How outside boards give CEOs what they can't get anywhere else.
How outside boards give CEOs what they can't get anywhere else.
I'm my own boss," is the entrepreneur's credo. At least it's the credo of Kenneth Hendricks, chief executive officer of ABC Supply Co., a building-materials distributor in Beloit, Wis. ABC, founded by Hendricks in 1979, did $82.3 million in annual sales in 1984 -- a 76,075% five-year growth rate, placing it #2 on the 1985 INC. 500 list of America's fastest-growing private companies. Despite the size of the company -- and the challenges that come with such fast growth -- Hendricks sees no reason to establish a board of directors at ABC.
"The energy that goes into setting up a board, and then periodically sitting down with them, is a reduction in productivity," Hendricks says. "A board is a convenient way for an entrepreneur to shift responsibility to other people. I like being responsible for this company. I'm a hands-on kind of guy, and the buck stops here. I love the independent environment at my company, and I don't want to change it. Every day, it feels like a party around here." The 44-year-old Hendricks owns 100% of ABC, and there are no procedures, implicit or explicit, governing such long-range policies as succession. "I haven't thought about it," he says when asked who might take over should anything happen to him. "That's too far down the road. I'm having fun and satisfaction now."
Most people who start their own companies side with Hendricks when it comes to naming outsiders to a company board, even though the benefits to the business go well beyond planning for succession. In fact, the reasons to have a board are so sensible sounding that they are hard to dispute. Boards are an inexpensive way to get hardheaded, expert, objective advice. A board forces a CEO to drop back from day-to-day operations and to think strategically about the direction the company should take. Why, then, the reluctance on the part of so many CEOs? The answer seems to lie less with business tactics than with individual style. The very personality traits that lead people to start successful companies in the first place -- a passionate concern about control; a bias toward action, not rationalizing and explaining; a desire to create a management style that is appropriate to the business, not one learned in an MBA program -- are the same characteristics that make company heads chary of boards. When the subject comes up, the feeling that is voiced most often is fear of losing control of the company.
John Cross, chairman and former president of Elphinstone Inc., a $1.7-million Baltimore distributor and renter of construction equipment, has some strong opinions about why most heads of privately held companies shun boards. Cross, who joined the company in 1937 and became president in 1962, didn't set up his own board until 1979. "Entrepreneurs," he says, "tend to be secretive and trust no one. At the top of the corporate flow chart is the word 'me,' and underneath that is 'everyone else.' It's logical for entrepreneurs to have a board, but entrepreneurs tend to be ruled by their emotions, not by logic. That's why so many firms fail when the founder or driving force dies. The entrepreneur tends to put great faith in his own powers. He subscribes to the John Wayne image -- the longer battling against impossible odds, the macho achiever. I've talked to many of my colleagues who don't have boards, and they say it's because outsiders are a threat. They're afraid they wouldn't be able to run their company the way they want."
David Boyd, associate professor of organizational behavior in the College of Business Administration of Northeastern University, finds much the same attitude. "For [the entrepreneur] to seek advice from something like a board is to admit weakness and vulnerability," Boyd says. "Entrepreneurs tend to compete with themselves. Relying on a board of directors is anathema to their desire of projecting an image of strength and omniscience."
Many small companies do have boards. But, as Leon Danco, president and founder of The Center for Family Business, in Cleveland, points out, most are rubber stamps. "The CEOs of most small businesses," he says, "either do nothing or pack their courts with shills. It's because successful entrepreneurs worship flexibility, i.e., 'freedom,' more than anything else -- including, it would seem, survival."
That is a lesson that Victor Pomper learned well when he was head of marketing at H.H. Scott Inc., in Cambridge, Mass. For two decades, the company, founded by Hermon Scott in 1947, was a standard-setter in the high-fidelity stereo equipment industry. "Hermon Scott was a genius," says Pomper. "He had an incredible, towering intellect. But he never shared his feelings, and he always refused to take advice. When imports started to eat away at our market share, and we started to get into trouble, he just couldn't cope. We'd come out with another brilliant engineering innovation, and we'd do well at first. But, invariably, our competitors would copy the technology and then undercut our price. Instead of cutting prices right along with them, he kept our prices up. He consistently traded market share to maintain profit margins. He was obsessed with our prestige. It was folly.
