Unlike large organizations, private companies often do not have robust and independent boards of directors, but instead have smaller boards consisting of friends and family members of the company's owners. This tendency may be because the owners want to avoid the risk that a rogue or truly independent board will disagree with the owners' decisions on important corporate issues. The owners also may lack the contacts or experience necessary to select and recruit qualified and independent directors. Sometimes both considerations are the reason.

Under either situation, the company and its constituents are deprived of the asset of objective guidance by highly qualified, experienced, and independent directors. Instead, the company essentially has a fictional board that may comply with board formalities, but does not provide the quality input and oversight expected from a true board.

Some of the ways private companies can mitigate the underlying factors which typically contribute to inadequate private company boards are discussed below.

Advisory Boards

Some private companies utilize a two-tier board structure, consisting of a formal board of duly elected “friendly” directors and an informal “advisory board,” consisting of qualified and independent persons who are not formally elected as directors. The company's goals in adopting this practice frequently are to: (I) create the best of both worlds by protecting the owners against the risk they will not be able to control the decisions of the true board, but gaining the benefit of the advisory directors' insights, and (II) insulate the advisory directors from the liability exposures of a director. Use of advisory directors, however, raises potential liability and financial protection issues and should be carefully evaluated before persons are asked to serve in that capacity.

A person who is not technically a duly elected director, but who performs similar functions or otherwise fulfills a comparable role with the company will generally be treated as a de facto director and held to the same liability standards and exposures as a duly elected director. This means that generally speaking, if a person is an active participant in board discussions or serves on an advisory board that effectively acts the same as a duly elected board, U.S. courts will likely treat that person as a director for liability purposes. This is especially true if the company publicizes the advisory director's involvement with the company, thereby encouraging company constituents to take comfort from and to rely on the contributions of the advisory director.

In addition, advisory directors may not have adequate financial protection in the event a claim is made against them. Because the advisory director will usually contend he is not a director for liability purposes, the advisory director may not be treated as a director for indemnification and insurance purposes, in which case the advisory director may have no financial protection against claims for wrongdoing absent special arrangements. To avoid that result, the company's duly elected Board should adopt a resolution mandating indemnification protection for such persons, and the D&O insurance policy should expressly state that advisory directors are included as Insured Persons.

Because of these issues, companies should be thoughtful, careful and transparent when considering the use of advisory boards or advisory directors. If the company wants to gain the benefits of advice from persons with relevant experiences, expertise and perspectives, those persons should be acknowledged as directors, and both the company and those persons should maintain a relationship and performance expectations consistent with a director's legal responsibilities. On the other hand, if the parties prefer a much more limited role for the advisor, then the person's involvement should be very limited, not formalized and not publicized.

Director Recruitment

An important challenge for most private companies is the identification and recruitment of high quality directors who are willing to commit the necessary time and are capable of providing real value to the company as a duly elected director. The following are attributes of an effective private company director and strategies to use in recruiting such an individual.

Director Attributes

1.Diverse talents, experiences and perspectives. The most effective boards are composed of a diverse group of directors. The fundamental purposes of a board are to debate issues, challenge management and oversee company performance. The more diversity on the board, the better chance the board will perform at a high level. Although gender and race diversity can be helpful, the more important diversity relates to skills, background and business experiences.

2.Independent thinkers. Quality directors should be willing to objectively challenge management. Though not mandatory, it is advisable to avoid close friends or other people who for whatever reason may be reluctant to speak directly, particularly when dealing with senior management.

3.Mature and practical judgment. Quality directors have deep experience and a proven record of success in the business world. Their approach to evaluating issues should be practical.

4.Integrity and respect. Directors are often seen as ambassadors of the company. Quality directors should be a positive voice and face of the company, and their commitment to the highest standards of ethics and integrity should be without question.

5.Financial literacy. At least one outside director should be “financially literate.” Other directors will expect that expertise on the board and will rely on that expertise.

6.Prior board experience. This is desirable, but not essential. Particularly for many private companies, getting a highly qualified board candidate with prior board service is a luxury that often cannot be satisfied.

7.Views of key constituents. Although a board should not be composed exclusively of representatives from each of the company's significant constituents (because they may be too focused on what is in their own best interests rather than the best interests of the company as a whole), it is a good idea to include one or more directors who at least have a perspective consistent with some of the company's key constituents.

8.Time and interest. A good director must have sufficient time to devote to the job (especially if the time commitment needs to be significant) and has sufficient interest to actually devote the necessary time. Being a director involves more than merely attending a few meetings, but should also include significant preparation time before meetings, attending committee meetings, nurturing and supporting conversations with the CEO between meetings, and generally serving as an ambassador of the company.

Recruiting Directors

1. For private companies, the most effective recruiting tool is networking. There are a surprising number of highly qualified folks who either are or know qualified people willing to serve. Advisors to the company (lawyers, accountants, etc.) are good places to start with the networking process—in addition to other business people who the CEO knows and respects.

2. Before the networking process starts, the CEO should develop a “wish list” of skills/experiences for the board. That list should be created with a view toward the company's current and foreseeable challenges and opportunities. That list can then drive the networking efforts. The CEO should recruit for specific “positions” on the board (much like recruiting for a football team).

3. There are professional recruiters available to assist with this process. While private companies do not view the cost of such recruiters as a necessary expense, utilizing them can often save the company both time and money.

Conclusion

In summary, a high quality, engaged and independent board of directors is as important for private companies as public companies. Unfortunately, too few private companies are willing or capable of recruiting a truly effective board. Those owners who prefer a less effective board that can be controlled are the ones who most suffer from such a compromised governance structure.