How exactly do you go about finding independent board members?

BY MIKE COHN

Small and mid-size companies are beginning to realize that having “outsiders” on their board of directors can provide intellectual resources to the family business that, more than ever, needs to compete in a complex, global marketplace. Outsiders, by definition, are not the company’s CPA, banker, or attorney who already has existing relationships with the family business.

But there is plenty of confusion about who should be on the board, how they should be selected and what a board does and does not do. Take the case of David S., CEO of a mid-size company. David owns 20% of the stock; his two sisters, not active in the company, each own 20%, and a family trust owns the remaining 40%.

David and his sisters make up the current board. David proposed, and the sisters agreed to add two outside board members and a year ago David began a search process. They hired a search firm to help them find qualified candidates. David and his sisters agreed David should interview several prospects, recommend the three best, then he and the sisters would meet with the “finalists” and pick two for the Board.

But David made some critical mistakes that sabotaged the process:

1. he told the search firm the sisters wouldn’t be involved,
2. he didn’t keep the sisters informed,
3. he invited two to join the Board before the sisters had met them, and
4. a letter he sent to the new Board members said they should meet the sisters “as a courtesy” before the first meeting. Result: the sisters went ballistic and a plan to help the CEO and company grow has instead turned into a divisive family issue.

What should David have done? Beginning with their business plan, David and his sisters should have first decided on the core competencies they wanted in outside directors. For example, since David had strong marketing skills but was weak in accounting and finance, expertise in corporate finance is one requirement this family needed.

One of the most important missions of the Board is to ensure that shareholder value is both enhanced through corporate performance and protected through adequate financial controls. Board members should have specific experience to help accomplish those goals.

Some additional core competencies for Board members include:

• Business Judgment—a record of making good business decisions
• Management Expertise—an understanding of management and industry trends, including “best practices” and their application in complex, rapidly-changing environments.
• Leadership—both the skills and experience to motivate high-performance talent
• Crisis Experience—all firms experience the unexpected; the company’s response to crisis often has long-term impact so having a director with experience, availability, and resources can help mitigate negative consequences.
• Strategy and Vision—strategic thinking and insight can be provided by Directors who encourage innovation, conceptualize key trends, evaluate strategic decisions, and challenge the organization to stay focused

Next, David should have presented the Board (his sisters) and the stockholders (the trustees of the family trust) with information about the candidates David recommended, including the competencies the nominees possessed that would help the company achieve its goals.

Board members should have passion for the company, an understanding and respect for its past and the ability to challenge and inspire the CEO and top management. David’s sisters couldn’t know if Board candidates possessed these traits by just reading their resumes. Outside directors should want to meet the major shareholders as well.

One of David’s biggest mistakes was assuming that the Directors he chose would be “his guys”. One of the most important duties of the Board is to evaluate the CEO, which includes performance and compensation review, planning for CEO succession, and when appropriate, replacing the CEO.

David’s sisters had correctly assumed that adding outside Board members would make David more accountable. As sisters, they were reluctant to confront him, yet as shareholders they wanted their CEO to be the best possible leader for their family business. An important function for the Board is to review the CEO’s performance at least annually.

The Board should have an understanding with the CEO about the criteria which will be used for the evaluation, and the results should be shared with the CEO. As David admitted, he wanted advisors he could turn to, but not greater accountability. David saw his sisters as “meddling” when they challenged him; the sisters wanted to avoid further friction with their only brother.

The more David learned about the role of the Board, the more he believed he would be giving up autonomy and would be subject to criticism by others. The more the sisters learned about the role of the Board, the more they believed it was exactly what the company (and the other shareholders) needed and that outside Board members could provide some objectivity and perspective on handling tough issues like David’s compensation and his performance.

Outside Board members do not want to find themselves in the middle of a family feud so some families have created a committee of owners, as a subcommittee of the Board, to address family ownership, estate planning, and stock issues. This subcommittee reports back to the Board with its recommendations on family stock issues, so the Board can vote. This keeps outsiders on the Board informed without (hopefully) involving them as family referees.

The Board has only one relationship to supervise: the CEO. For the CEO who wants to grow, this can be an exciting opportunity. David and his sisters have decided to delay their decision on outsiders for three months so they can focus on, and try to resolve, their bigger issues. David may decide to step down as CEO, or he may accept that greater accountability comes with greater responsibilities (and compensation). Either way, what this family learned is that finding and recruiting outsiders was the easy part; becoming ready for what the outsiders will bring to the table is often more challenging.