Principles and principals - Exploring corporate governance in small and privately owned businesses

Dominique Burnett, Director of Private Client Services, was recently published in STEP Journal. The article titled "Principles and principals" explores the need for corporate governance in small and privately owned businesses.

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Why should small and privately owned companies care about corporate governance? Are governance principles not aimed at public listed companies, the giants of the FTSE 100 or the S&P 500? How could a smaller enterprise hope to match the systems and processes of a large, listed company? Modern theoretical focus on governance has largely focused on the public listed company, with issues like shareholder activism and short-termism taking centre stage. But what does governance have to say to the smaller, privately owned business, particularly one in which the owners are also the managers?

To understand these questions, we need to go back to basics: what is corporate governance and whom does it benefit? Effective governance sets standards of ethical behaviour within a company and creates transparency in decision making. Fundamentally, it is about strategy: good corporate governance creates rules that help promote the interest of shareholders, customers, employees and other stakeholders, while ensuring that the board of directors respects each stakeholder’s rights.

THE OWNER-MANAGER AND THE BOARD

A company is a collective enterprise that requires the participation of a range of individuals, all of whom will have differing interests and objectives. Privately owned companies are often run by an individual who is also the owner of the business. Frequently charismatic and dynamic, the private business owner brings not only their experience to the business of the company but also sets the tone of the enterprise. When this is focused in a positive way, the company benefits hugely from their drive, creating a recognisable brand that customers can easily identify and relate to.

However, from a governance perspective, the owner-manager dynamic is prone to conflicts of interest. The lines between what benefits the company and that which benefits the owner can become blurred in the hurly-burly of day-to-day business. Effective corporate governance helps separate the roles of ownership and management, ensuring that the company is managed in the best interest of all stakeholders, including shareholders, employees and customers.

Checks and balances are essential to prevent one person from having too much power; a company should separate the roles of the chief executive and chair of the board to spread authority across the management team. Appointing a board whose members have a range of experience and abilities, and who have the authority to challenge each other, also helps to balance out the influence of the owner-manager.

It is important for privately owned companies to establish a culture of accountability. The company’s management team should be held accountable for their actions, and mechanisms should be put in place to ensure that they are held responsible for any failures or shortcomings. This includes establishing performance metrics and regularly reviewing the performance of the board and senior managers.

ORGANISATIONAL STRUCTURE AND ROBUST INTERNAL CONTROLS

An effective organisational structure is vital for companies to meet their goals efficiently. Applying the principles of corporate governance, even to a small company, ensures the enterprise benefits from professionalism and improved decision making.

By creating a system of clear roles and responsibilities, good governance ensures that the team understands how their actions contribute to the overall success of the company. Roles should be created based on an identifiable need of the company and allocated based on individuals’ strengths and talents.

Ensuring everyone has a reasonable workload is essential in order to prevent mistakes arising from time poverty or being overwhelmed. Assigning tasks and deadlines, encouraging collaboration, providing feedback and offering rewards for good performance all contribute to the good structure of a business.

Having strong internal controls in place can help to prevent fraud and corruption within a business. This includes having clear financial reporting procedures and regular audits (whether internal or external) to ensure that financial records and systems and processes are accurate and transparent.

Operating a small company under the same governance principles as a large one has a future-proofing effect. Although a small, single-owner company may not see the need to record all meetings or document its processes, should that company grow, it will find it eventually needs to implement a more formal system of processes, checks and balances.

Having these in place from the beginning removes the cost and complications of reverse-engineering a governance system into an up-and-running business. The company is good to grow from the start.

ACCOUNTABILITY AND TRANSPARENCY

In recent years, the focus on environmental, social and governance (ESG) factors in business includes a reflection on the ethics of an organisation. Pure attention to the balance sheet is no longer sufficient to satisfy regulators or investors. Setting clear policies and procedures can ensure a company is run transparently and ethically. This includes a code of conduct for employees, a whistleblower policy and training programmes on identifying and reporting suspicious activities.

A single-owner private company may not see the need for imposing structural requirements for accountability. After all, the results of the company will show its effectiveness; the small number of people involved inevitably means most of the team will know what is happening on a day-to-day basis. But setting clear rules for reporting builds trust both within the company (everyone knows what is expected of them) and externally (stakeholders, including future lenders, know they can rely on the information provided).

Being open and transparent with stakeholders, including shareholders, employees and customers, is essential. Disclosing potential conflicts of interest and ensuring everyone is treated fairly is crucial, as these processes protect not just stakeholders but also the company’s wider reputation. Reputation management can be costly when done after a ‘bad news’ event; it is better to set in place processes that protect a company’s reputation from the start.

CORPORATE GOVERNANCE IN FIDUCIARY RELATIONSHIPS

Governance does not only speak to owner-managed businesses. In the case of a private company held within a trust structure and managed by professional fiduciaries, the same principles apply. Although a trustee may rely on anti-Bartlett clauses in a trust deed to avoid the need to monitor underlying company activity, such technical considerations may not be significant when the wider world is scrutinising the actions, and reputation, of the trustee.

Trustees can apply good governance with a view not only to successful profits while safeguarding the trust assets for the beneficiaries but also to preserving the reputation of the trustees. In an increasingly interconnected and socially conscious world, corporate governance has become a significant factor in reputation management. Companies that prioritise ESG principles tend to earn the trust and loyalty of stakeholders.

As a professional trustee, aligning oneself with companies that demonstrate strong corporate governance practices not only enhances the trustee’s own reputation but also helps mitigate potential reputational risks associated with poor governance or unethical behaviour.

Dominique Burnett, ‘Principles and principals’, STEP Journal (Vol31 Iss4), pp.65-67