Private Companies and Director Compensation

Small Business Management Consultant, Business Succession, Business Transition, Succession

We were recently contacted by a client about competitive compensation for directors in private companies. As we explored the needs of the company and the roles that board members were undertaking we realised that we had been asked the wrong question.

The presumption was that board directors in a private company served the same purpose as in a public one. Nomenclature being the same it was assumed that duties and obligations were the same. The fact is that they serve quite different purposes.

The role of director in a public company is mostly generic, representing the interests of shareholders within a well regulated structure. They may be expected to bring industry or other specialized experience to the Board but their primary role is clear and there are well established schools with the purpose of educating prospective directors how to operate within this structure. We have fallen into the habit of using the same title for a person who may sit on an advisory panel for a private company or partnership and that of a director in a public company. They may have very different purposes.

Let’s look at some of the reasons why a private company may want a board:

Represent Shareholder Interests

This is not the same role as in a public company. It doesn’t involve regulated compliance. A public company needs to observe a set of disclosure, policy and accounting rules to ensure that widely dispersed shareholders can compare alternative investments and assess investment risk.

Directors in a private company are more likely to have a role created for a specific purpose. For example in a family owned and managed business they may oversee the family’s participation in the management, to ensure that family managers are paid commercially and not otherwise advantaged, or they may represent the interests of family shareholders not involved in management, in major decisions. They may also have a role in ensuring that family members appointed to management positions are done so based on their abilities. In other circumstances the role may be to ensure the family’s legacy or fortune is managed conservatively without undue risk. These are different responsibilities and require different skills than might be required for a board position in a public company.

Provide Business Advice

Many private companies are the result of a lifetime’s work of one or two founders who have had no opportunity to work in other companies or industries. The purpose of an advisory board in these circumstances could be to bring specific insights from other businesses or industries. The type of advice is likely to be far less specific than say that that could be obtained from a consultant or subject matter expert. Sometimes such input is obtained by the CEO by participating in peer-to-peer groups (e.g. The YPO) but on reaching a certain size or complexity founders often want an advisory panel dedicated to just their company, to help take it to the next level. The frequency of meetings and agenda is likely to be quite different from the groups that meet to represent family interests.

Oversee Succession

A private company may need to transition ownership to the next generation of the family, to members of senior management or even a sale to a third party. The amount of work and time  involved in this endeavour will be substantial and a major distraction from the day to day running of the business. Most owner managers are completely unaware of the value that their involvement in the business represents. Take them out of the business and its value deteriorates substantially. Having an objective advisory group oversee separation will often secure a higher sales price and will somewhat distance the owner from a potentially emotionally draining exercise particularly where other family members are involved. See Jean MacKinnon’s case study on LinkedIn.

There are other reasons why external oversight may be useful in a private company from time to time and there may be occasions when different inputs are required simultaneously from different sources. Valuable advice can be obtained from professional service firms such as lawyers and accountants but this is often one person’s perspective, sometimes conflicted by their training and may be without the required broad based business acumen. Private company boards for whatever purpose, normally comprise trusted advisers who know the company and who bring a variety of different experiences as needed.

In public companies director compensation is not difficult to assess. In private companies fees paid to advisory boards should reflect the skills needed, their urgency and the value at stake. The question should not be what is the cost of oversight but what is the potential value at stake where advice is required?

Ask us how to establish a governance process for your private or family managed business that will keep pace with your businesses growth.

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