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Small Business Boards of Directors Jim Elwell, 15 May 2008 Today’s Presentation 1. Books to read 5. Compensation & 2. Typical Boards Liability 3. “Real Boards” 6. Directors’ 1. What is it? Handbook 2. Objections 7. Board Meetings 3. Benefits 8. Board Evaluation 4. Creating a Board Books To Read – 1 • Very methodical, step-by-step approach to creating a Board • Many forms and example documents worth having • A bit weak on topics such as committees and document retention • Ideal if you have never had a real Board. Books To Read – 2 • Much more detail than 5 Steps on Board duties, obligations, etc. • Not as strong on forming a Board, but some material. • Excellent material on getting the most out of your Board. • Excellent list of Board & Directors' duties • Good material on family-owned businesses. Books To Read – 3 • Better for larger companies with Boards in-place • Whole chapters on audit and compensation committees • Best on topics like Minutes and document retention. • Includes chapter on becoming a Director and improving your performance as a Director Advisory Boards vs. Boards of Directors • Advisory boards are not required for any company. • Management can ignore the suggestions of Advisory boards. • My personal experience on an Advisory board is that it was not effective. • Nonetheless, much of what follows can be used with Advisory boards. Statutory Requirement for Boards • State law requires that Corporations (C or S) have a Board of Directors • Generally must have a minimum of 3 Directors • No constraints on who can be a Director (owner, Mom, golf buddy, etc.)except age (18) & not incompetent • Stockholders elect Directors either annually, or as specified in the Bylaws (with Article authorization) • Most aspects of Boards are governed by the Bylaws • Similar in all 50 states with minor differences Corporate Bylaws • Bylaws govern most operations of the corporation – who calls Board/Stockholder meetings – who gets to vote; record date – what constitutes a quorum – Director terms – Officer positions and responsibilities – Indemnification of Directors & Officers – How notice of meetings must be made Typical Small Business Boards • Often just the owner or owners plus a few family or friends. • Often never meet formally, even though required by law to do so. • Directors frequently have little or no business experience • Family Boards often are contentious and non- productive • Family/Friend boards have NO upside – only downside. What Constitutes a “Real Board”? • Typically 3 members for very small companies (< $1M in sales), or 5 to 7 members for larger companies • Ratio of “outsiders” to “insiders” should be at least 2:1. Preferably only one insider – the CEO • Do not put your managers on the Board – you already get their input. • Do not put advisors (banker, lawyer), vendors or customers on your Board. • Outsiders should have varied experience, and lots of it – typically at least 50 years old Owner's Objections to a “Real Board” – 1 • Directors will see private information. – They cannot help you if they do not know what is going on. However, they are legally obligated to maintain confidentiality; you can also ask them to sign non-disclosure agreements. • Directors will criticize my decisions. – Good Directors offer feedback and suggestions, and justify their suggestions. • Directors will “take over” my company – Shareholders pick Directors, and usually can replace them during the year. If you own 50%+ of the stock, you have absolute control. If you own less than 50%, you may still have effective control, since Directors have no interest in running your business. Owner's Objections to a “Real Board” – 2 • Directors might fire me. – This again relates to who owns the stock. Besides, if you have good Directors and they want to fire you, what does that tell you? • Directors might force changes I do not like. – Directors do not “force” anything. They give you their best advice, and you mostly can ignore or follow it. Ignore it too often and your Directors will quit. • Boards are not effective – Good Boards are extremely effective. This is proven by the fact that small companies with Boards have better success than those without. Owner's Objections to a “Real Board” – 3 • We do not have a strategic Plan – A good Board can help you develop one. • My business is too small. – This is when you really need a good Board to help you overcome the hurdles to growth. It may be small and meet only four times a year, but it can be tremendously helpful. • My managers will not like it. – They have the same question to deal with as you do: if a good Board offers advice you do not like, is it bad advice, or are your managers missing something important? Owner's Objections to a “Real Board” – 4 • I am too busy – Boards take time, perhaps 16 to 20 hours preparation per meeting (meetings are quarterly for most small companies). They save time in helping you avoid serious mistakes. • Boards are too costly. – The cost varies with company size, and the value of a Board far exceeds its cost. The main function of a Board is to support and nurture the CEO, not beat him up. A good Board is a CEO's greatest champion! Benefits of a “Real Board”– 1 • Experienced, Unemotional, Objective Advice – Owners have few, if any, avenues for posing problems and getting unbiased feedback and advice. This is by far the most important service a Board provides to the closely-held business owner. • Expanding your network – Five experienced Directors will have far more contacts than you do, in a wide variety of areas. • Improving Accountability – You and your managers will be more accountable for your actions and failure to meet projections and expectations. The mere fact of having to answer to the Board improves performance. Benefits of a “Real Board”– 2 • Enhanced