What is the Best Board Structure?

To help understand and evaluate the different governance structures, TABS proposes the Alternative Board Structures (ABS).

ABS progresses from Level 1, in which the business owner gets input from individuals he or she trusts and respects, to Level 7, in which a Board Directors is composed of all independent, outside members.

Level 1: A business owner getting input from individuals as he or she chooses.
Level 2: A business owner meeting with an identifiable group on an as-needed basis to get input.
Level 3: A business owner meeting with an identifiable group on a regular basis to get input.
Level 4: < An elected group of insiders with legal decision-making authority.<
Level 5: An elected group with legal decision-making authority consisting of a majority of insiders.
Level 6: An elected group with legal decision-making authority consisting of a majority of outsiders.
Level 7: An elected group with legal decision-making authority consisting of all outsiders.

Successful transition plans can use any of these Board levels and can use more than one as the plan evolves. What level is most appropriate depends on the defining characteristics that the business owner wants the governance structure to include. The business owner must also ask these questions:

  • What role do I want to play?
  • What structure will I accept and endorse?
  • Why is a Board needed?
  • What goals are we trying to accomplish?
  • What do we want the Board to do?

The business owner must also realize that each Board structure has strengths and weaknesses and risks and rewards.

Role of the business owner. How does the business owner want to be involved? In Levels 1, 2 and 3, the business owner is the Board of Directors. The Board functions are transitioned to the group in Levels 4 through 7.

The business owner can decide to be the only member of the Board and still have effective, functioning governance. This is true even if the business owner seeks advice from others, including forming an Advisory Board. What is essential, though, is for the business owner to realize that he or she has the sole responsibility to follow a process that provides effective, functioning governance. All too often, when the business owner is the sole member of the Board, the process of governance reverts to the status quo. Reverting to the status quo will likely not allow the business owner to achieve the kind of change he or she is seeking. In addition, if the business owner wants the business to continue after he or she is no longer involved, the status quo will likely not adequately prepare the managers and successive owners. The reason for this phenomenon is simple. If a business owner wants some change, the way the business owner is involved and the way decisions are made must change. Change simply does not happen without the business owner changing.

TABS encourages the business owner to continue to be involved, but involved in a way that allows the business owner to achieve his or her goals. Also, TABS allows the business owner to control the pace of change, based on the abilities and desire of the business owner and successors. The business owner can choose how much power and control is transitioned at any particular time.

An Inside Board. A Level 4 Board is comprised of all insiders with legal decision-making responsibility. If each Director feels free to participate as a Director without feeling the need to acquiesce to the person in power and if the individual in power allows the Board process to work without “pulling rank”, this structure works well.

Role of others. Does the business owner want to involve others? If so, others can be involved in the governance structure in two ways.

First, others can be involved to give advice (Levels 1-3). As the advice of others is sought on some regular, permanent basis, a Board of Advisors is formed. The defining characteristic of involving others in this way is to seek advice. The business owner retains the Board functions. So long as the business owner is the Board, even if an Advisory Board has been established, it is essential that the business owner and others understand that the business owner retains all of the governance functions and that others understand how the governance functions are carried out.

Second, others can be involved as members of a Board of Directors (Levels 4-7). Involving others on a Board of Directors has several defining characteristics. One is that the legal authority to make decisions (that is, the vote) is moved from the business owner to a group. This is a big step for the business owner, who is now bound by the vote of the Board.

Role of outsiders. An Advisory Board or a Board of Directors can open up to the input of the outside world, either in an advisory capacity (Levels 1 – 3) or as members of a Board (Levels 5 – 7). In either case, involving outsiders shows a willingness to receive input from the outside.

At some level, of course, outside input is always occurring. Business owners may read a relevant article in The Wall Street Journal, say, or discuss a business issue with golfing partners. But when the business owner involves others in a continuing advisory capacity or as members of the Board, this outside influence becomes less easy to dismiss. ABS provides different levels a business owner can use to regulate how the input of others is received based on the business owner’s goals and transition plans.

