Board Issues You Can’t Ignore

A seasoned investor once told me,“Even though business schools teach you that management works for the shareholders’ benefit, in the real world management works to keep management employed.” Cynical, perhaps, but sadly true. As a result, even an engaged board may find that it is unprepared to face significant operational problems, since the most defensive management team often has good reason to be concerned.

Because of this, a board needs to be prepared with a few high-level, penetrating questions to identify and mitigate risks. Which actions are appropriate for an activist board seeking to manage a company through a challenging environment?

Understand the key drivers in your company’s cash conversion cycle. Ultimately, a business is an organization that profitably converts customer needs into cash. While financial statements shed light on all the company’s actions, usually only a few activities drive the company’s success in creating free cash. Board members should ask management teams this question: “What are the three key drivers that affect how you turn needs into cash, and how are you mitigating those risks?” It is interesting to see if management is candid or evasive, and how the team articulates the risks. These should be the issues that keep management up at night.

For instance, manufacturing companies may carry inventory that makes the balance sheet look attractive but negatively impacts the income statement because the manufacturing expense does not bring a revenue stream. Does this point to poor inventory management or an inaccurate assessment of marketplace demand? Ask these penetrating questions on an ongoing basis.

On the other hand, service businesses do not carry inventory but may have other return policies, credits or other agreements that bring seemingly high revenue numbers but reduce the company’s profitability. Are there hidden costs that reduce your top line from the outset and hinder profitable operation? They may be hidden as “the cost of doing business” but in fact are readily mitigated.

Create effective board committees. At a minimum, a board should have active audit and compensation committees comprising management and major shareholders. Middle-market companies unwilling to invest in an audit must still ensure financial reporting that is “auditable” – i.e., consistent with generally accepted accounting principles (GAAP). Similarly, the compensation committee should conduct an evaluation of key members of the management team under clearly stated performance metrics defined at the outset and under management’s control. Implement these committees as soon as you have enough critical mass to make it feasible.

The company may choose to create additional groups such as a nominating or corporate governance committee, an ethics committee or a strategic planning committee. Obviously the number of committees varies based on the size of the company and the industry (for instance, a company in an environmentally sensitive business may wish to create a committee on corporate social responsibility). However, creating subsets of directors overseeing various aspects of the company’s operations is critical for a transparent organization and gives your directors real responsibility above a simple “rubber-stamp” role.

Remember the board’s role. In times of crisis, board members often step in and begin making critical decisions. However, the most important decision an engaged board can make is to supplement or replace a compromised management team. If a renegade board member inappropriately makes operational decisions, particularly overseeing cash flow, the management team is no longer accountable, compromising the opportunity to dismiss management for cause – an opportunity that is often sorely sought by boards in times of crisis. (Of course, this is simplified when a compensation committee is already overseeing management performance.)

Ultimately, a board approves an operating plan and grants company leadership the authority to manage the company’s operations subject to the plan. If you don’t trust management, replace them formally rather than making decisions around them. Simply put, a board that steps in and begins managing the company is no longer a board, but is management without clear responsibilities or authorities, potentially compromising the board’s independence and potentially even its coverage under directors’ and officers’ insurance.

Supreme Court Justice Louis Brandeis wrote that “sunlight is said to be the best of disinfectants.” Manage your board’s risk by shedding light on the company’s key operational risks, creating effective committees to oversee key aspects of management responsibilities, and maintaining a clear boundary between your actions and that of management.

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About the Author

Andrea Belz is president of Belz Commercialization Consulting Group. The author of “The McGraw-Hill 36-Hour Course: Product Development,” Andrea is an expert in technology commercialization, providing guidance to global leaders in innovation, such as the Jet Propulsion Laboratory, the California Institute of Technology and UCLA. Her savvy combination of technology review and business analysis has been used by groups ranging from General Electric to NASA. Andrea’s deep expertise in evaluating and managing investment opportunities has attracted venture capital funds, investment banks, private equity groups and individual investors.

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