"Many times, I suggested we set up a board. But trying to get him to follow any advice was a knock-down, drag-out fight," says Pomper. "He was a strong man, but some strengths carried too far can become weaknesses." In 1972, the company finally went bankrupt. Scott, a broken man, died within a few years.
"I learned from Scott's mistake," says Pomper, who founded his Bedford, N.H., company, Satellite Data Corp., in 1981. "And what I learned was that a company is much better off with a board, preferably one that has a good number of outsiders sitting on it. A CEO needs a steady source of unbiased, outside advice."
William H. Chisholm, president of Boardroom Consultants Inc., a New York City consulting firm that helps companies recruit directors, agrees. "It's like putting inexpensive management consultants on retainer," he says. "But, typically, small firms have not resorted to outside directors, although that's finally starting to change." The change, though by no means a groundswell, is taking place most often at maturing start-ups. And it is giving birth to some boards that are as diverse as the companies that have created them.
We hold over 10 meetings a year," says Rick Terrell, president of Microware Distributors Inc., describing the board at his $15.3-million Aloha, Ore., company. "That's an extremely high frequency for any kind of firm. But I depend on that many meetings. We're a fast-growing, dynamic firm, and we need to sit down and talk a lot. Not so much to discuss day-to-day operational stuff as to look at the strategic opportunities that are constantly presenting themselves." Terrell founded Microware -- a distributor of microcomputer hardware and software, and #350 on the 1985 INC. 500 -- in 1979.
Microware's board has six members, who include three top officers and three outsiders. One of the key outsiders is Lou Manrique, a buyer for PacTel InfoSystems. "He's a retail man," explains Terrell, "who knows the buying patterns of our customers. He'll say: 'You don't want to start buying that. You won't find customers for it.' He's saved us from making many costly mistakes. This industry is changing every day, and I would have trouble keeping up with it without my board."
While the usual ratio of outsiders to insiders favors in-house directors, a number of small companies have taken a chance on a broader view from the outside. Richard Parker of Richard Parker & Associates, a $15-million direct-mail fund-raising company in San Francisco, recently set up a board composed of three outsiders and himself. "I don't want to live in my own little universe," says Parker, who is founder, CEO, and sole owner. One of the outsiders is an attorney. The other two are Aaron Adler, retired chairman of the board of Stone & Adler, in Chicago, and Pat Connolly, a vice-president of Williams-Sonoma Inc., in Emeryville, Calif., both recruited for their direct-marketing sophistication.
Parker says his four board meetings a year help him organize his thoughts and actions. "Just the process of meeting, and having to prepare ahead of time, helps me think more clearly," he says. "From having a board, I've discovered that if you can't logically explain what you want to do, it's probably not worth doing. Many entrepreneurs are too insecure about themselves to have a board. They're afraid they'll look naive in front of them. But I've gone into that boardroom and shared bad quarterly statements and bad moments with my directors that I wouldn't want to share with my mom. A board helps you face things a CEO would be tempted to deny or sweep under the rug."
George Clement, CEO of Clement Communications Inc., says straight out that before he created his outside board five and a half years ago, "I wondered if, under scrutiny of a board of sophisticated businesspeople, I could measure up. I wasn't so sure I wanted to be put to the acid test." Clement Communications, in Concordville, Pa., is a $10-million producer of posters and publications that help businesses communicate with their employees. The company, founded by Clement's grandfather, is closely held and family owned. "When I thought about forming a board, I was afraid of losing control," he admits.
