Good governance for SMEs why bother?

Unlike the household names of the FTSE100, SMEs are not obliged to take mind of any formal corporate governance arrangements, beyond the regulatory requirements of the Companies Act 2006. That said, companies of all forms stand to benefit from implementing corporate governance practises.

Corporate Governance has rarely been out of the news recently, from the scandals seen at Sports Direct and BHS, to the changes in the framework put forth by the Government and regulators. While the majority of stories on the subject focus on failure, this misses the point of corporate governance – putting frameworks in place to help organisations achieve long term success and value creation. This applies to organisations of all shapes and sizes. Furthermore, the earlier a company begins to give mind to these structures, the easier implementation can be. Good corporate governance can help bring in outside expertise, attract funding, and ensure long-term sustainability.

The UK’s corporate governance is world-renowned and replicated in large part due to its flexibility and recognition that no two business or boards are the same. The ‘comply or explain’ model that listed companies are obliged to adhere to could be voluntary replicated by start-ups, scale ups, and SMEs. These organisations should verse themselves with the regulatory environment they inhabit, map out their objectives and risks, and then replicate examples of best practise to comply with while explaining to themselves the ones which are not appropriate.

This level of self-discipline may seem onerous from the outset, but it will show investors, suppliers, and customers of the sincerity you have in your operations. As well as displaying a prudent attitude to risk, it can also help to display recognition of your organisation’s footprint on the community you interact with, and that you take the interests of your employees, customers, and supplier into account in your decision making processes.

So, where do you start?

Each company will need to ‘find their own way’ when it comes to building a governance framework, however there are some features which are universally applicable. These should include building clear reporting lines and decision making processes so that there is an understanding of where responsibilities lie. The responsibilities themselves should be distributed over appropriate roles so as to both provide checks on power, but also to ensure that there is a proper balance of skills. One resource we would encourage directors to use to track their own skills is the IoD Director Competency Framework which sets out the knowledge, skills and mind-set that a director needs to perform effectively as a board member.

All levels of an organisation should be clear on what expectations and goals apply to them. When you then come to build on this further there are many sources of ‘inspiration’ for SME’s to look to.  The UK Corporate Governance Code while applied to the listed market contains much of use for companies outside the equity markets. Its main principles; Leadership, Effectiveness, Accountability, Remuneration and Relations with shareholders all have lessons for an SME prepared to adapt them to their need.

Let’s consider some of the main principles of corporate governance which are applicable to all unlisted companies

1. Shareholders should establish an appropriate constitutional and governance framework for the company. This would typically be embodied in a company’s articles of association – the ground rules of the organisation.
2. Every company should strive to establish an effective board, which is collectively responsible for the long-term success of the company, including the definition of the corporate strategy. An interim step on the road to an effective (and independent) board may be the creation of an advisory board. At an early stage of a company’s development, it may be appropriate to operate many aspects of the board’s activities in a relatively informal and non-bureaucratic manner.
3. The size and composition of the board should reflect the scale and complexity of the company’s activities. During the early years of the company’s existence, owner-managers may be uncomfortable about inviting outsiders onto the board. They may not yet be ready to share sensitive company information and decision making powers with external persons. Hence the board often consists of owner-managers’ colleagues, family members, or close friends. As the company grows, more focus will be placed on the board, which is the key decision-making body of the company and so they composition and competence of the board will need to change to reflect this.
4. The board should meet sufficiently regularly to discharge its duties, and be supplied in a timely manner with appropriate information. Too many board meetings may result in the board becoming too operational. On the other hand, too few meetings may pose problems for the fulfilment of the board’s duties. Therefore sufficient attention should be given to the appropriate number of board meetings. Smaller companies will typically have four to eight board meetings per annum, possibly including a full-day strategic board meeting. However, the exact number of meetings required by the board to fulfil its responsibilities will depend on the specific needs of the company
5. Levels of remuneration should be sufficient to attract, retain, and motivate executives and non-executives of the quality required to run the company successfully. In contrast to executives, non-executive directors are normally remunerated on a fixed-fee basis. This is to ensure that non-executives retain an objective and independent perspective on the activities of the company. For this reason, share options would not normally form part of a non-executive’s remuneration framework. Shareholders and boards may consider the rewarding of non-executives through stock. However, although stock ownership may increase the alignment of directors’ interests with those of shareholders, the board should be aware that equity holdings may affect external perceptions of independence (see principle 11). The compatibility of stock-based remuneration with non-executive duties is ultimately a matter for shareholders.
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. It is useful for companies to develop a basic risk register, which is reviewed by the board on a regular basis. This will contain the following categories of information:
   • A description of the main risks facing the company
   • The impact should this event actually occur
   • The probability of its occurrence
   • A summary of the planned response should the event occur
   • A summary of risk mitigation (the actions that can be taken in advance to reduce the probability and/or impact of the event).
7. There should be a dialogue between the board and the shareholders based on a mutual understanding of objectives. The board as a whole has responsibility for ensuring tshapinghat a satisfactory dialogue with shareholders takes place. The board should not forget that all shareholders have to be treated equally. Shareholders of unlisted companies may particularly value a close dialogue with boards due to the illiquidity of their shareholdings. In contrast to listed companies, they are less able to express their views on a company’s strategy and risk profile through the buying and selling of their shares.
8. All directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge. Director orientation is an essential means of providing non-executive directors with the informational building blocks they need to effectively engage in strategic reflection and oversight. It is also important for executive directors, who may come from a functional background and may not yet be used to exercising oversight across the company as a whole.In the UK, it is possible for directors to develop and update their director-specific skills by qualifying as a Chartered Director. Such a professional qualification provides a framework within which to undertake continuing professional development. It also establishes an ethical and disciplinary framework within which to hold directors to account
9. Family-controlled companies should establish family governance mechanisms that promote coordination and mutual understanding amongst family members, as well as organise the relationship between family governance and corporate governance.A family constitution outlines how this family governance structure should work. It clarifies the family’s approach with respect to the following:
   • The family’s values, mission statement, and vision
   • The role of family institutions, such as the family assembly and the family council
   • The role of the board of directors, and its relationship to the family institutions
   • Policies regarding important family issues, such as employment policies with respect to family members, restrictions on transfers of shares, and succession policy with respect to the CEO
   • The nomination of family members to the board.

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