures, with greater diversity of directors, are becoming the standard. To implement these strategies, some of the key questions companies need to answer are:

  • Do we have the most effective board structure in place – including independent directors and the committee structures? 
  • How do we ensure we’re finding the most qualified outside directors and meet our commitment to diversity? 
  • Do we place enough emphasis on strategy and long-term planning in our board discussions or do we need to implement stronger metrics?
  • Are we adequately planning for risk, and how might we improve our risk oversight and assessment, including emerging risks such as cyber threats?
  • Do our directors meet frequently enough to adequately address the concerns facing the company?

​For companies of all sizes, more formalized board structures, with greater diversity of directors, are becoming the standard.

1 2014 Board Practices Report: Perspectives from the board room, Deloitte LLP Center for Corporate Governance and Society of Corporate Secretaries and Governance Professionals, 2014, http://www2.deloitte.com/content/dam/Deloitte/us/Documents/regulatory/us-2014-board-practices-report-final-9274051-12122014.pdf

2 Ibid.

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