Cor­po­rate gov­er­nance for small-to-medi­um enter­pris­es (SMEs)

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In brief – Cor­po­rate gov­er­nance for SMEs

Many SMEs con­sid­er that cor­po­rate gov­er­nance is only rel­e­vant to large com­pa­nies. How­ev­er, good gov­er­nance presents major advan­tages for all com­pa­nies, espe­cial­ly when rais­ing cap­i­tal or sell­ing the business.

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All com­pa­nies ben­e­fit from good cor­po­rate governance

The major­i­ty of com­pa­nies in Aus­tralia are small-to-medi­um enter­pris­es which often view cor­po­rate gov­er­nance with scep­ti­cism. Good gov­er­nance in this con­text is not pri­mar­i­ly con­cerned with com­pli­ance with for­mal rules and reg­u­la­tions. Rather it is about estab­lish­ing a frame­work of com­pa­ny process­es and atti­tudes that add val­ue to the busi­ness, help build its rep­u­ta­tion and ensure its long-term con­ti­nu­ity and success.

Good cor­po­rate gov­er­nance is par­tic­u­lar­ly impor­tant to the share­hold­ers of unlist­ed com­pa­nies. In most cas­es, such share­hold­ers have lim­it­ed abil­i­ty to sell their own­er­ship stakes and are there­fore com­mit­ted to stay­ing with the com­pa­ny for the medi­um to long term. This increas­es their reliance on good governance.

Twelve essen­tial prin­ci­ples of cor­po­rate gov­er­nance for SMEs

1. Share­hold­ers should estab­lish an appro­pri­ate gov­er­nance frame­work for the com­pa­ny. The process and the gov­er­nance require­ments will devel­op with the growth of the company.
2. Fam­i­ly com­pa­nies should estab­lish fam­i­ly gov­er­nance mech­a­nisms which pro­mote coor­di­na­tion amongst fam­i­ly mem­bers and organ­ise the rela­tion­ship between the fam­i­ly and the business.
3. It is impor­tant to estab­lish an effec­tive board which is col­lec­tive­ly respon­si­ble for the long-term suc­cess of the com­pa­ny. A start­ing point for an SME may be the cre­ation of an advi­so­ry board for management.
4. There should be a clear divi­sion of respon­si­bil­i­ties at the head of the com­pa­ny between the run­ning of the board and the run­ning of the company’s busi­ness. No one indi­vid­ual should have unfet­tered pow­ers of decision.
5. All boards should con­tain direc­tors with a suf­fi­cient mix of com­pe­ten­cies and expe­ri­ence. The size and com­po­si­tion of the board must reflect the scale and com­plex­i­ty of the company’s activities.
6. The board is respon­si­ble for risk over­sight and should main­tain a sound sys­tem of inter­nal con­trol to safe­guard share­hold­ers’ invest­ment and the company’s assets.
7. Dia­logue should be encour­aged between the board and the share­hold­ers on the company’s strate­gic objec­tives. The board should always remem­ber that all share­hold­ers have to be treat­ed equally.
8. A stake­hold­er engage­ment process should be estab­lished, ensur­ing that the board always presents a bal­anced assess­ment of the company’s posi­tion and prospects to its stakeholders.
9. The board should be sup­plied in a time­ly man­ner with appro­pri­ate infor­ma­tion and should meet suf­fi­cient­ly reg­u­lar­ly to com­ply with its duties.
10. All direc­tors should receive induc­tion train­ing on join­ing the board and should reg­u­lar­ly update and refresh their skills and knowledge.
11. The board should under­take reg­u­lar appraisals of its own per­for­mance and that of each indi­vid­ual director. 
12. Lev­els of remu­ner­a­tion should be appro­pri­ate to attract, retain and moti­vate exec­u­tives and non-exec­u­tives of the qual­i­ty required to run the com­pa­ny successfully.

Sev­en key con­cepts of good governance

Any com­pa­ny can devel­op good cor­po­rate gov­er­nance prac­tices. The key is to under­stand the foun­da­tions of good gov­er­nance and how these will apply to your company.

Del­e­ga­tion of authority

In any com­pa­ny, the ori­gin of author­i­ty is own­er­ship. How­ev­er, the com­pa­ny may soon reach a point in its devel­op­ment where the main share­hold­er is no longer able to ful­fil the roles of share­hold­er, exec­u­tive direc­tor and man­ag­er simultaneously.

The own­er and/​or the board should devel­op a sys­tem­at­ic approach to del­e­gate author­i­ty and should for­malise this in writ­ing. A sched­ule of mat­ters reserved for the board and for exec­u­tive man­age­ment should be established.

Del­e­gat­ed author­i­ties should be reviewed peri­od­i­cal­ly to ensure that they remain appro­pri­ate giv­en the struc­ture, size, scope and com­plex­i­ty of the company.

Checks and balances

A basic prin­ci­ple of good gov­er­nance is that no one indi­vid­ual should have unfet­tered pow­er over deci­sion-mak­ing. Aside from the prac­ti­cal dif­fi­cul­ties involved in a sin­gle per­son mak­ing all the deci­sions, a lack of appro­pri­ate checks and bal­ances expos­es the enter­prise to human weak­ness. Even the most capa­ble of indi­vid­u­als can some­times make mis­takes or lose their abil­i­ty to analyse issues in an objec­tive man­ner. To min­imise these risks, it is impor­tant to estab­lish gov­er­nance pro­ce­dures that sub­ject all deci­sion-mak­ing to some kind of third par­ty scrutiny.

