Independent Directors Guiding Strategy for Industrial Manufacturers

Affirmations or Improvement?

What's most important to you?

Most will say the latter, but actions of the majority belie the former. (Of course intent is a confused and largely separate topic as I'm seeing clearly outlined in my current read Mistakes Were Made (but not by me): Why We Justify Foolish Beliefs, Bad Decisions, and Hurtful Acts.)

The role of board oversight for privately held businesses is illustrative; and therefore a potentially uncomfortable but fruitful topic for the traditional, middle-market, industrial manufacturing firms for whom I often consult.

The NACD (National Association of Corporate Directors - of which I am a Governance Fellow) publishes volumes of data from surveys they conduct among public and private company directors. The 2017-2018 Private Company Governance Survey¹ highlights some challenges for private company boards. Additionally, a recent NACD (Boston) event sponsored by Ernst & Young explored the role of independent directors before and after liquidity events. What follows are a couple highlights and observations for private company owners.

Survey Highlights

• Only 18% have a standing strategy committee
• only 63% of boards discuss customers' changing needs
• key among the top five trends with greatest likely impact on businesses are:
  • 58% significant industry changes
  • 44% business model disruptions
• and yet....71% don't feel that the board contributes to strategy
• 72% cite lack of follow-through on board recommendations
• 80% worry that they don't fully understand the risks and opportunities that will impact the business
• only 39% of private company boards conduct individual director performance reviews
• industrials have the greatest variance in board retainer fees (perhaps reflecting the perceived value delivered?)
• cultural oversight is....overlooked
  • only 54% discuss whether incentives are aligned with desired outcomes
  • less than half looked at alignment between company's purpose, values & strategy
  • only 46% evaluated the CEO's leadership in areas of culture
  • only 42% asked whether revenue generation practices were consistent with company values
  • only 32% visited different locations
  • only 21% thought they had a high/very high understanding of "buzz at the bottom" of the organization
• while 60% had a standing Nomination and Governance committee, there are some gaps in its execution
  • 58% don't see enough board education
  • 50% find inadequate board succession planning
  • only 52% believe they spend enough time on board evaluations
  • just over half believe there's enough time spent on board recruitment and succession

Summing it up, it seems that private company boards are rather loosely run. That's understandable. Many of the onerous requirements of public company boards are driven by securities regulations and some could argue they wouldn't add value to the narrow pool of private company shareholders.

Further, many boards are largely comprised of friends and family who may not be experienced in board operation or responsibilities. In some cases this happens as a natural result of how companies are formed and grow, while in others it's an explicit design of the CEO to avoid rigorous oversight. That avoidance isn't necessarily indicative of nefarious intent, but rather reflects the preference to operate a lifestyle business.

The risk however, is that having a "board" provides biased confidence for the CEO that they're really strongly vetting business plans and operations - and I've seen it lead to unhappy surprises when rubber stamp, or unqualified boards "whistle past the graveyard" along with CEOs.

For a different perspective, it's interesting to consider what the private equity investors on the panel described as their approach to private company boards after an acquisition or owner recap.

Private Equity's View of the Private Company Board

Panelists included:

• Michelle Noon - PE
• Laura Grattan - PE
• Michael Cassata - Inv. Banker
• Paul Griffiths - Company founder and CEO who did a partial recap
• Rich Adduci - M&A transaction service provider

The panel represented two different perspectives. In one case the investors held a minority position, held a single board seat, and agreed on an independent with the founder. In another, the investor controlled the business and the board.

Here are some key takeaways:

• A dysfunctional board (ineffective, family infighting, etc.) will likely compromise the business valuation. In contrast, a strong board will likely boost valuation both through the stronger performance that will probably result over time, but also as a function of the investor's confidence in how solid the business is with the board being a reflection of management maturity
• If you want a board to check the box for your lender, or mollify family members, then you'll get limited value from it
• Even professional investors add independent directors to fill gaps in the board skills matrix. Cybersecurity, international business growth, digital & marketing, industry experience, transactional chops, inorganic growth through acquisitions, and business model transformation were examples cited. But that's not the kind of depth one is likely to find by asking around the club. It's a function of a healthy corporate strategy and engaged board; and an example of why board governance and best practice have value even when not required by the SEC
• A strong board will be involved in talent management. When the bookkeeper, cum controller, cum CFO is now responsible for financial strategy, you're almost certainly compromising the function of the firm. A board can be the "bad guy" to help resolve key management issues that may be especially awkward for a CEO with legacy friendships and relationships
• A board should contribute vision and strategy - with less time spent on financials review which can be accomplished in meeting prep
• An independent director can help to bridge two very different perspectives (e.g. owner and investor)

I would add that a good board should be asking about whether a private company is optimizing its return on equity. Understanding that many lifestyle businesses involve other considerations, simply asking whether running the business is even appropriate (digging into how later) is an important question that's often overlooked. Maybe it's being held for the wrong reasons!

Why Strong Boards are Increasingly Important

Going back to the initial question, if you want affirmations, then keep a board of buddies. If you want growth, value, success, vibrance and an exciting legacy, then consider a powerful and strategic board of experts. (Looking for that? Maybe we should talk.)

Industries, technologies, sales models, business models, revenue streams and even manufacturing is undergoing disruption. Annual planning (last year +7%) has worked, but soon won't.

Boards with limited perspective and ossified process are doing companies a disservice even though they may be increasing CEO comfort.

Companies that will thrive, will proactively anticipate disruption and seek out opportunities. The skunk works model I've written about is one option. They'll recognize that their revenue model and market offerings in ten years will likely bear little resemblance to today's. That's a daunting project for a CEO with an executive team head-down in day-to-day details to manage. A qualified and capable board will be invaluable.

Want to learn more? Download my free guide that provides a question roadmap for directors and exec management teams to consider how to evolve their strategy as disruption looms.

References

1 - https://www.nacdonline.org/analytics/survey.cfm?ItemNumber=60038