The independent edge Featured

8:00pm EDT October 26, 2007

In order to prepare a business for advanced stages of growth, the owners of many privately held organizations can benefit from opening up their boards and their operations to outsiders.

“Once a company reaches an advanced stage of growth with a number of different stakeholders, it should consider adding a layer of independent oversight,” says Mitch Bryan, partner in the litigation practice group at Levenfeld Pearlstein, LLC.

Smart Business spoke with Bryan about the significance of including independent oversight in the management of privately held second-generation companies.

Why should growing companies include independent directors on their boards?

The advantages include access to business experience, insight and contacts that can enhance a business’s ability to grow and help them reach the point of going public or simply transforming into a larger entity.

Also, unless the top managers in private companies are very well-disciplined and have a broad skill set, they may not have all areas of the company running optimally. Outside directors hold top management accountable for its actions and force management to focus on the areas where the business isn’t strong or may be at risk of changing market conditions. This often includes elevating the level of internal controls over financial systems.

Establishing independent board seats will also enhance decision-making and succession planning. Independent board members provide a check and balance when managers promote outside contracts that serve their self-interest but not the best interest of the company. If company management includes family members, independent directors can help avoid intrafamily arguments and enhance development of a strong, favorable and objective exit strategy based on what’s best for all stakeholders.

What are the challenges of working with outside directors?

The economic and organizational benefits of adding independent members to a board of directors ordinarily outweigh the costs. Companies will need to invest in a more formal structure and consistency to board meetings, which will put additional responsibility on the accounting and finance departments to ensure correct and current operating reports and other key documents. Top managers will also need to relinquish some of their autonomy. But over time this increased professionalism in management will only improve the credibility of the organization and the strength of the working relationship between managers, minority stakeholders and third parties, such as lenders and regulators.

How can companies find the right board members?

To achieve the goal of objectivity, executives should look for potential outside directors through purely business contacts, such as lenders, bankers and accountants. These people understand the business and can connect owners with other successful, responsible individuals in their industry or a similar industry. These truly independent candidates will examine a company carefully before accepting an invitation to the board. They will want to know that they can offer something and gain something of value through the time they invest.

Why should companies form an audit committee?

Forming an official audit committee within a corporate board establishes a norm and a center of responsibility for getting financial data collected and analyzed consistently throughout the year. This verifies the reliability of operations, allows businesses to take advantage of opportunities and establishes proper internal controls. This official process will also highlight areas where businesses should establish risk management procedures.

This committee should consist of some combination of the CFO, controller, a financial expert and independent directors. These individuals can create a specific structure that encourages continuity, efficiency and integrity in financial reporting.

Why is a compensation committee beneficial for businesses?

The immediate goal of most executives is to extract as much profit as possible from their companies, which might not serve the best long-term interest of the business. A compensation committee, including a financial expert, compensation consultant and independent directors, can help objectively evaluate the appropriate compensation for executives and keep the welfare of the business in mind. Independent decision-makers can offer a practical perspective on the performance of the company and the marketplace value of the executives’ performance.

One or more independent directors on a compensation committee create a healthy tension that balances companies’ treatment of dynamic individuals who occupy positions of respect within the core management group and will help motivate them to better serve the company as a whole.

MITCH BRYAN is a partner in the litigation practice group at Levenfeld Pearlstein, LLC. Reach him at (312) 476-7553 or mbryan@lplegal.com.