The Board of Non-Executive Directors – Toothless Tiger or Turbo for growth and corporate development

The Board of Non-Executive Directors (BoD) can contribute significantly to the long-term and sustainable growth of a firm and offers similar benefits as good (and expensive) top consultants or strategic departments in the corporate landscape. The role and composition of the BoD determines success or failure in everyday life. On the other hand, increasing competition, eroding differential criteria and competitive propositions, declining market shares and increasing economic difficulties can very often be tracked to the lack of effectiveness of a non-executive board. Lack of strategic leadership is still number one reason for corporates, to go out of business.The typical perception of the BoD by the management team is often between “valuable counterbalance to the executive management” and “toothless tigers, with high administrative costs and little use”. The value added by the Non-Executive Directors (NEDs) is measured by the overall success of a company. Strategies and opportunities to create success, are subject to the specific challenges, the company is facing. As these challenges are ever changing, the requirements for the NEDs as well as the realistically expectable contribution to success are subject to change. Typical situations SME companies find themselves in, include:

• Start-Up– with the support of politics and media, a Start-up culture is promoted throughout different economies. Start-ups are hip and offer individuals first opportunities to gain credentials in Non-executives roles. However, the situation in Start-up companies is particularly challenging. Due to high uncertainties and the lack of processes in the company’s daily business, planning and risk assessment are much more difficult. Going Concern is not secured, correspondingly the risk of loss of reputation and liability for members of the BoD (subject to applicable legislation) is high.
• Business transformation– (also) in the SME environment, the on-going improvement of the business processes is a permanent challenge. This includes increasing operational efficiency, expanding market share, and targeted internationalization, improving and expanding the range of products and making acquisitions. The digital transformation of business processes is still neglected by many companies, but absolutely urgent and decisive, to secure the company’s future readiness.
• Turnaround & Distress Management– The successful management of a crisis situation is, in the narrow sense, a special case of business transformation, yet offers no room to manoeuvre, since the company is likely to hold no financial reserves anymore. The requirements for the BoD regarding competences and commitment are well above the average, while at the same time the personal risks for NEDs are increasing in parallel to the risk of insolvency.

The aforementioned, including the special situations of Turnaround & Distress Management, place different requirements on the non-executive Directors. Three aspects determine the possibilities for the individual to make an effective contribution from the boardroom:

• With regard to the specific company situation, does the individual hold eligible personal and professional experiences? While professional aspects are relatively easy to detect through training and previous performance, eligible personal experience for the respective company environment is often neglected. As an example: The setting of a large corporation is difficult to compare with the environment in a SME or Start-Up. Respective experiences cannot always be transferred. Dealing with personal risks is an additional relevant aspect, especially in Start-up and turnaround mandates. If a board member fails to deal with his personal exposure to financial and reputational risk, decisions may turn out to lack objectivity.
• Interaction with the executive management– In the ideal situation the management and the BoD solve the challenges of the company in a joint effort. This requires a regular, intense and sometimes critical dialogue. An aversion to open communication will make it very difficult for either side, to achieve good results. The success of the BoD therefore also depends on the executive management. Is it open for coaching? Can criticism be placed and discussed for the good of the company? Is there a willingness to challenge and improve also established paths?
• Scope and structure of the mandate by the shareholders– Depending on local legislation, the minimum framework for the responsibilities of the BoD is determined by the underlying legal regulations. These can define the BoD as non-operative governance and audit body, primarily installed, to secure compliance (e.g. Germany), or, as in Switzerland, assign the BoD as the highest executive committee of a company. Here from, the role and responsibilities of the executive management as well as the responsibilities (liabilities) of the members of the BoD derive. In reality, however, the role of the BoD is considered very often along different guidelines and expectations. Specifically in SME companies, a balance has to be found between the part-time commitment of the members of the BoD and the full-time commitment of the executive management.

In order to understand the expectations of the role and the contribution of the BoD correctly, it is also important to understand what the BoD is not:

• The BoD is not a “good old boys” network to nip at any management decisions, as friends of the owner or the CEO. The BoD answers to the General Assembly (GA). As a legal body, the BoD is liable to the GA.
• The BoD is not a decoration to polish the image of the firm, filled with “renown and respected names”. Respected personalities of the business community contribute to the success of the BoD, but the role is in no way limited to purely representative tasks.

