How Boards Enhance Value of Private Enterprises
November 5, 2018
By Darren Rawson and Mary Cameron
Most economists agree that Private Enterprises or Small & Medium Sized Enterprises (SME) are a critical engine of the economy. Some of the traits that make SMEs so successful include: (1) strong entrepreneurial spirit, (2) customer focused culture, and (3) nimbleness with the ability to mobilize decisions quickly. SMEs are often constrained by: (1) limited resources (people and capital), (2) lack of size and scale to tackle large initiatives, and (3) a narrow breadth of skills and experiences inside their company.
Most SMEs do not have active boards, and SMEs can definitely be successful without a board of directors. There is a point in an organization’s evolution where adding a board of directors makes sense such as dealing with significant expansion, dealing with enhanced organizational complexity, or managing shareholder dynamics such as a change of control.
One of the recognized best practices to enhance enterprise value of SMEs is having an established, high performing, independent board of directors. The March 2014 paper titled Advisory Boards: An Untapped Resource for Business published by the Business Development Bank of Canada (BDC) quantitatively reported SMEs with advisory boards have superior growth and better financial results. 86% of SME leaders felt that having an advisory board had a significant impact on their business, in particular in the areas of vision, innovation, risk management and profitability.
The following outlines ways a board enhances value of an SME:
- Discipline. By far, the most important benefit to a potential buyer is a board of directors helps build a culture and practice of discipline in an organization. Regular board meetings create focus on the business and, in particular, the goals. Management is trained to run and manage the business using key performance metrics. Accountability is increased through rigour of regular reporting and business review. Business plans and board reports are prepared to a higher standard of professionalism. Commitments from executives are made with more care and accountability to deadlines is enhanced. The long term benefit to an organization is enhanced profitability and growth. Potential buyers are often willing to increase the offer price knowing the organization is governed by a high performing board that drives management to consistently achieve its goals and exceeds targets.
- Succession and Talent Development. SMEs typically spend very little time on succession and talent development, often procrastinating on the topic to focus on the problems of today. A board of directors invests time and energy to understand the talent inside the organization and assess succession options and scenarios. Succession plans are prepared with more depth and rigour with a lens to the long term needs and health of the organization. In family-owned businesses, an independent board of directors can help provide insight and wisdom into the capabilities of family and non-family potential successors and help the CEO prepare accordingly for eventual succession. The objective external oversight gives outside investors confidence that positions have been awarded and earned on the basis of merit, giving confidence in the depth of management experience. Potential buyers are much more willing to take a risk on an organization with diverse talent and an organization with succession plans in place compared with a thin organization with the talent and heavy lifting concentrated on the CEO and/or family members.
- Strategic Thinking. The leadership team of most SMEs, including the owner/operator, often spend the majority of their time on business development, customers and operations; very little time is spent on strategy. A high performing board of directors, with well established operating processes and a culture of healthy skepticism, will stretch the conversation towards the macro environment, the competitive landscape and the strategy of the organization. High performing SME boards typically invest 60% or more of their time on strategy and strategic thinking. Potential buyers are more willing to invest in a business that maintains focus on strategic thinking rather than just day to day operations. This matters because it can enable the business to be prepared for change, either to handle a threat or take advantage of an opportunity. Many SMEs have experienced success but may fall short in seeing the wider opportunities of the market.
- Risk Mitigation. Owners and executives of SMEs are often very deeply imbedded into their organization and can have difficulty making the time or finding the objectivity to step back and assess the strategic risks facing their business. A high performing board of directors with a diverse, broad set of experiences provides both a sounding board and a lens into the potential risks facing an organization which can erode shareholder value and/or cripple a business. Potential buyers have more comfort investing in a business that has a culture of assessing and embracing risks and has sound mitigation strategies.
- Reputation. A board of directors populated with capable, experienced, and well known professionals will help add to the credibility of any organization. This credibility can benefit discussions with lenders, customers, suppliers, auditors, investors, and government regulators. Having a board of directors can also provide confidence to staff giving a boost to morale and retention.
- Crisis Management. In the event of a crisis event or major setback, a board of directors can be an invaluable asset to owners and executives to help mitigate the crisis and establish a plan to get the business to a healthy state. An owner or CEO is one of the loneliest jobs on the planet, and at a time of crisis, it can be even more stressful. Having a team of high powered, experienced directors at your disposal can be invaluable in navigating through a crisis. The Board provides added stability to the organization. Board members can leverage their experience to assist the CEO to evaluate various courses of action and stay calm and confident in addressing crises.
- Opportunity Capitalization. Businesses geared to capitalize on opportunities, planned or unplanned, are considered much more valuable to buyers than businesses that are primarily internally focused. A high performing board of directors provides an incredible resource for SMEs to leverage when evaluating the risks and prizes from any opportunity, be it an internal growth strategy, operational improvement or acquisition. Potential buyers put significant value on businesses that have a risk appetite, understand how to effectively utilize capital and are effective at monetizing opportunities.
There is no question that a board of directors is an added cost to any organization, in particular an SME. Like any team, a newly formed board of directors will require time to become high-performing, possibly as much as one or two years. Whether operating a business for the long term or setting a business up for a sale, a high performing board of directors should be accretive and contribute to enhancing enterprise value