Should I care about corporate governance? – a guide for SMEs, owner-managed businesses and family companies
On 22 April 2021, the European Confederation of Directors Associations published its updated Corporate Governance Guidance and Principles for Unlisted Companies in Europe (the “Guidance”), originally published in 2010. Despite its name, the Guidance explicitly states that it was prepared with the help of the Institute of Directors in the UK and as such, it can be viewed as a helpful tool for unlisted UK companies who wish to review their existing corporate governance framework or even up their corporate governance game.
Here we summarise some of the key points set out in the Guidance and explain why corporate governance should not be ignored by SMEs, owner-managed businesses and family companies.
What is corporate governance?
The phrase “corporate governance” refers to the way that a business is controlled and how decisions are made. Having an effective corporate governance strategy in place ensures that the decision-makers in an organisation are accountable, that a company’s objectives and how it intends to achieve them are transparent and that stakeholders’ interests are borne in mind.
Over recent months, corporate governance has become an increasingly popular discussion point for companies and their advisors and the expectation that organisations will have corporate governance strategies and processes in place is undoubtedly here to stay. But, while the need for quoted companies to tick the “corporate governance” box is understandable and regulated to some degree, what about unquoted companies, particularly SMEs, owner-managed businesses and family companies? Do such businesses need to take on the added administrative burden and accept reduced control in order to shout their corporate governance credentials from the rooftops? Does it really matter if such businesses choose not to adopt a corporate governance framework?
Corporate governance – disadvantages
Unlisted companies may find that a corporate governance regime comes with certain disadvantages, in particular, the increased administrative burden of establishing, reviewing and complying with the framework, as well as a reduction in control by, for example, their owner-managers.
That said, the downsides are arguably few and far between when compared against the upsides and with no regulation surrounding unlisted companies’ corporate governance regimes, the flexibility available to set up a framework that suits your business at a particular time means that any disadvantages can be fairly easily overcome.
Corporate governance – advantages
Establishing a corporate governance framework for your business can have several advantages. To name but a few:
- Stakeholder relationships. Corporate governance is, without a doubt, a “hot topic” and stakeholders, such as investors, financiers, employees and suppliers are increasingly asking questions about a business’ corporate governance stance. Having a regime in place may help to recruit and retain high quality employees, result in better finance terms or greater investment opportunities and improve key supplier relationships.
- Reputation. Reputation is key, particularly for small businesses which are less likely to be able to weather the storm of bad publicity; showing the public that you take corporate governance issues seriously is only going to improve your standing.
- Longevity. Having in place continuity and succession planning will assist with the long-term survival of your business. In addition, establishing an experienced and diverse board of directors will also improve your business’ chances of success.
- Next steps. Depending on where your business is at in terms of its lifecycle, you may be gearing up for an IPO or a disposal. Having a corporate governance framework in place is a pre-requisite for an IPO and if you are considering selling, potential buyers will be keen to see that your business is structured and run professionally, transparently and with accountability measures in place.
- Risk mitigation. By setting up risk controls and management strategies, your business’ exposure to risk and the extent of that risk will be reduced and conflicts, whether between employees, board members or across stakeholder groups, will be better managed.
The Guidance - introduction
Aimed to assist unlisted companies in establishing their own corporate governance framework, the Guidance makes clear that it is in no way binding and that no “one size fits all”; each individual company should consider the Guidance and its corporate governance regime in light of its own size, lifecycle stage, complexity and aims. The Guidance also includes a Self-Evaluation Questionnaire intended to help companies determine where they need to improve or reconsider their corporate governance offering.
Comprising of 14 principles, the Guidance explains that the first nine principles apply to all unlisted companies with the remaining five principles applicable only to larger and more complex companies, for example, those considering an IPO or which have notable financing arrangements in place. (Please note that this summary does not deal with these five principles.) The Guidance emphasises that in certain cases, a “phased” approach may be required, for example, where a founder is not yet ready to relinquish control or where the company is not yet sufficiently established to warrant the action.
Below is a summary of the first nine principles and how they might apply to SMEs, owner-managed businesses and family companies. This should not be read as an alternative to the Guidance but in conjunction with it; the Guidance covers each point in much more detail.
The Guidance – summary
- Principle One – establish an appropriate corporate governance framework. This should be put in place by the company’s shareholders using the company’s constitutional documents, i.e. the articles of association. Many newly incorporated companies adopt the Model Articles but as the company grows and becomes established, bespoke articles of association may be required. Similarly, a company may have a shareholders’ agreement in place. These are private documents and as such, could cause lack of transparency issues as the company grows.
- Principle Two – establish an effective board of directors. The board of directors is the decision-making organ of any company and as such, should take decisions objectively in respect of the company’s interests but also considering their impact on society. Consider producing a schedule of matters reserved for the board and possibly a schedule of matters reserved for the shareholders, as well as a statement of the company’s purpose and strategy; this will help inform decision-making and ensure that all are aware of the company’s longer-term focus. Ideally, a board should be made up of an experienced, diverse group of individuals and include independent, non-executive directors. Effecting these changes may be one step too far for some companies, particularly newly-established organisations or those which are owner-managed. If this is the case, the Guidance suggests that an advisory board be put in place as an interim measure. Its purpose is to guide and advise the board without being able to make decisions.
- Principle Three – size, composition and diversity of the board. A board’s size, make-up and skills set should be appropriate to the business in question, but it is important that a proper appointment process is put in place for new directors and that their term of appointment is also considered; in some cases, a long term in office may not be advisable or the best option for the company. Having a diverse board can ensure that different opinions and new ideas are generated to prevent stagnation. Succession planning should also be considered by companies, particularly owner-managed and family businesses. This may be a sensitive and difficult subject but is an important issue which should be addressed to avoid problems in the future. For further discussion about succession planning, see Looking to the Future - Business Continuity.
- Principle Four – regularity of meetings and information provision. Each company will need to consider the logistics and organisation of board meetings but should bear in mind that meeting too regularly may mean that the board is becoming too hands-on at an operational level. The Guidance suggests that four to eight meetings each year is typical. Procedures should be put in place for obtaining the information required by the board members to make decisions and written meeting guidelines may also be helpful. Board members should not hold back from obtaining professional advice to the extent required for them to make an informed decision.
- Principle Five – remuneration. One only has to read a newspaper to see headlines about executives being paid vast sums for poor performance. It is vital that companies put in place effective, transparent remuneration policies for both executive and non-executive directors which do not reward poor performance and which take into account the remuneration and reward strategies in place for other employees in the company. Although comparison with other, similar companies is encouraged, the Guidance cautions companies from placing too much reliance on this. Rewards should be linked to both corporate and individual performance but should not relate just to short-term performance; longer-term aims should also be borne in mind.
- Principle Six – risk oversight and internal control. The board needs to consider the key risks faced by the company and whether transparent procedures are in place to manage them. The Guidance suggests the use of a “risk register”, which can be as simple or as complex as it needs to be depending on the company’s size, complexity, business, sector and so on. Obviously, risks are likely to change over time so it is important to keep these under review. It may be appropriate for the board to take professional advice in this area; this may particularly be the case for smaller boards which do not have an audit or risk committee and may not have the experience to establish effective internal processes.
- Principle Seven – dialogue. An open dialogue between the board, shareholders and other key stakeholders is imperative and should be seen as a continuous objective, i.e. not just on offer once a year at the AGM. Arguably, keeping shareholders informed and listening to their views is of particular relevance for unlisted companies where shareholders are captive investors unable to dispose of their holding if they disagree with the way that the company is being managed or its objectives. Companies may find that increased communication is required at key points of the business’ lifecycle.
- Principle Eight – induction and training. Induction and continued training for directors is important both for their individual development and for the company’s growth. The extent of these will depend on the circumstances of the particular company. For example, a small family business is unlikely to put in place a formal induction exercise or bring in external trainers, however, consider the use of your business circle and the Institute of Directors which can assist with keeping directors’ skills and knowledge up-to-date.
- Principle Nine – family governance mechanisms. The Guidance suggests that family companies should put in place appropriate mechanisms to allow for information to be disseminated among family members and ensure that company strategy is understood by all. Often in family companies, certain members of the family will make the key decisions. This can create conflict and also blurs the line between family-related issues and operational issues. Consideration should be given as to whether other forums should be put in place within the family structure (the Guidance suggests a family council and a family assembly) each with a clear remit set out in a written family constitution.
Although the above may seem a daunting list, companies should remember that corporate governance is a subjective exercise, particularly for unlisted companies; corporate governance is not a one-time only consideration but rather a continuous process and there is no right or wrong approach.
- Decision-makers must be on-board with the corporate governance framework in order for it to be successful.
- Establishing a corporate governance regime is not simply a paper exercise; attitudes and processes must consistently adhere to the regime to be effective.
- Take it slowly – a company does not have to put in place processes and strategies overnight. Ensure that any changes are right for your business and align with its size, objectives and what its shareholders and founders want.
- Don’t be afraid to change – as businesses move on and changes occur, so too will their corporate governance regime. Although U-turns and fundamental changes shouldn’t be occurring too often, stakeholders and the public at large will expect new or updated procedures and plans to be put in place.
- Accountability, transparency and dialogue – remember these three words and you’re on the right track.
If you would like to speak to anyone about corporate governance or any other commercial or corporate law issues, please contact a member of the Corporate team.
Lianne Baker is a Knowledge Development Lawyer in the Corporate team.
This note reflects our opinion and views as of 4 May 2021 and is a general summary of the legal position in England and Wales. It does not constitute legal advice.