Proper incentives are important

The BoD is responsible for the application of thorough management to the company, as well as the correct implementation of the defined strategy. In this sense, the Board is a honourable but not an honorary function. While in companies with uncertain going concern, the downside potential for the NEDs is already determined by the legal framework, including possible damage to the personal reputation; the established level of economic incentives is only of low attractiveness for experienced executives. The usual fees for SME-BoD mandates range in Germany and Switzerland around approx. CHF 20’000 p.a. Whereas the compensation in the UK is settling at a higher level, around £ 60’000 p.a. In challenging situations, however, it is important to acquire the best experts for the BoD. Possible solutions to align responsibilities with incentives include, the combination of BoD mandates and (extra-paid) consulting roles. Notorious examples are the trustee or lawyer assigned to the BoD. This model can also be extended to other areas. Alternatives from the Start-Up or turnaround environment include equity incentives. This enables NEDs to participate of the outcomes of their work on a long-term and relevant basis. In this context, private equity investors, who hold a seat in the BoD, have a special role. Due to the interest, to secure their investment they hold a sufficient incentive. However, this does not necessarily imply a strategic alignment of interests between the investors and the company. Also, the role as investor holds no information on the professional or personal eligibility for the non-executive role in the respective company situation.

Diversity and applicable knowledge is imperative

The desired set of experience of the NEDs is determined by the strategic challenges the company is facing. As in all other areas, diversity is a clear plus for the BOD. In order to leverage its combined experiences and competencies to the benefit of the company, the BOD must also foster good internal communication and alignment. “Backroom talks”, bilateral alignment etc. are dysfunctional and jeopardize good performance in the boardroom. One core objective of the BoD is to address the central questions of the company from different angles. Typically, these settle around the areas of “markets”, “finance” and “operational implementation”. Details matter. General advice without specific reference, provided by honourable executives offers very little value added. The advice of the BoD must be:

• Up-to-date to latest technologies and market trends
• Specific to the company’s current situation and
• Tested in comparable situations in order to be of good use.

Typically the NEDs are one or two stages ahead of the company, in terms of experience. Success factors for an effective & efficient BoD include:

• Mutually agreed expectations and objectives
• Clear competences and responsibilities of the BoD as well as the executive management
• A common understanding of the each other’s roles among the shareholders, NEDS and the executive management
• Good (regular, constructive, open) communication within the BoD as well as between BoD and the executive management
• Attractive incentives that adequately compensate, hence motivate, the BoD for expenses and risks.

A good BoD creates comprehensive value added

The performance assessment of the BoD falls into two areas:

1. No news is good news!

The BoD is responsible for the early identification and avoidance of risk. This can include governance topics, as well as questions regarding the succession of key positions in the company, as well as securing of liquidity. In essence, the BoD ensures, no bad news about the company is heard in public, whereas the executive management can focus on forward-looking and market-oriented activities. For the implementation of the company strategy, i.e. healthy growth, the BoD is laying the foundation.

2. Cannibalise yourself, before the market will do!

While the executive management is to deal with the day-to-day business, the BoD defines and challenges the company’s strategy. Especially in times when old business models are disrupted by new technologies and established markets face erosion, it is the role of the BoD to search for future opportunities and to identify new business models, potential competitors, acquisition targets etc. The alignment with the executive management is indispensable, yet it is the external perspective of the BoD to provide out of the box inputs and impulses also for a very good executive management.

Whereas in Start-up and Turnaround situations, the focus is more on securing going concern, thereby protecting shareholder value; in Business Transformation challenges creation of shareholder value is in the scope. Protection and creation of shareholder value is ultimately reflected in the company’s evaluation. While the annual P/L reflects mainly the operational performance of the executive management, the performance of the BoD is mostly (only) measured on an exit or during a valuation by new investors.

Take away:To foster performance of the non-executive board, diversity is a relevant aspect. For different phases, different skills are required. Start Up situations differ from SME and corporate settings. The outcome of the board is assets from providing stability to foster value protection, as well as in value creation in terms of strategy and strategic development. The real value is visible only at the valuation of the company at moments of exit or new investors entering the company.