Build A Brain Trust with an Independent Board

Outside directors bring big company corporate governance—and added smarts—to small businesses

In the post-Enron era, the big buzz word in Corporate America is “corporate governance”—a catch-all term that includes ensuring that boards of directors are independent, free of conflicts, and will have the interests of all shareholders at heart.

What does that have to do with small businesses? Plenty. The same discipline and probity that a well-constructed board can bring to a Fortune 500 company can help a smaller enterprise, too. And, increasingly, small business owners are recognizing this. Some are taking the formal steps to create a board of directors and others are simply tapping knowledgeable men and women in their business circles to serve on boards of advisors.

Ask Larry Coben, who learned the hard way. He founded New Tech Machinery, a Denver-based manufacturer of portable roll-form equipment for gutters and roofing in 1991. In seven years, the company lost $1.25 million, partly because of quality control issues on outsourced parts. Cohen was forced to seek protection in Chapter 11 bankruptcy.

The company emerged from Chapter 11 in 1999 and brought manufacturing in-house—leading to a successful comeback. But, determined never to put the company at risk again, Coben decided to recruit a board of advisors made up of experienced outside executives who agreed to share their knowledge and help guide the business. “I recognized I was not a president that had all the background I should have had to run a manufacturing company,” he says. Within months, he had converted three of the four advisors to full-blown directors, who together with four inside directors now make up the seven-member board.

“They put us through our paces,” Coben recalls. But he was committed to following their advice—even when they shot down his own ideas. That commitment helped head off a family squabble between Coben and his two daughters, who are part-owners. Coben was looking for more compensation than his daughters thought he should be paid. They put the matter before the board, which recommended harsher limits on Dad’s pay than the daughters were seeking. “I didn’t agree with it, but I accepted it,” he says.

Coben also accepted the board’s hard-nosed questions about a planned expansion in Mexico. “It took a year or better before I had the board’s permission to start doing anything in Mexico,” Coben recalled. Eventually, in March 2004, he convinced the directors that this was more than a hunch and they approved a $750,000 investment to turn a warehouse in Hermosillo into a production facility.

The move paid off: Sales leaped to $9 million in 2005 from $6.25 million in 2004. “With the advent of the Mexico plant, we’ve been able to increase our quantity of gutter machines, reduce our price, take a lot more market share and just go wild,” Coben says.

The beauty of an independent board, says Kim Schneider Malek, family business consultant with the Schneider Consulting Group in Denver, is that it gives the business owner the benefit of a broader perspective and deeper collective experience—much more than entrepreneurs who are caught up in the day-to-day details of the business can bring. “Entrepreneurs need advice in making wise decisions and systemic decisions from people looking at a variety of external factors,” Malek says

That more rigorous approach can have many benefits, including when it comes time to sell or transfer a business to the next generation. “Many small businesses are gravitating toward an infrastructure of governance that allows the business to sustain itself without being reliant on one person, the founder,” says Malek.

Still, independent boards remain a rarity in small business, not least because owners are often reluctant to share control. But there are also practical obstacles, too. Most small private companies can’t recruit and pay hefty stipends to professional directors, which makes it difficult to comply with the guidelines for director independence that big corporations now live with.

But, if they can’t follow the letter of the new corporate rules, small businesses can embrace the best practices that board reforms are aimed at, says Kevin Klock, corporate governance analyst at the National Association of Corporate Directors, a non-profit in Washington, D.C. “Private companies have to take notice,” he says. “You can’t ignore it for certain.”

So, instead of hiring executive recruiters to find distinguished, disinterested business experts, the small company will tap the owner’s network of contacts to fill a board with people who have integrity, sound judgment and skills that complement those of the company’s management team, Klock says. In Corporate America, that’s a “packed board,” but for the small business, it’s acceptable, he says. Still, he warns, “What’s appropriate and OK for a small company is not always appropriate when the company gets bigger.”

Another issue is liability, which is why Bob Michelson created an advisory board, rather than a formal board of directors for Goliath Solutions, his marketing services company in Deerfield, Ill. Directors can be named by plaintiffs when a company is hauled into court—advisors can’t. “The sophisticated people you want to have on your board are probably not going to want to be on your board of directors where they have liability and fiduciary responsibility,” he explains.

In practice, however, he treats his boar members as directors, paying strict attention to their advice. “If you don’t use them, and exercise their knowledge and expertise, they’re not going to stick around. They’ve got too much to do,” Michelson said.

When forming his board, Michelson looked for outsiders with backgrounds in advertising, retailing and consumer-product marketing. They have helped the company, which uses RFID technology to track the results of in-store displays, fine-tune its business plan. “We’ve changed many of our strategies because of what they say,” says Michelson. “They’re right more often than not.”

The liability issue is significant, Klock acknowledges, and has even affected the ability of larger companies to recruit directors. “The liability compared to the compensation is disjointed,” he says. According to his data, average compensation for directors serving companies with revenue of between $50 million and $200 million is about $58,300 including about $30,000 in cash and $28,300 in stock.

To keep his board in place, Coben provides directors and officers insurance for his directors. An annual policy covering all directors costs $5,000 to $7,000, he says.

Coben’s only regret is that he didn’t recruit his board earlier. “I would not give up the board,” he said. “It is worth everything to me.”