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The Importance of Outsiders

By Sonjui L. Kumar & Karen Robinson Cope Email By Sonjui L. Kumar & Karen Robinson Cope
January 2012
The Importance of Outsiders

Running a privately held company can be a lonely job. Additionally, most C level executives of private enterprises are also often its majority shareholders, with their income and personal net worth tied up in the companies that they run. It would seem that these executives have a great need to interact with people outside their own organizations for advice and guidance. However, unlike public companies, most private-held companies tend to select insiders such as key employees, family members, friends and investors for their boards. A model like this can easily result in a “rubber stamp” board of directors. There are a number of ways that an “outside” director can contribute greatly to an organization, including providing independent perspective and judgment on ongoing and new issues facing the company.

Outsiders can provide guidance that is markedly different from someone involved in day-to-day operations. Directors who are employees may be more concerned about job security or may be in charge of the areas that should be scrutinized, essentially lacking the confidence and independence to provide the same advice as an outsider. Bringing in outside directors can also add more structure to a company’s board, such as by setting up regular meetings, establishing agendas and keeping accurate minutes. The need to be accountable to outside third par-ties can trigger the institution of processes that are often overlooked in a more informal setting.

So what kind of a person should be an outside director, what should they do, and should they be paid? The director will usually be a business professional who is not an employee or a major shareholder. Their role will be the same as other board members—to protect the interests of the shareholders, to oversee management, set the company’s policy, approve major decisions, and serve as a resource to the company. In addition to all of that, they may also bring their experience and insight from the industry, other organizations, and positions to the table. Out-side directors are usually compensated for their service, generally in cash but sometimes with stock or options. Outside directors may also demand that a company carry director- and officers- liability insurance. Although this may be an additional expense, it should be outweighed by the benefit of the independent oversight brought in by the new directors.

Certain companies are prime candidates to bring in outside directors. The following are periods in a company’s lifecycle that an independent director could be invaluable:

• A company that is on the move, either merging, acquiring or entering new markets

• A company that is in crisis, such as addressing a corporate mistake or a situation created by regulators, the press or shareholders

• A company that is in transition, dealing with management turnover or an industry/technology/market that is changing or evolving

• A company is trying to create wealth for its share-holders, by positioning itself as an acquisition target or for a public offering

• A company at risk that needs to investigate some aspect of the organization such as financial controls or risk management.

In any of these situations, the expertise from outsiders can supplement the current management’s decision-making process and provide a valuable reality check.

Although some companies will set up advisory boards or peer review boards to give them similar outside guidance, it is not the same as bringing an independent voice to the board of directors. For one, an advisory board has no accountability, legal or fiduciary, to the shareholders or regulatory authorities. Their role, although an important one, is purely ancillary and does not need to be considered in the company’s decision-making process.

So depending on the company and its current challenges, an outside director can bring much-needed diversity of thought and independence to the organization.

[Business Insights is hosted by the Law Firm of Kumar, Prabhu, Patel & Banerjee, LLC.  Sonjui L. Kumar is a corporate, transactional attorney and a founding partner of KPPB. Karen Robinson Cope is a long-time entrepreneur and chairperson and founder of ACOD, the Atlanta Council of Directors(ACOD), a TiE Atlanta Initiative.

Disclaimer: This article is for general information purposes only, and does not constitute legal, tax or other professional advice.]

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