Tony Featherstone investigates when and how a small company should go about forming a board.

    There are two distinct views on when a small enterprise should form a board. The conventional view is based on size: as the venture grows, raises capital and adds shareholders, a board is formed to protect stakeholder interests. It evolves from an advisory to full-functioning board over time.

    The emerging view on small and medium-sized enterprise (SME) board formation is based on growth and ambition. Here, the venture forms a formal board early in life to help shape strategy, coach the founders, develop systems for sustainable fast growth and avoid landmines. The board is viewed as a strategic asset.

    Technology entrepreneur Brand Hoff AM FAICD formed a four-member board for TOWER Software Engineering when it had just eight employees and scarcely any revenue. Hoff, his wife Peta and two TOWER employees had monthly board meetings to plan the company’s long-term growth.

    Board meetings usually involved a dinner afterwards with partners and were as much about team bonding as formal governance. And, sometimes they turned into executive committee sessions – not surprising in a small venture. Nevertheless, Hoff was determined to build a formal governance structure.

    That was in 1985. By 2008, TOWER Software had grown to 240 employees and was acquired by Hewlett Packard for a nine-figure sum. During that time, the TOWER board had at times grown to six directors and was well led by its prominent independent chairman, Jim Service AO FAICD.

    Hoff believes the board was a big part of TOWER’s making. “From day one, we had a philosophy of always planning for the next stage of growth. We formed a board so we could get away from day-to-day work and think about the bigger picture. The board became a great asset.”

    Now an angel investor, Hoff has been on more than 20 boards of SMEs. “The smaller the company, the bigger the egos,” he quips. “You see two directors start off as best mates pursuing a great idea, but sooner or later there is a divergence of opinion. Or the company looks like being successful, greed sets in and there are corporate shenanigans. A board can help overcome these inevitable problems and keep the business on track when tensions emerge.”

    Hoff says SMEs shouldn’t wait until they have sufficient scale to form a board. “As soon as you have two shareholders, you need a board. As soon as you have external capital, you need one. It does not have to be large or costly, but the board must be part of the early strategic planning.”

    He adds: “Even if the board is merely a duplication of the executive team, it is beneficial to convene a monthly board meeting to concentrate on ‘working on the company’ rather than ‘working in the company’. Small companies tend to be over-busy and excited with entrepreneurial core activities.”

    Hoff’s deep appreciation for boards is unusual in start-up entrepreneurship. Founders often see boards as a brake on their creativity, flexibility and drive, or an unnecessary layer of bureaucracy best reserved for corporations. Also, board fees can spook cash-constrained ventures.

    Many SMEs only form a board when external investors require a directorship to represent their interests. For example, an angel investor who provides seed capital receives a directorship and a venture capital company that provides more funding requires two board seats. When early investors exit through an initial public offering (IPO), a new board is formed to transition the company to public ownership.

    Family companies, too, have different motivations behind board formation. As the family expands and the business grows, a board is formed to help separate family and company matters. Or the founder realises new skills are needed, so an independent chairman is recruited. Or a board is formed to help the family company prepare for a critical succession event.

    In these examples, board formation for SMEs is more reactive than proactive. Such boards can still add great value, but forming them earlier in the venture’s journey – with a focus on strategic growth and developing compliance systems to sustain that growth – is arguably more beneficial.

    Tony Iannello FAICD has a useful perspective on family-company boards. He chairs the family companies MG Kailis Holdings, a marine business, and D’Orsogna, a smallgoods company, as well as insurer HBF Health, Empire Oil and Gas NL and exploration company Energia Minerals. He is also a non-executive director (NED) of energy company ERM Power and electricity and gas company SPAusNet.

    Iannello says family businesses should form a board – separate to a family council – when an external CEO is appointed or as the shareholder base grows. “An external CEO simply cannot manage relationships with seven or eight family members who are key shareholders. He or she needs to report to a board that acts as an interface between the shareholders and executive team.”

    Iannello adds that succession is also a key trigger for SME board formation. “The business gets to a certain size, the family has a lot invested in it and the founder wants to retire or step back from the business. The board is established to oversee the transition and create more structure.”

    Iannello joined the board of MG Kailis, a seafood processor, jeweller and marine business, in 2007, just weeks before an underwater virus damaged its pearling operations and it had to decide whether to reinvest or exit the business – a tough decision. MG Kailis had been in cultured pearls since 1975 and the business had sentimental value. “The real value of boards in family companies is when a problem strikes,” says Iannello. “The board was able to focus on a complex issue about pearling, without any attachment and dispassionately make the best decision [to exit pearl harvesting in 2009].”

    Like a growing number of family businesses, MG Kailis formed a board to oversee the next stage of its growth. After appointing an external CEO, the Perth-based company established a board in the mid-1990s. The board has evolved over time. It now has four family-member NEDs, two independent NEDs and an external CEO. In 2013, MG Kailis had revenue of $81.3 million and 240 employees.

    Perth-based D’Orsogna, established a board to bring in new skills. The D’Orsogna family decided more than a decade ago that different skills were needed to enhance the company and drive its next stage of growth. To its credit, the company brought in several external directors to join three family members on the board. Iannello became chairman last year. He says: “The skill of a family company director is knowing where the organisation is at in its growth phase. You want to develop strong governance structures and processes without dampening the entrepreneurial flair or slowing it with bureaucracy. It’s not easy. The family has often been involved in the business for decades and knows far more about it than directors ever will. The board’s challenge is to capture that knowledge and help take the business forward.”

