Much of the theory on good governance for boards has been written with large, listed companies in mind. However, the vast majority of New Zealand companies are small and medium privately owned businesses. We’ll look at some of the governance issues faced by those smaller firms, and how to address them.
Finding the time
The directors of small and medium sized businesses are likely to have many competing demands on their time, so setting some of that precious resource aside for governance can be a difficult feat to achieve. Ignoring good governance would be a mistake, as it has been demonstrated to have a positive effect on company performance, and is also likely to be looked on favourably by funders, improving access to credit. For example, one of our clients was struggling financially due to high debt levels, so we worked on procedures to improve sales and reduce costs with the directors. As a result, profitability improved, and the bank which had provided funding, agreed to restructure the loans from high interest overdrafts to term loan facilities, which could be serviced at a significantly lower cost.
While most of the actions taken were simply common sense, it can be difficult for directors to take a step back and look objectively at what is needed. Setting aside time for regular board meetings for the whole year at the beginning of each year will help to ensure that they are prioritised.
Making informed decisions
Making good decisions as a director often relies upon having reliable, accurate and timely information to support the decision making process. This can be achieved by putting effective systems in place to provide daily or weekly sales data, production reports and cash flow updates (depending on which areas of the business need to be prioritised). Preparing monthly management accounts rather than relying on annual financial statements will enable decisions to be based on up to date data. This is significantly easier to achieve with accounting software that is automatically updated from direct bank feeds. Also, preparing a budget or forecast will enable directors to monitor progress and highlight whether the business is on track to achieve the goals set for the period under consideration.
Where a smaller business has family members as shareholders, but who are not active in the day-to-day business, there is significant potential for conflict. Again, good governance principles with regard to the provision of transparent information can help to allay misunderstandings. If those shareholders are also non-executive directors, holding regular meetings can be beneficial not only to those shareholders, but also for the directors working in the business by providing them with an outside perspective.
Similarly, many directors of smaller businesses may turn to their accountant or lawyer for advice. Formalising this arrangement with regular advisory board meetings ensures that the advice provided is fully informed, as those advisors will have the opportunity to learn more about the business and industry, at the same time as bringing that outside perspective. The ‘outsiders’, be they advisors or family members, may contribute a helpful network of contacts and contribute experience gained in other businesses that is useful when trying to benchmark performance.
Dealing with minority shareholders
We’ve looked at the potential conflict that can occur between family members. Similar issues can arise where there are minority shareholders, often employees who have been provided with, or been sold, a small parcel of shares in order to incentivise them. The difficulty faced by the directors is how to involve those minority shareholders (who may not hold board positions) but still maintain control. Again, the provision of information and good communication can help to avoid disputes. Further, a comprehensive Shareholders’ Agreement should ensure clarity with regard to expectations on all sides, covering topics such as financial contributions, levels of authority for decision making and access to information.
Importance of good controls
One of the problems faced by smaller businesses is that there are simply fewer people in the business to undertake all of the roles and responsibilities, and that can make it difficult to ensure adequate separation of duties to safeguard against fraud. Implementing strong internal controls should lower the likelihood of fraud, and the process of identifying potential problem areas and allocating those duties should help to provide clarity around areas of responsibility. It can be as simple as ensuring that the person who opens the mail and does the banking is not also responsible for bookkeeping and having dual signatories on bank accounts (especially for transactions over a certain value). We recently helped one of our clients put these controls in place for their business, providing peace of mind not only for the directors, but also for the employees who could potentially be the object of suspicion.
Practising good governance is especially important for smaller businesses when going through a period of intense growth or experiencing a crisis. At those times, operational issues can be all-consuming, yet decisions need to be taken that may have a long term effect upon the future performance and sustainability of the business. This is exactly when directors should be focussing on the business, rather than solely working in the business. Having the discipline of regular reporting, review and strategic discussions should ensure that issues are addressed.
We have been working with a couple of clients who are experiencing rapid growth. In one case, we have helped the directors to prepare a three year forecast for the business, so that they can use the predicted growth to help make decisions as to whether to lease larger premises to house inventory at peak periods. Analysing the profitability clarified that choosing to outsource logistics was the better option at that time.
The other client was working on a number of opportunities that had arisen, in a scatter gun approach, and simply spreading themselves too thinly. We encouraged the directors to take time out of the business to evaluate each of the options, in terms of potential contribution, resource requirements and the logistics of pursuing overseas opportunities. Once they were in a position to prioritise each potential pathway, it soon became apparent where they should be focussing their energies. In particular, they understood that the far flung overseas opportunities, while potentially lucrative, were also subject to a much higher level of risk and needed to be set aside while the domestic business was bedded down to provide a strong base for further growth.
Many of the issues faced by smaller businesses are different to large corporations that have access to greater resources. Understanding how good governance can improve performance, reduce conflict and help with difficult decisions can encourage directors of smaller businesses to set up advisory boards or at least hold regular directors meetings.
For further information on how implementing good governance can help your business please contact Tracy Hickman in our Auckland office on 09 373 1133 or contact your usual advisor.