It happened all of a sudden. I was reading an article about non-family CEOs of family companies. In the middle of the article, the author asserted the following: “While boards of directors are common in many companies, they are less common in family-owned or privately-held companies.”
That author means well, but what he said is incorrect.
Yet it reminds me of a client who called one day and jubilantly announced, “We’re getting a board of directors!” I pointed out that under Ohio law, the client’s business, a corporation, was required to have a board of directors, and in fact a board had been in place for years, even though the client had not acted like the board existed. (There’s a procedure in Ohio for shareholders to delegate to themselves the authority of the board of directors. But that’s not what this client meant.)
What’s going on here? Why do people associated with family companies believe the business has no board of directors?
The answer likely consists in a phenomenon my colleague, Ken McCracken, calls “natural governance.” Nearly all family or private businesses originate as an idea in the mind of an enterprising person. The idea gains traction as a real business. As the business grows, the founding entrepreneur uses a decision-making structure that reflects his or her temperament and mindset. As more family members work in the business, they and the founder (sometimes the founder alone) tend to make decisions informally. They don’t need fancy mechanisms to decide what they will do. The business is still relatively simple. The family is still relatively small. If the family owners need to make decisions together, they simply talk among themselves and hash out what needs to be done. Maybe they talk in the hallway of the office. Maybe they talk at dinner. They do make real decisions, and in so doing they do govern the business and themselves. They just do it informally. One might say they do it naturally – in the sense of doing it by their nature.
But eventually, maybe years after the founder dies, the business becomes more complex. Making decisions is less simple than it used to be. To get things done, the family needs a certain amount of formality – not unbearable, suffocating formality, but responsive, supportive formality that fits this particular family.
A more formal outlook
Meanwhile, when the legal entity of the business was first established, it almost certainly was set up to include a board of directors. Under Ohio law, a corporation must have a board of directors. (In Ohio, the shareholders can delegate the board authority to themselves, but they must do so on purpose, by agreement. They have to mean to do it.) Similarly, if the business is a limited liability company, it must have people in charge of the management – the managers if manager-managed, or the members if member-managed. The law does not allow a business to have no one in charge.
Our well-meaning author probably intended to say that in practice, many family companies do not have active, functioning boards of directors. In practice, they just collapse the board into the job of the CEO. And my jubilant client was trying to say that whereas in the past the family had not used the board of directors to make decisions, now they were going to make active, purposeful use of it to help run the company.
An Active vs Dormant Board
The distinction between an inactive, dormant board and an active, engaged board raises serious issues for owners of a family company. In the one case, the board exists but does not function. In the other case, the board exists and makes decisions that influence how management operates the business. For the owners, the first scenario spells trouble – especially if the board’s function is collapsed into the person of the CEO. An inactive board allows for simplicity when the business is young. But as the business ages and the number of owners grows, an inactive board impairs and can destroy the owners’ relationships with each other and the company. Consider these two examples (based on recent, actual situations).
- Father and uncle are co-managers of a very profitable second-generation family business. Uncle dies. Father promotes one of his five children, a son, to president. The board of directors consists of the father and the son, but they never meet as a board because they communicate informally, their offices being next to each other. As the father ages, the son makes almost all the decisions. The father dies unexpectedly, leaving the son to deal with four siblings who, being non-voting shareholders, have no voting authority to vote for directors. The economy hits a recession, and the son has trouble running the business. The company’s stock value falls. His four siblings sue him, claiming he permitted a non-functioning board.
- Father and mother die, leaving two children as the only voting shareholders. The children, being the only people who can vote directors into place, disagree about voting, so the board goes dormant for over a decade. One child, over the objection of the other, tries to re-populate the board. A fight develops over why the board is not functioning. One child sues the other, demands a functioning board of directors, and accuses the other of damaging his valuable investment in the family business.
As these examples show, the board of directors is not just a technicality. A family should not make its decision-making any more complex than necessary. But once the family reaches a certain level of complexity, it’s more than ok to use the board. It’s quite advisable. The board always has existed. The board and the CEO are two different things. The company belongs to the owners. Using the board to oversee the company is what family owners are supposed to do.
Now, you can remember where you put your board.