The Board of Directors in the Early Stages

Posted on October 31, 2012

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While operating and shareholder agreements play an important role in corporate governance, they are insufficient when it comes to corporate governance. Ensuring that best corporate practices are followed cannot be spelled out in a legal document. A group of individuals is usually necessary to provide oversight and direction and help set the strategic tone. Personally, I am a strong believer in utilizing a board of directors to accomplish this.

First, from a legal perspective, what are the duties that a board member has to the shareholders? A board member has a fiduciary duty, and as such, must place the interest of one party (in this case the shareholder) above him or herself1. That phrase, in and of itself, should focus one on what is expected when one is a member of the board of a company.2 Expanding on this, corporate law views this fiduciary duty in two parts: the duty of loyalty and the duty of care.3

For the small company, meeting this legal requirement is often not as difficult as is feared. At its most simple level, the single owner level, a corporation is not going to have an issue meeting its fiduciary duties. Obviously, a single owner will do what is necessary to meet the duty of loyalty and the duty of care, and if for some reason he or she does not, then the owner has no one to blame but himself or herself. Similarly, if the ownership pool remains small and limited to employees, and if they are also all on the board, they will continue to act in the best interest of the company. Even if only higher executives get board seats, the incentive to move the company forward generally is aligned4 with all shareholders, and the board should be able to properly fulfill its fiduciary duties.

My advice for developing a board:

1) Give it time.
A director should have a good relationship with the officer(s) of the company. For a growing board, the advice needs to be readily available, sufficiently informed and generally supportive. For a director to have this perspective takes time. Talk to several people, and ideally those who are supportive will emerge and be good board candidates.

2) Realize that you have got to have self-interest involved.
While people generally like to provide advice and give helpful encouragement, everyone’s generosity has its limits. My suggestion is to deal with this head on. While you need it to take time, you also need to be direct about how you intend for the relationship to develop.

3) Try to get the business overview function accomplished by a board of advisors.
We will discuss this more in a later article, but if you can separate the fiduciary legal duties and the advisory duties, you are often able to find more willing participants.

Baseline requirements for corporate governance:

1) Shareholders elect directors.
2) Directors elect officers of the company.

Good corporate governance practice:

1) Have the board vote on a budget for the year.
a. Include approval of compensation for the officers.
b. Have non-conflicted directors approve the compensation.
2) Have the board approve finances.
3) Have the board approve the professional relationships, specifically the lawyer and the accountant for the company.
4) Meet quarterly. Take good minutes of the meeting.

Above and beyond:

1) Pay outside individuals

This last point – payment of outside directors – cuts to the true challenge facing small businesses and boards. On the low end, pay for outside directors of public companies is $20,000 cash, but it often exceeds $100,000 in addition to equity compensation. Of course, for small businesses the scope, and more importantly the legal liability, is significantly lower and will of course command a lower rate. However, compensation for an outside director is often something that is simply unaffordable  to a small business. Yet, having capable individuals who can advise the company is an essential part of growing the business. Entrepreneurs, as they have to do with almost all aspects of business, need to cajole, bridge, plea, beg, be very nice, and be very smart to have a board that functions like a true board of directors.

Mike Goodrich
Goodrich Law Firm, LLC

1 Operating agreements can restrict, particularly in Delaware, this fiduciary duty for a board of managers in a limited liability company. This is one reason why many companies have a board of managers.
2 A similar, albeit more nuanced, duty exists for members of nonprofits.
3 We explore duties in later articles. There are also disclosure (and many other) duties applicable to public companies and heightened duties in the case of a sale of the company.
4 Compensation issues are the notable exception and where people’s interest may not necessarily align. For this reason an outside director, who votes on the issue, is helpful to overcome the conflict.

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