Despite his anxieties, Clement plunged ahead and set up a board consisting of himself and four outsiders. As his outside directors, he chose the company's legal counsel of 20 years for his long-range view of the firm; the CEO of a similar (but not competing) company for his knowledge of the publishing industry; a financial expert; and another CEO for his business savvy. Within a year, the board had convinced Clement to set up a system of bad-debt management that saved the company $190,000 before two years were up. The board also helped Clement Communications improve its financial reporting and, according to Clement, kept him from making foolish acquisitions. "My board has made me a better CEO," he says. "CEOs who don't use outside advice run the risk of internalizing too much. They never realize their full potential, and they miss a lot of opportunities."
Elphinstone's John Cross says the major reason he set up his board in 1979 was to establish continuity. "I'm 68 years old," he says. "It would be irresponsible and selfish of me to not plan for the future. I don't want this company to fall apart after I go. I want a smooth succession. A company is a living organism, not an appendage of the leader's ego."
Cross set out very methodically to choose the four outsiders who would join three of his company's top managers as directors. First, he identified the areas in which he wanted advice from the outside. Then he and his management team drew up a list of candidates, which they pared down to four names. Cross sent each and invitation to join the board, along with a prospectus, a brief history of the company, a full set of financial figures, and a one-year and a five-year marketing plan. A sheet describing the duties of directors was also enclosed. Cross said he then phoned the candidates, explained what was on the way, and waited. All four accepted.
Cross's wife, Mary, a vice-president, attends every board meeting and lends her advice, even though she is not a board member. "Who cares more about your best interests than your spouse?" asks Cross. "She knows me better than anybody alive, and I trust her. It helps cure some of the loneliness that comes with being in charge. She doesn't have much marketing or financial knowledge or anything like that, but she has remarkably good hunches about personnel matters. We're a small company, with only 16 employees, so she knows everyone here."
Recent hikes in directors and officers (D&O) liability insurance -- and the difficulty in getting coverage -- may put a damper on some small business's attempts to recruit outside directors. Premiums are from 3 to 10 times higher than they were last year, and in most cases, higher premiums are buying less coverage.
A company can set up an advisory board, however, an effective alternative that also skirts the insurance and litigation problems that formal boards may face. "Many people in high positions are reluctant to serve on a formal board of directors because of possible legal hassles," says Howard Anderson, managing director of The Yankee Group, a consulting firm in Boston. "A board member is stuck with a hell of a lot of legal responsibility. If a company screws upo, a stockholder, supplier, or customer can name that company's board of directors in a lawsuit. And an outside member of that board, even if he only attends a few meetings a year, is just as liable. Advisory boards, on the other hand, generally carry no legal liabilities. That means experienced, influential people are more willing to serve on them."
HoltraChem Inc., a $30-million chemical distributor in Natick, Mass., set up an advisory board of two outside members last year, partly in response to the D&O insurance problem. The company was founded nine years ago by president Herbert Roskind and executive vice-president Ery Magasanik, who are co-owners. Roskind and Magasanik chose for their advisory board two men who have specific talents that they themselves lack. One is John Remondi, vice-president of finance at Fidelity Investments, in Boston, and the other is Glenn Petersen, retired president of a manufacturing company. Remondi's expertise in structuring deals is particularly valuable right now as HoltraChem tries to expand by acquiring other companies. Current plans, for example, call for the acquisition of a chemical-manufacturing company, in order to -- in Magasanik's words -- "integrated backwards." Remondi already has helped HoltraChem engineer a 1% reduction in the lending rate charged by its bank, a maneuver that might never have occurred to Roskind and Magasanik.
Such money-saving maneuvers have convinced many CEOs that they were smart to appoint outsiders to their boards in the first place. Increasingly, as John Cross predicts, the practice of setting up a board, formal or informal, is likely to become a matter of survival. "The rapid change in today's economy, the influx of computers, and the expanding information base are making entrepreneurs realize that they can't live in their own little universe," he says. "I think small-business people are becoming less and less provincial. From now on, companies run by the seat of their pants will either see their market share shrink, or get destroyed by their competitors."