Spe­cif­ic exam­ples of checks and bal­ances with­in the cor­po­rate struc­ture include sep­a­rat­ing the role of exec­u­tive man­age­ment from that of the chair­man of the board, the require­ment of a ​“four eyes” prin­ci­ple when sign­ing con­tracts or mak­ing impor­tant com­mit­ments on behalf of the com­pa­ny and the involve­ment of inde­pen­dent direc­tors on the board.

Pro­fes­sion­al decision-making

The focus of col­lec­tive deci­sion-mak­ing in most com­pa­nies is the board of direc­tors. How­ev­er, sim­ply plac­ing com­pe­tent peo­ple of good­will around a board­room table will not nec­es­sar­i­ly result in an effec­tive­ly func­tion­ing board. Build­ing an effec­tive board takes time and patience on the part of board mem­bers and ben­e­fits from a pro­fes­sion­al approach to board­room procedure.

The chair has a par­tic­u­lar respon­si­bil­i­ty in mould­ing a group of capa­ble indi­vid­u­als into an effec­tive board team. The chair has to find a way to reach a con­sen­sus between diverg­ing views on the com­pa­ny and its future. An atmos­phere of open dis­cus­sion should be encour­aged. Per­spec­tives and view­points should be prop­er­ly doc­u­ment­ed in the min­utes, allow­ing dis­sent­ing voic­es to be record­ed. There should also be a clear for­mu­la­tion of deci­sions, so that the deci­sion-mak­ing process is fol­lowed by deci­sive action.

Accountability

It is impor­tant that each employ­ee, man­ag­er and board mem­ber under­stands expec­ta­tions about the nature and scope of his or her respon­si­bil­i­ties. As the com­pa­ny expands in size and com­plex­i­ty, explic­it busi­ness con­duct rules includ­ing eth­i­cal prin­ci­ples will need to be formalised.

Once respon­si­bil­i­ties have been defined, the effi­cient func­tion­ing of the sys­tem depends on prop­er oversight.

Transparency

Direc­tors, man­agers and employ­ees are like­ly to give greater thought to their con­duct if they per­ceive that they are being observed.

A key stage in open­ing up the com­pa­ny to exter­nal scruti­ny is tak­en by the appoint­ment of inde­pen­dent non-exec­u­tive direc­tors. This sig­nals a company’s will­ing­ness to become more open and account­able in respect of its deci­sion-mak­ing and per­for­mance assess­ment. The replac­ing of the own­er-man­ag­er or found­ing entre­pre­neur by exter­nal man­age­ment can also be per­ceived as an impor­tant step in this direction.

At some stage, the SME must make choic­es about the extent of its dis­clo­sure to exter­nal stake­hold­ers. This is impor­tant if the com­pa­ny is seek­ing exter­nal cap­i­tal or con­tem­plat­ing a future listing.

Con­flicts of interest

Espe­cial­ly in small com­pa­nies, it is impor­tant to recog­nise that the com­pa­ny is not an exten­sion of the per­son­al prop­er­ty of the major­i­ty owner.

The prin­ci­ple may be dif­fi­cult for own­er-man­agers or large share­hold­ers of SMEs to accept or under­stand. They may view the company’s inter­ests as syn­ony­mous with their own. This may lead to a self-inter­est­ed bias in their deci­sion-mak­ing. At worst, it could lead to them seek­ing ways of expro­pri­at­ing the assets of the com­pa­ny at the expense of minor­i­ty share­hold­ers or stakeholders.

A robust gov­er­nance frame­work needs to define cred­i­ble mech­a­nisms by which poten­tial con­flict of inter­est issues can be man­aged or resolved. Direc­tors should always declare poten­tial con­flicts of inter­est to the rest of the board and abstain from influ­enc­ing such decisions.

Align­ing incentives

The direc­tors and employ­ees are pri­mar­i­ly incen­tivised by the SME’s remu­ner­a­tion pol­i­cy. SMEs ben­e­fit from the fact that they are not sub­ject to the same degree of pub­lic scruti­ny and manda­to­ry trans­paren­cy regard­ing remu­ner­a­tion as pub­licly list­ed com­pa­nies. How­ev­er, SMEs have the same need to ensure that the remu­ner­a­tion pol­i­cy is incen­tivis­ing behav­iour from direc­tors, man­agers and employ­ees in a way that is con­sis­tent with the long-term inter­ests of the company.

Fur­ther­more, a cred­i­ble and trans­par­ent remu­ner­a­tion pol­i­cy can help win the com­mit­ment and loy­al­ty of com­pa­ny stake­hold­ers to the company’s objectives.

Con­clu­sion – Good gov­er­nance is for everyone

Remem­ber, good cor­po­rate gov­er­nance is not just for large pub­licly list­ed enti­ties. All com­pa­nies, regard­less of their size or extent of their oper­a­tions can achieve tan­gi­ble ben­e­fits from imple­ment­ing strong gov­er­nance systems.

For fur­ther infor­ma­tion or to dis­cuss your spe­cif­ic gov­er­nance needs please contact: