Family businesses have a lot in common with venture capital (VC) backed companies. First, they are led by passionate, inspired individuals, their founders, who are determined to challenge the low odds of success for their new venture in order to realize their vision. They also both face major business challenges as they grow, and their early evolution can be characterized as operating from one crisis to the next— these are resource constrained companies in need of risk capital to grow.
For venture-backed companies, their future depends on whether the company can justify attracting the next round of preferred equity from insiders or from a new investor—with the latter being far preferable to the former. For family businesses, they rely on “friends and family” much like “angel” investors in early stage VC, to reach self-sustaining operations. The greatest similarity between these types of companies, however, lies in the fact that they are governed by a small, insular group, the board of directors. Most important, these boards, whether they are populated by professional investors or family members, are often dysfunctional.
Whether or not they are bound by blood relations, in both the family owned company and the venture-backed company, the most influential directors feel they have an inalienable right to be at the table. This perceived right also has the effect of immunizing many of these directors from feeling that they owe accountability to their peers on the board. In venture-backed companies, this is facilitated by contractual board seat rights granted to a fund when it makes the investment. In family owned companies, the right is conferred by your place in the family.
In family boards the key issue is that, since they usually do not have any outside voices mandated by investors, there is no check and balance on the patriarch. In venture backed company boards, independent directors can play a critical role as a fiduciary that does not carry such inherent conflicts of interest. In common practice,however, VC’s recruit independent directors who help build revenue, and their skills as consensus builders are often not considered when these directors are recruited. A closely held family board needs outside voices, just as the VC board does, that are able to challenge the leader.
Unfortunately for both of these types of closely held businesses, lack of accountability leads to bad board behavior and to violations of fiduciary duty.
Some of the signs of bad board behavior and dysfunction follow—are any of these familiar to you?
2. Inability to confront difficult issues
3. Distraction and over-commitment
4. Misalignment of interests between Board Members and investors
5. Divisiveness on the Board
6. Paralysis over liability issues
7. Board member role confusion
8. Leadership vacuum
9. Loss of trust in the CEO
10. Resolution to fail
Note: for a full discussion of these warning signs, please refer to “After the Term Sheet: How Venture Boards Influence the Succes or Failure of Technology Companies”, which is freely downloadable at http://www.levp.com/news/whitepapers.shtml
It is well known in the venture capital industry that most venture boards do not review their own performance, and most family owned businesses do not welcome independent third parties to review their performance as fiduciaries. Dysfunction on private company boards, when allowed to persist, can lead to crisis.
The most common example of dysfunction leading to crisis occurs when a lead director or controlling family member knowingly acts in his or her own best interests at the expense of the other shareholders. Another example is the director who assumes that the other directors are doing the work thoroughly and therefore that it is not necessary to be individually attentive or to fully understand the activities of the company. These are violations of the business judgment and oversight rules, respectively, and open directors to personal liability.
The good news is that having good governance processes in place is good for business.
Closely held boards should consider implementing the following good governance practices:
• Developing a self-assessment and performance tool
: Boards must assess not only the company, but also how well they are performing as a collaborative team.The board should look at itself both as a whole and in terms of the performance of each individual.
• Creating an open information-sharing system
: The CEO and the management team must trust and feel comfortable with the board members so they can share their questions and concerns. At every point, the board must enforce the open exchange of information and ideas in the
• Facing emotional dynamics as they arise
: Tensions will arise between the board and the CEO, the board and the management team, and among the board members themselves. Usually these stresses are clear to everyone, but too often the tendency is to avoid the issue. The path to resolution is through direct confrontation of the issues. These issues become particularly acute in the family enterprise.
• Holding a Board retreat
: The most successful retreats retain an outside facilitator or consultant whose role is not to be an expert or content provider, but to assist the Board and the CEO to deal with the critical issues. Successful retreats require preparation and commitment to drive to resolution, evidenced by an outcome like a strategic plan or strategic decision.