Majority of Insiders. In Levels 1-3, having a majority of insiders is not a major change because the advisors have no legal authority to make decisions. But in Level 5 and beyond, there is a shift in the voting power of the Board and hopefully a corresponding increase in the quality of the Board discussions. The shift in voting power comes from the fact that outsiders have the same legal power as the insiders. This means that outsiders can significantly impact Board decisions. For the business owner who wants an outside voice on the Board to facilitate change, help accomplish his or her goals or help the next generation, Level 5 is a good Board starting point.

With Level 5 also comes an increase of the quality of Board discussions. It becomes less acceptable for old family conflicts to dominate the discussions or for the Board meetings to have that private “we can do what we want” feel. Outsiders, because they are outsiders, have a way of moving discussions forward, getting back to agendas, and/or suggesting that the family address family issues outside the Board meetings. Outsiders can and should have a positive impact on Board effectiveness.

Majority of outsiders. In Levels 1-3, having a majority of outsiders is not a major change because the advisors have no legal authority to make decisions. But in Level 6, this structure changes, with a major impact on the family business. In this structure, the outsiders have the majority of the vote, enabling them to outvote those with the majority of the stock or the management experience, or both.

Some may question the value of having a majority of outsiders on the Board. The fact is, though, that having family members, majority owners, and managers dominate the Board can, and often does, present problems. We recognize that excluding these individuals from sitting on the Board also has its problems. Again, each Board structure has its strengths and weaknesses, risks and rewards.

Family businesses have demonstrated to us over and over again that the more owners, family members, and managers serve on the Board, the harder it is for the Board to be the balancing point between owners and managers. While the reasons for this have many nuances, two essential characteristics underlie most conflicts relating to Boards that include owners, family members, and/or managers. First, the Board is not perceived to be a third party. Rather, the Board is seen as siding with the owners, or, more commonly, some faction within the ownership group. Or, the Board is perceived as siding with management. Second, it is much more difficult to maintain the boundaries between ownership and management if owners and managers are on the Board. Owners on the Board acting as owners tend to become advocates for the views of owners, and managers on the Board who act as managers tend to advocate management’s position. This completely compromises the Board process.

Having a majority of outside directors on the Board, on the other hand, tends to lessen the dominance of owners, family members, and managers on the Board, but only to the extent that these outside directors are committed to exercising their authority to adhere to the Board process and committed to the Board as a “balance point” between owners and managers. The best chance to preserve both the third-party nature of a Board and the proper boundaries between owners and managers lies with a Board consisting entirely of outside directors.

All outsiders. At Level 7 the Board has the best opportunity to be truly independent and function as the “balance point” between owners and managers. Level 7 offers the best opportunity to mitigate the significant problems that can exist with having owners, family members, and managers on the Board. For one thing, Level 7 offers the best structure to address power struggles that exist within the ownership group or power struggles between owners and managers. Moreover, Level 7 helps business owners who are concerned about how their presence influences the involvement of other owners and managers, by regulating their effect.

We acknowledge that there is a lot of resistance to a Level 7 Board structure. And we are not advocating a Level 7 Board structure for every family business. We do, though, contend that a Level 7 Board structure offers the best chance for a successful transition within a family business over the long term and ought to be considered as a stage in the transition plan.

Some people also argue that owners lose control over their business if the Board consists entirely of non-owners and non-managers. In reality, the owners retain their power by being able to work together to come up with an owners’ plan. This plan should identify all aspects that the owners believe need to be addressed for the owners to remain committed as owners for the long term. In addition to common needs and goals such as dividends and debt levels, the owners’ plan might require management to evaluate perceived risks affecting the owners or to review policies the owners believe conflict with their values. In addition , the owners retain control by establishing structures guiding what the owners, Board, and managers are expected to do and how they will work together to accomplish their respective responsibilities. The owners also exercise control by evaluating these structures from time to time, and in particular by assessing how the Board is guiding the process.

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