Companies often underestimate the need and rationale for having a board of directors. The typical model for SMEs in Central Europe is to have a strong owner-manager who makes all decisions single-handedly. This certainly has the advantage of speed of decision-making, and having a clear, unambiguous line of authority.

However, there comes a time in the development of a company when a board of directors should be considered. This article deals first with the issue of why to have such a board, and second, what kind of board members should be appointed.

The rationale for having a board

There is something to be said for the collective wisdom of a well-selected group of individuals being greater than the wisdom of any single individual. Psychologists have shown that where a decision-making body functions harmoniously, the group actually consistently makes better decisions than would normally be made by any individual in the group. The collective IQ of a harmoniously functioning group is greater than the IQ of any participant in the group. Often, the mere process of dialogue or debate allows additional dimensions of a decision to be explored, which otherwise might not have come to light.

In a board, it is possible to select individuals who represent different perspectives and have different competencies: industry experts, finance, marketing, legal, etc. Having all of these perspectives represented when decisions are made may result in better decisions.

While a strong owner-manager is usually quite capable of running the business, should such owner-manager become incapacitated or pass away, a board can play an invaluable role in assuring the continuity of the business. Often a member of the board may act as an interim manager, or the board may appoint an interim manager, and then work on the issue of appointing a new manager. Having a board that is capable of acting on matters of succession diminishes or brings under control an important source of risk regarding the continuity of the business.

Should a company seek outside investors, or where a company has multiple shareholders, a board is usually the preferred structure by investors and shareholders for decision-making. Two of the greatest inventions of modern capitalism are the invention of the corporation and the separation of the roles of shareholder and management. The board is the means by which the shareholders may exercise their control of the corporation. (As the chairman of a board of a company in which I was involved once told the CEO: you are the chief executive officer. That means you must execute the directions of the board). Creating a board is often a condition precedent to having a private equity or strategic investor invest in a company. Investors place a premium – and are often willing to pay a premium – for companies with a well-functioning board of directors.

Composition of the board

Board members are appointed by the shareholders, and it is perfectly natural to have at least the most important shareholders of a company sitting on the board. There are at least two potential additional categories of Board members:

• Management: Where the CEO or other senior managers such as the CFO are not shareholders, shareholders may consider appointing the CEO, or even additional senior managers as board members. This may improve the quality of decisions, and ensure continuity in the implementation of decisions taken by the board. As an alternative, the board may invite the CEO or other managers to participate in all or parts of board meetings as observers. One should nevertheless be careful to observe that the distinction between the role of shareholders and management is maintained.

• Independent shareholders: There may be different reasons for bringing independent shareholders to the board. First, they may have specific expertise. For example, a lawyer may help ensure that the company by-laws are maintained, and that the company operates fully according to regulations and the law. An investment banker might help assure that the company is moving towards its objectives of achieving financing, or an eventual exit by shareholders. Independent shareholders may add prestige or lobbying power to the board (e.g. when a former senior politician is appointed to the board). And independent board members are often individuals who are capable of identifying opportunities for the company, and are used to asking hard questions or at least the right questions, keeping the board and management on their toes.

Ownership in a limited private company is one of the most illiquid forms of investment. Having good corporate governance, including a strong board, is a way of both enhancing corporate value and liquidity.