    Neil Hamilton FAICD is well versed in the challenges of governing fast-growth companies. He chairs miner OZ Minerals and is a NED of wholesale grocer Metcash. He has chaired many companies in the past, including financial information provider IRESS Market Technology and also D’Orsogna for a decade.

    Hamilton says SMEs often take small steps with board formation. “There is no one-size-fits-all approach. If the company is cautious about forming an external board that is independent in structure, it might start with one director: a non-executive chairman who is a trusted adviser and confidant.”

    Hamilton adds: “In effect, the founder is brought along with the idea of a board. He or she sees the benefit of having one very good director and starts to understand that a bigger board can be a real asset. The board, in turn, has the wisdom not to overlay heavy governance structures on the company and can adapt to its  needs as it grows. I have seen situations in small companies where having too many governance processes becomes stifling.”

    Hamilton experienced the challenges of governing a fast-growth SME as chairman of IRESS from 2001 to 2010. Now a $1.3-billion company, IRESS was a much smaller, lesser-known business when Hamilton joined its board. “The IRESS board back then could not come close to matching the company and industry knowledge of the executive team. Our role was more to support, guide and encourage management, without interfering or slowing down business development. It’s a fine balance for SMEs: you don’t want to stop the momentum, but equally you don’t want to later wonder if the board should have been more active.”

    Hamilton says boards of fast-growing SMEs must accept that their roles will evolve. “It’s not like joining the board of a large organisation that has established governance processes. The board and the founder are finding the best way to work together. In my experience, the most successful people surround themselves with people smarter than themselves and that is true of many entrepreneurs. They want to take advice from very good people on their board.”

    Hamilton believes board formation can be problematic in small mining companies or those heading towards an IPO. “Some junior mining companies see a board as a requirement rather than an asset. They know they need a board to take them through an IPO, but put insufficient thought into its composition. It is important to form a strong board well before listing, so that directors can help oversee the establishment of risk management, information and financial systems to support future growth”

    Keith De Lacy AM FAICD knows the challenges of board formation in the resources sector and through the IPO process. The former Queensland Treasurer chaired Macarthur Coal from an IPO in 2001 that valued it at $128 million to a $4.8 billion coal producer that was taken over in 2011. De Lacy currently chairs STAG Beef and Integrated Food and Energy Developments and is a director of Reef Hotel Casino, Queensland Energy Resources and the Australian Institute of Company Directors.

    De Lacy recalls: “[Macarthur founder] Ken Talbot asked me to be chairman when he was seeking to list the company. He was the quintessential entrepreneur and this was before the boom years. I checked as much as I could, but in the end I took my greatest punt. On reflection, Talbot was just ticking the boxes for the IPO and wasn’t ready for the structure and process and constraints of a listed company. But we worked it through, with extraordinary results.”

    De Lacy says dealing with a dominant founder is a “perennial challenge” on SME boards. He advises founders and prospective directors to do the Company Directors Course to understand their roles and responsibilities from the outset. “Directors need to understand to whom they owe their obligations and owners need to understand that all the directors are equal in terms of their responsibilities and liabilities.”

    De Lacy says directors must understand the risks of joining an SME board. “There may be many skeletons in there, a tendency to cut corners and an innate determination to do things ‘my way’. That is what made the company successful in the first place. But sometimes there is only a fine line between what is right and what is wrong. Your reputation can survive a failed venture, but it can’t survive a scandal. Due diligence is vital, but sometimes easier said than done. Ask around, keep your wits about you and insist on proper process without being pedantic.”

    He says an SME should appoint a board as soon as it can afford one. “An astutely selected board can provide much needed, and very often absent, skills and experience. It does add to the costs, overheads and process so don’t rush into it. I would say to a founder, make sure you are appointing a board for the right reasons – to add value and capability. Sometimes two NEDs can be enough. Let the board grow with the company, leaving space to grow the board should there be merger and acquisitions activity. Look at the skills gap and compatibility when appointing directors, but not for mates to join the board.”

    De Lacy does not favour advisory boards for SMEs where directors have more of a mentoring than formal governance role, even though such boards can still carry significant legal risk. “People get confused about their roles. If you are going to have a board it should be a decision-making board – you are either in or you’re out.”

    Tony Fittler, managing partner of HLB Mann Judd Sydney, says all SMEs could benefit from a board. “However, in order to be effective, the owner must accept that having a board will change the way decisions are made. This can be difficult for those used to making all the decisions. Sometimes owners think they are ready, but when confronted with different views from a board, they have trouble accepting these.”

    Fittler says establishing a board involves a significant cultural change for a company. “The new directors need to understand SMEs, and the need to change, and be able to help implement change in an SME environment. Therefore, an SME should establish a board when it is ready to accept the changes that will flow and when it has found a good person to start with. The danger is that sometimes SMEs procrastinate.”

    TOWER Software was not one of them. Hoff’s investment in a board, so early in TOWER’s evolution, paid off many times over. So much so that he has become a strong advocate of SMEs forming boards as soon as they can. He says: “The best thing I ever did was learn about governance early in my career and form a board early. The governance focus helped TOWER grow into a much larger business, and steered it through all the ups and downs along the way. The board wasn’t only about compliance; it was also about having directors who could help build a much larger, more successful company.”

    A board can help an sme:

    • See the big picture.
    • Better manage succession planning.
    • Improve access to capital.
    • Embark on an IPO.
    • Transition from family to professional management.
    • Plan or manage expansions.
    • Minimise business risks.
    • Fill experience or skill gaps.
    • Expand its networks.
    • Improve management accountability.

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