At the end of every year, I try to pass along to CEOs some of the best examples I came across from the preceding 12 months – examples of how and why better governed companies make more money.
As my firm enters its ninth year of partnering with small-cap leaders, one thing I continue to find in advising board of directors is that transformative governance moments often start in seemingly innocuous ways. A shift in one board member’s body language opens the door, perhaps, for another board member to interject, and before long, a major risk is avoided or capital is more efficiently allocated.
But one thing is resolutely clear year after year – particularly from the perspective of a former institutional investor – and that is: boards can’t ever become a competitive advantage for shareholders if the CEO thinks governance is a waste of time, or if the board doesn’t have the right people seated at the table.
Here are a few instructive vignettes from 2018:
When There Is A Culture Problem
Even CEOs who are highly attuned to corporate culture can have incomplete renderings of corporate behavior, because direct reports and lower-level employees aren’t always transparent with CEOs for obvious reasons. On one private company board I came in contact with, a director became increasingly concerned about the CFO’s comportment. He raised the issue numerous times with other board members and with the CEO, but to no avail (it’s worth noting that the CEO had worked with the CFO in prior companies as well). After the board member was repeatedly rebuffed, he asked the CEO whether he could spend the day meeting with finance department personnel onsite. After meeting with more than a dozen employees, the board member reported back to the board and the CEO, that the CFO: (1) was verbally abusive to those who attempted to give the CFO bad news; (2) had made inappropriate comments via email about a female employee who repeatedly raised accounting issues to the CFO; and (3) had smelled of alcohol during some personnel meetings.
The moral of this story is two-fold:
- Understanding corporate culture is a time-consuming, “hands-on” job for board members that smart CEOs should welcome; and
- You can have a boardroom full of geniuses, but it can all be for naught if there isn’t also the requisite courage to act.
When The “M” in M&A Stands For… Malware
A lot of stars have to align for corporate acquisitions to create value for shareholders. Sometimes even hyper-experienced CEOs get so bullish on a particular transaction that their judgment can get jaded. That’s why veteran CEOs and M&A attorneys will tell you that an unrelenting, thorough process must always be followed for every acquisition, and boards must ensure that it happens. On one board I came in contact with, a board member asked the CEO, CFO, outside counsel, and investment bankers to provide a detailed report on the status of due diligence undertaken on a pending acquisition. The CEO and the investment bankers were both clearly a bit taken aback by some of the board’s questions during the call, particularly when it came to the subject of cybersecurity. One board member with quite a bit of cybersecurity experience persisted in objecting to the caliber of cybersecurity diligence that had been done on the target, particularly in light of the fact that closing was scheduled for a couple of weeks out. Notwithstanding a lot of pressure to relent, the board member persisted and suggested that despite conducting “industry standard” analyses, the company should make sure that they scanned the endpoints of the target to ensure that there were no signs of a breach (or, worse, an exfiltration of critical data). A subsequent scan of the endpoints showed that the target’s computer systems were riddled with sophisticated malware, and probably had been for a long time. Though the acquisition ultimately took place six months later, it was for a much lower price, and after confirmation that the target’s key intellectual property hadn’t been compromised.
The moral of this story is two-fold:
- Even rigorous processes can be “garbage in, garbage out” in the absence of board members who are asking the right questions, and listening really carefully to the answers; and
- When you acquire companies, you also acquire their cyber hygiene.
When A Boardroom “Expert”… Isn’t Such An Expert
I came across a company that was in dire need of growth capital; i.e., they had about four months of cash left. The board had been presented with two different term sheets by an investment bank, but each time the board rejected the financing terms. On closer inspection, the board was predominantly following the lead of a board member who was a prominent (read: very successful) investment banker earlier in his career. That is, the other board members lacked any capital markets experience, so they were really just deferring to their resident banking “expert.” One board member started feeling like the board was making a mistake by turning down term sheets when they were so close to running out of cash, and suggested to some of the other board members that perhaps they should be more cautious about blindly following their colleague. When the dissenting director didn’t get very far with his colleagues, he requested much more detailed information from the investment bankers about the kinds of financings the company’s peers had recently been transacting. When the data showed that the terms they were being offered were clearly the “market” for companies like theirs, the dissenting board member confronted their resident banking expert with the industry data. Succinctly, it then became clear to management and the other board members that their banking expert was indeed an expert… on large-cap bond financings in the 1980s. In other words, the “expert” they had been deferring to basically knew no more than the other board members about the small-cap equity capital markets in 2018.
- Large-cap expertise often doesn’t translate to the small-cap ecosystem; and
- Courageous, tenacious board members are what every shareholder, officer, and director should want.
It’s amazing how fast boards can evolve from a box-checking mindset to becoming a true competitive advantage for shareholders once they hear real-life examples about what high-performing boards actually do.
Adam J. Epstein, is a former institutional investor, and now an advisor to CEOs and boards of pre-IPO and small-cap companies through his firm, Third Creek Advisors, LLC. He speaks monthly at private corporate events, and corporate governance and investor conferences, and has appeared internationally more than 100 times since 2012. Mr. Epstein is a key contributor to Nasdaq’s Amplify small-cap content initiative, and a mentor at the Nasdaq Entrepreneurial Center in San Francisco. He writes the “Entrepreneurial Governance” column for Directorship magazine, he’s the author of The Perfect Corporate Board: A Handbook for Mastering the Unique Challenges of Small-Cap Companies (New York: McGraw-Hill, 2012), and he’s a contributing author to The Handbook of Board Governance: A Comprehensive Guide for Public, Private and Not for Profit Board Members (New Jersey: Wiley, 2016). In June 2017, The Perfect Corporate Board was the #1 ranked corporate governance book on Amazon.com, and, in June 2016, The Handbook of Board Governance was the “#1 New Release” in corporate governance on Amazon.com. Connect with Adam on LinkedIn or learn more on his website.