Cracks In The Company Foundation

SEP 27, 2017

The Board's Role in Identifying and Addressing Foundational Risks Hidden Within Private Companies

(Originally appeared in the September 27, 2017 'Across the Board' Publication Reaching 22,500+ Savvy Business Leaders In Over 65 Countries - sign up here)

Boards in the private sector run the gamut when it comes to varying structures, operational procedures, size and required time commitment (yes, this list is much larger with considerations of voting members, non-voting members, equity partners, etc.). However, the overarching, and somewhat ambiguous, responsibilities of Board members when it comes to the true definition remains the same.

Under state statutory and common law, officers and Board members are fiduciaries of the organization they serve and must act in accordance with 3 fiduciary responsibilities:

  • Duty of Care: Requiring the members of the Board to make prudent and informed decisions. Directors must take reasonable steps to protect the assets (and reputation) of the organization and ensure that they are used to further the legitimate purposes of the organization.
  • Duty of Loyalty: Requiring directors to exercise their powers with undivided allegiance to the organization. This means, among other things, carefully evaluating any transactions that may financially benefit, directly or indirectly, any 'insider.'
  • Duty of Obedience: Requiring directors to ensure that the organization’s activities are in support and furtherance of its mission and values, and that the organization is in compliance with applicable laws and regulations as well as its own internal governance rules and policies.

In support of these 3 fiduciary responsibilities of the Board, there are high-risk areas within private companies that aren't frequently addressed nor do they receive the required 'digging' to ensure all is in order. In his book 'Business Divorce,' author Rocco Luisi addresses the top ten red flags hidden within private companies that drastically increase their risk of failure. It should get you thinking that even with the best intentions, skillsets and experience of the Board, these festering rust spots can breach the hull and sink the ship.

  1. Silent Partner(s): A "fertile ground for business divorce" due to the potential of an unsupervised partner not behaving in the best interest of the company.
  2. Majority Shareholder(s): A multiple-partner business in which one owner is the majority shareholder can lead to a structure in that "the minority shareholders are liable for the business, but do not have decision-making authority to control that liability."
  3. Insufficient or No Written Ownership Agreement: "Fundamental and crucial terms are either absent, unclear and/or ambiguous. Topics include valuation, voting and deadlocks," etc.
  4. Family Business Squabbles: "Family business disputes are typically characterized by lying, deception, back stabbing, self-dealing, attempted coups, theft, extra-marital affairs and jealousy. These, however, are the symptoms and not the cause. The true culprit is often lack of an agreement, or one that is either unclear on fundamental and key issues, or does not address them at all..."
  5. Business with Unsupervised & Distant Branch(es): Unsupervised in that "people in charge of the branch are not well known to the owner who put them there," which can lead to unscrupulous behavior affecting the business and its reputation.
  6. Head of Business Refuses to Retire: "The crux of the dispute is the fire that is ignited when stubbornness and impatience create friction..."
  7. 50/50 Owners: "The obvious problem is if the two owners do not agree on decisions that have to be made, how do they resolve their differences to move the company forward? This is a fundamental issue that needs to be determined at the outset of the business relationship."
  8. Unfair Compensation Between Owners: This manifestation of trouble typically "stems not from unequal compensation, but unfair compensation" when the potential of varying time commitments and value-generation to the company between partners arises.
  9. Theft: "Many times, business owners with weak financial skillsets partner with another who is savvy in this area, and the financier takes advantage of [their] partner's naiveté."
  10. Lack of Independent and Competent Board: "The absence of corporate governance - the setting, implementation and monitoring of a company's policies - can lead to lack of transparency, mismanagement, lack of appropriate management supervision, conflicts of interest," etc.

Companies face a myriad of challenges today, and this grows on a yearly basis. Addressing and mitigating risks associated with some of the known red flag areas in private companies can assist in creating a baseline of checkpoint areas - so you are not caught off guard attempting to bail out a sinking ship.


What will you consider when evaluating the private company you advise and serve?

Reach out directly to Mark A. Pfister to discuss your Board's overall strategy.


About the Author: In addition to sitting on numerous Boards, Mark A. Pfister is a certified Board Director and advises public, private and nonprofit boards in efficient and effective operations. He is the inventor of the 'Board as a Service' (BaaS) engagement model and an expert project/program manager frequently consulting on strategic global initiatives in their initiation and operational phases....... << read full bio here >>


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