Credibility – Almost all outsiders, such as bankers, investors and customers find a business with an independent Board to be more credible than one without. • Strategic Advice – Boards are outside the daily grind, and can often offer strategic advice that simply escapes the insiders, and offer fresh insight into Management's strategic planning. • Protects the Shareholders – If you have Shareholders who are not involved in the business, you have a legal, fiduciary responsibility to them. Boards help you fulfill this responsibility. Benefits of a “Real Board”– 3 QSI Sales ($) How to Create a Board of Directors Step 1 – Define Who You Need • What skills are you (the owner) missing? – Be candid – you are not the best at everything! • You need Directors who have expertise you do not. – Might include: Marketing, Sales, Operations, Finance, Administration, Strategic Planning, Human Resources, Engineering, Mergers & Acquisitions, Franchising, etc. • Decide which skills to put on your Board. – You will only have 2 to 6 seats to fill. Which of the many areas are most important to your long-term success.? How to Create a Board of Directors Step 2 – Write a Board Search Memo • Define the skills/positions you are looking to fill. – Do not be too specific – you will not find perfect matches. Include experience level, integrity demands, prior Board experience, etc. • Describe your company – This Memo is the first thing most potential Directors will ever see about you. Tell them who you are, what you do, what your plans are for the future. • Describe the responsibilities of being on your Board. – Number of meetings, need to come to meetings prepared, etc. – See Exhibit 1 – QSI's most recent Board Search Memo. How to Create a Board of Directors Step 3 – Network & Interview • Send your Board Search Memo to anyone you know who might know good, potential Directors. – Attorneys, accountants, bankers, CEO members, clergy, people you know are Directors, etc. • Follow up promptly – Contact candidates, meet them, ask them for bio information (i.e., résumé). At the meeting, discuss their business experience. • Rate your candidates – Prepare a rating chart of important characteristics; use it to unemotionally evalute your candidates. – See page 86 of 5 Steps to Board Success How to Create a Board of Directors Step 4 – Select & Recruit • Send your preferred candidates more information. – How they will be compensated, high-level financial statements, description of your indemnification Bylaws and D&O insurance. • Ask them to join your Board – Most candidates are honored to be asked, and are very serious about wanting to help. Most will accept. • Elect them to your Board – Mid-year appointment by current Board, election by stockholders, etc. Follow your Bylaws! • Send Director's Handbook, schedule meeting dates. – Handbook is described later in this presentation. Compensating Directors • Some combination of – Annual retainer: $0 to $2k per year – Per meeting fee, in person (local): $250 to $1500 – Per meeting fee, in person (out-of-state): double the in-state fee – Per meeting fee, teleconference: about ½ of in-person – Expenses: mileage, airfare, hotel, etc. – Stock or Options: none to 0.2% of issued stock per year – Opportunity to help a small, growing company! • Top-quality Directors are worth more than you can afford. – They serve because they want to help, not for the money. The modest amounts above are an honorarium, not consulting fees. QSI's Director Compensation • As of the 2008-2009 term (sales ~$20M) – Annual retainer: $2k per year – Per meeting fee, in person (local): $1000 – Per meeting fee, in person (out-of-state): $2000 – Per meeting fee, teleconference: $500 – Expenses: mileage, airfare, hotel, etc. – Stock or Options: 5k share option, vesting over 3 years • Total cost (4 outside Directors, one out-of-state): about $32,000 plus 20k shares (about 0.7% of outstanding). • 14 years, 10% increase in stock issued, 11X increase in revenue. Director Liability Concerns • The one issue that might keep Directors off your Board is Liability concerns • You must provide indemnification – check your bylaws • Consider obtaining Directors & Officers (D&O) insurance – it is not cheap, but some people will not serve on a Board without it • QSI's D&O insurance: $2M policy, $5500 per year • In reality, the likelihood of a Director getting sued for his/her performance on a small company Board is very small • According to Creating Effective Boards (page 80), risk of a D&O liability claim for companies under $25M assets is less than 2% over a 9-year period. Board of Directors' Handbook – 1 • A vital tool – do not dismiss it! – Helps orient new Directors – Provides a wealth of necessary information in one place – Ensures Directors are informed of important issues such as their obligations as Directors – Discusses general Board operation – Gives them direct access to your Bylaws. In general, improves the productivity of Board meetings Board of Directors' Handbook – 2 Sections of the Directors' Handbook • Mission & Vision & Philosophy – A page or two that help Board members know why you exist and what you are trying to do. • History – Where you have been, how you got where you are • Products & Markets – A detailed discussion of what your company does, the customers and markets it serves, and who your competitors are • Board Charter (purpose, goals, etc.) Board of Directors' Handbook – 3 • Strategic Summary – What is your business model? What is your strategy for success? • Organization – Ownership of the company; names & ownership of major shareholders – Organizational Chart, at least three levels deep – Key advisors – attorneys, accountants, etc. – Executives – include pictures and biographical information – Board – pictures & biographies current Directors • Financials – Current Balance Sheet, Profit & Loss, Cash flow – Projections for the current year – Most recent Audit Report Board of Directors' Handbook – 4 • Articles of Incorporation, Bylaws – These are the legally-binding governance documents – Helps Board understand its duties • Board Policies – how the Board is run – Director General Responsibilities – Director Legal Responsibilities – Scope of Activity (i.e., stay at a high level) – Director compensation policy – Code of Conduct – Procedural Rules • Mostly informal, but take formal votes on agenda items Board of Directors' Handbook – 5 • Board Policies – continued – Board Committees • Audit Committee • Compensation Committee • Committee responsibilities & authorities – Document retention policy (very important!) – Succession Plan (tells the Board what to do if you get run over by a truck) – Board Evaluation Policy – Activity Lists – Board Do's and Don'ts • Use three-ring binder; tabbed sections for quick access Board of Directors' Handbook – 6 List of Director Duties • Review corporate objectives • Monitor corporate performance • Adopt or change bylaws • Approve amendments to articles of incorporation • Elect corporate officers • Set senior officer compensation • Approve any merger, acquisition or sale • Recommend dissolution • Approve dividends • Many more – see Table 2, page 50, in Creating Effective Boards Prior to the Board Meeting • Have a half-day Orientation the day before a Director's first Board meeting – Give them a Facility Tour, show them your products, etc. – Have them meet all senior executives – Compensate the Director with ½ of a meeting fee. • Have a pre-meeting Dinner (night before) or Breakfast (day of) the Board Meeting – Lets Directors get (re)aquainted. – Allows time for personal discussions (“how are the kids?”) – Provides better focus on business at the actual meeting – No compensation Running Board Meetings – 1 • Prior to the Board meeting – Have an Agenda and supporting documentation distributed at least one week prior to the meeting! • Agenda Guidelines – Put times on each item; keeps the meeting on track, indicates item importance to Directors – Agenda items should be descriptive enough that Directors do not have to guess at what the discussion will be. • “Inventory” is not an adequate description • “Discuss large obsolete inventory write off” is much better Running Board Meetings – 2 • Agenda Guidelines (continued) – Use the Agenda to keep the discussion at a high level; keep the Board out of day-to-day management – Always have an Agenda item setting the dates for the upcoming meetings one year in the future! – Always have an Agenda item approving the minutes from the prior meeting. – Try to keep the “housekeeping” items to no more than one-half of the meeting. Leave half for substantive discussion of big issues. – If you can, send a preliminary agenda earlier than one week, especially if there is a lot of reading to do. – See Exhibit 2 ̵̶̵ Sample QSI Agenda Running Board Meetings – 3 • Minutes – Minutes must record formal decisions by the Directors. – Minutes should record any objections by any Director to actions taken by the Board as a whole. – Do not record the details of discussion that take place, only the decisions that are made. – A four-hour meeting should generate no more than two pages of minutes. – The rule is: If it is in the minutes it is a permanent part of company records. If it is not in the minutes it did not happen. – Minutes that are too detailed are dangerous to Directors in case of lawsuits. Running Board Meetings – 4 • Boards should stay at the big picture, strategic level – Do not let Directors get involved in day-to-day operations – The Chairman (& all Directors) should be ready to say “That is an operational issue, not something the Board should spend time on.” • Listen, Listen, Listen – You are paying money and time to have your Directors there – LISTEN TO THEM!! – You should spend far more time listening and asking questions than preaching to your Directors. Running Board Meetings – 5 • Committees – Review your Bylaws for committee requirements. – Almost certainly the Board should set the CEO/President pay. • A compensation committee should be formed to do this, and it will not include the CEO. – Committees serve at the pleasure of the Board, and can be formed and disbanded as the Board desires. Their main purpose is to relieve the Board as a whole of time consuming research, resolution writing, etc. – In general, a committee is obligated to perform the tasks assigned to it, and has no authority not specifically granted by the Board. Running Board Meetings – 6 • Committees (continued) – Committee Chairmen are either appointed by the Board upon formation of the committee, or, if not, the Committee members pick their own chairman. – Be sure to have a committee guideline such as: • Any Director may communicate with any committee member at any time. Substantive communications should be copied to the committee Chairman, who determines what committee discussions are read into the official minutes of the Board. – An Audit committee is essential if you have an annual Audit done. The Audit committee communicates directly with the audit firm, and must not contain any inside Directors. Board Evaluation • Boards that self-evaluate improve every year; those that do not self-evaluate may not improve. • Good Directors want feedback to help them perform better. • Have Directors fill out evaluation forms at the end of each Board year – Excellent forms and process in 5 Steps • Do something with the evaluation! – Replace poor performers, provide materials or training where lacking, etc. Summary • Real Boards dramatically improve small business success. • Real Boards cost significant time and money to create and operate. • The return of a Real Board far exceeds its costs.
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