Tony Featherstone asks Company Directors’ chairman Michael Smith how an SME should go about forming a board and the benefits for directors who join.
In addition to other positions, Michael Smith FAICD is chairman of iiNet, Western Australian energy retailer Synergy, Lionel Samson Sadleirs Group and the Australian Institute of Company Directors. He recently spoke to Company Director about the pros and cons of joining the board of a small and medium-sized enterprise (SME). Here is an edited extract of what he had to say:
Company Director (CD): When should a fast-growing SME form a board?
Michael Smith (MS): Board formation should be in the SME’s strategic planning right from the start and a full board should be something the organisation progresses towards. This is particularly important for SMEs that want to list on the sharemarket. Some private companies find it very hard to meet public company governance standards straight away when they list. The organisation should have some sense of the governance gap before it goes public and how forming a board early can address it.
CD: Should SMEs initially form an advisory board or full board?
MS: I would appoint directors on a normal basis, rather than an informal advisory basis. Once you are a director, you have very significant legal responsibilities to uphold your duties. Therefore, the SME board needs a clearly defined role and the power to execute that role.
CD: How large should the SME board be at the start?
MS: It is possible for SMEs to form a board with only one or two directors. However, I would caution against forming very small boards. In my experience, directors are most effective when they work with other directors and share the governance responsibilities and risks as a team. It is a big ask to be the only director on a board or as part of a two-member board.
CD: How can SMEs get board composition right at the start?
MS: It depends on the organisation. Generally speaking, fast-growth ventures need directors with strong industry experience, excellent financial acumen and SME governance experience. The SME board needs a keen sense of the organisation’s changing valuation; whether it is performing against that valuation; and where it needs to get to for the next capital raising. You want directors who have previously been through the process of taking a private company public.
As a general rule, SMEs should seek directors who are up-to-date with contemporary governance practices and have a commitment to ongoing training and learning for their board work. Board skills can go stale quickly in a constantly evolving governance landscape. SMEs should avoid directors who are seeking to “retire” or wind back after their executive careers by taking on a directorship. Australia has the toughest laws in the world on director liability. SMEs are better off starting with a few experienced, high-quality directors and growing the board as they expand.
CD: What are some key challenges for directors of SMEs?
MS: Fast-growth ventures are often like racing cars: exciting and also very dangerous if you don’t know what you are doing. Do not think an SME directorship is easy because of the organisation’s size. The safest place to be a director is usually in a large organisation. There, boards typically have other well-qualified, experienced directors; established governance procedures; tier-one accounting firms doing the audit; and a much deeper executive team. SME boards usually have far fewer resources to support directors and you have to be a lot more hands-on. Also, SMEs boards often deal with dominant founders who, through their own self-belief, determination and capacity to stare down the deniers, made the organisation what it is today. Some founders find it hard to take advice from boards although, in my experience, the best entrepreneurial CEOs, such as iiNet’s Michael Malone, recognise early that their company needs to adapt and the value that boards can add in that transformation.
CD: What are the benefits for directors when joining an SME board?
MS: It can be a tremendous experience joining the board of a fast-growth SME and helping shape it much earlier in its journey. The board helps mould the organisation and its governance structure when it is still wet clay. You are not trying to modernise an existing governance structure or having to break things before you can fix them, as sometimes happens in large organisations. Being part of an effective SME board can help you become a more rounded director as you take aspects of that experience to your other board roles.
CD: What due diligence should directors do before joining an SME board?
MS: Directors should do all the usual due diligence they would do before joining any board. With SMEs, pay extra attention to the structure of the balance sheet and the organisation’s ability to access funding as required. You must be very clear on the shareholder base, its intentions and whether key shareholders are actively or passively involved in the organisation.
You must carefully consider the executive team and other directors on the board, although that is true of joining any board. I find history is a good indicator of future performance: strong reputations are usually built piece by piece over long careers. Having experienced, reputable and successful directors on an SME board gives an insight into the quality of the organisation and its board.
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