Why do I need an independent director?
I’m a decision-focused executive and former corporate lawyer. I show companies how they can benefit from more action-focused, decisive management of corporate issues.
Do you need me? Let’s find out.
Why have an independent director at all?
As a company grows, the standards of corporate formalities become more demanding, and once external shareholders and stakeholders become involved, lapses in governance can have more damaging consequences. Many closely held businesses wonder, “Why do I need a board?” Even after they’ve seen the value of someone asking hard questions and trying to help a company become a business, they wonder where they’ll find directors who understand their challenges without putting a thumb on the scale.
In most of the companies I work with, the minimal requirements of compliance with corporate law, organizational documents, and investor documents start out relative simple and only grow more complex over time. But who wants to run a business only to do the minimum? Would you send your sales team to an industry conference only so they could attend all the sessions? No, you’d go nuts. And from the director perspective, if all you’re getting out of corporate governance is a handful of checked boxes, you’re missing out: you’re on the wrong end of the 80-20 rule. Lawyers, bless ‘em, focus on meeting the requirements – sign this, give notice of that, and vote on the other thing. Those are important, but they’re minimal. What lawyers don’t regularly control is the content of the board meeting process and the outcomes that aren’t on pieces of paper to be filed in your minute book.
What growing companies benefit from in a board process can be distilled to three things:
- the discipline of creating meaningful reports and reviewing them;
- giving the CEO space to work ON the business instead of IN the business; and
- a seasoned and broadly experienced board to help the company focus on the most important decisions.
Even when the CEO holds the vast majority of the votes, ALL of these remain true. Boards aren’t about control; they’re about a process to establish direction. It’s true: a board that votes the “correct” way on a complex issue without discussing it has violated its fiduciary duties. Not every company needs a Fortune-500 level of board structure, with lots of committees and associated policies. But they all benefit from knowing about existing solutions to long-running problems:
- Independent directors come to the table without a substantial set of preexisting conflicts. Founders have emotional and fiscal ties to the company that shape their view of alternatives; investors have expectations about returns and future investments that shape their views on the same alternatives. The purpose is to be able to help everyone set aside subconscious conflicts and focus on what’s best for the company in the long run.
- audit committees of independent directors help shareholders ensure that management is doing what they should
- compensation committees set senior management compensation so it’s fair and not shaped by the executive staff for itself
- nominating committees help bring new talent – board and executive – to the company by thinking about what’s needed vs. what’s wanted
- Governance policies such as conflicts of interest policies help everyone stay on the path of the company’s best interests by preserving everyone’s faith in the quality and reasons for decisions
- Special committees of the board negotiate with potential buyers and, by following specific process steps to protect shareholders, make the approval path for a company much smoother.
Why can’t my executives and partners do all this?
Sometimes, your existing team can. But sometimes there are specific problems that suggest a new approach is needed:
- Specific knowledge about a pending problem: I would regularly tell clients that while most of them would do 2-3 venture deals or 1 M&A deal in their lives, I was closing that many every week.
- Embedded interests: sometimes the set of influences on the team become hardened so that the company is falling into a rut of certain approvals and rejections of policies or suggestions. An independent director with no preexisting position to protect can break these logjams before they harden into rifts among the team.
- Preparing for a sale: one of the things that buyers most worry about when purchasing a business with a single CEO/owner is that the business can’t run without the CEO. By improving corporate governance practices to mirror more developed companies, other senior executives can quickly improve their skills so that a buyer can have greater confidence in the business’s operations after the transition period ends.
Independent directors are usually nominated by one party (founders or investors) and approved by the other. They can’t be employees of the company or have such a connection to either party that they lose their independence. (There are more detailed standards for public companies, but for most private or venture-funded companies, this is accomplished either in a de facto way, by having one group nominate a person and the second group approve that person (approval signifying agreement that the nominee is sufficiently independent), or in using a working definition like this: “an independent director with no affiliation to the Investors or the holders of Common Stock.”