The Founder’s Trap: Why Does A Private Company Need A Board Of Directors?

Sole management is useful at the beginning of a company’s life: its founder invests resources, takes risks, and really understands how to run a business. But there comes a time when the transition to collegial management becomes a necessity. How do you know that this moment has come?

The board of directors is a prerequisite for the work of public and large companies. But collegial management is sometimes necessary even for a small private firm. In the West, for example, a non-profit organization or a family company may have a council. In the UK there is even an unofficial but very large roster of experts from various fields who are ready to become independent directors.

In Russia, the trend towards the creation of a board of directors in non-public companies began to unfold in 2014. By this time, many companies had reached a “plateau” of development, when the former growth potential was exhausted. The founders were tired of operating activities, and the crisis added sharpness and nervousness: entrepreneurs began to look for mechanisms that would help businesses cope with market unrest without manual control.

Management Models

And although there has not yet been a mass wave in changing management models, significant precedents have emerged that reflect a new trend. The cosmetic company “Splat-cosmetics”, the confectionery factory “Nonfuel” and the medical laboratories “Inviter” came to the collegiate management.

Some of the owners began to introduce boards of directors into the business structure as a real, regulated management institution. Others are like an advisory headquarters without legal registration, although the informal (“conceptual”) weight of such a body could be quite high. For example, strategic decisions were not approved without going through a discussion within the advisory board.

Since there are no mandatory requirements of the regulator to the owners in this case, the models can be very flexible and adapt to the situation and characteristics of the owners. But with all the variety of forms, there are three main motives for creating a collegiate body.

Exit from operations and transfer of business to heirs

In a mid-level company, the levers of control are in one person – its founder. He knows the market better than anyone, and large customers and suppliers often contact the owner directly. A business in this model is associated with its owner – expectations, responsibility, and choice within market forks are concentrated on one person.

This, by the way, was one of the reasons why Sergei Galitsky sold the shares of the Magnet he created. He confessed that the company was too “personalized” and it became too much of a responsibility for him. Over time, companies with this kind of autocracy develop several problems. Firstly, such a business is practically not able to work without its founder. It is difficult to pass it on to heirs or sell it.

The number of tasks grows

Secondly, with the development of the company, the number of tasks grows, but the sole center may no longer have enough strength and knowledge to cope with them, and the management system continues to support maximum centralization. “The intensity that I had in the company was already destructive for my age,” Galitsky commented on his departure at the time. “You have to admit that what you can do at 35 or 40, you can no longer do at 50.”

This effect is called the founder’s trap. After 10-20 years of undivided control, many entrepreneurs feel tired of the role of patriarch. They might want to pass the company on to an heir, sell it, or move on to something else while maintaining strategic control of the business. But even if the owner is ready to emerge from operations, the company is not always ready to pick up all its functions. We need to change its structure.

One of the options for a consistent exit from the operating system is the creation of a board of directors, which gradually assumes the functions of oversight and strategic decision-making. And the founder of the business becomes the chairman of the board of directors, as the owner of several did Alexey Mordashov # 1. In some cases, the entrepreneur retains the position of CEO, but retains only those areas that are really strategic. However, there are known examples of a complete exit from management.

IPO and moving to the next level

It is common for medium-sized companies to have a very limited circle of owners. Often this is one person, sometimes two or three, but in any case there are very few partners. Many processes there are not formalized: the owners make decisions in a “club” format. Sometimes, in difficult situations, temporary consultants are involved. But if a business is going to scale and move towards publicity, then it needs a board of directors: to go public or place bonds, you need a history of corporate governance.

Head Hunter, for example, had a board of directors a few years before its IPO on the New York Stock Exchange, a company spokesman said in a presentation at the Association of Independent Directors forum. At first, the council existed as an internal tool for dialogue between management and shareholders. The company then created a formal board of directors in which three of the nine members became independents.

Since the IPO in May 2019, the board has been legally integrated into the structure of the company and complies with the requirements of the US Securities and Exchange Commission. And although the process of its creation was gradual, the owners obviously had a distant goal in front of their eyes. Without this work, entering the stock exchange would be impossible. Therefore, if the IPO is part of the company’s strategy for the owner of the company. Now you can see the best business coaching at The Moose Consulting.

Development of the company

Sole management is useful at the beginning of a company’s life: its founder invests resources, takes risks, and really understands how to run a business. But when the process of becoming is completed, the company needs other forms of management. Otherwise, she will not be able to move to the next stage of development. This is a big challenge for the owner. To move on, he will have to expand his horizons, understand the reasons for the halt in growth and see new ways of development. That is why the entrepreneur attracts independent directors. From them business is enriched with new ideas, experience and expertise.

At the same time, the advice of the council is not one-time, as in consulting or coaching sessions. The council works as a permanent headquarters that charts the course, helps and advises top management. At the start of the transition to collaborative management, many business owners reserve the final say. But more noticeable efficiency is brought by the board, in which there are independent directors and decisions are made collectively.

Consulting or Coaching Sessions

When the founder of the food company Yarmarka retired from operations and handed over control to the board of directors, the company’s EBITDA margin increased several times (Study of the practice of boards of directors in private business, p. 40).

At some point, for example, management can be “drugged” by success and offer to invest more and more in projects that cause skepticism among independent experts. In this case, the Board of Directors will require additional evidence of the effectiveness of new investments. He should be free to cut back on the investment program if he finds management’s ideas too risky.

It is these incentives — going beyond operating activities, preparing for an IPO, searching for new options for development — that the institute of independent directors will develop in Russia. Priorities may vary depending on the situation. Even if the second factor is not the most relevant now, the other two are beginning to increasingly affect the market. The generation of businessmen who created companies in the mid-90s is getting older. New technological trends require increased mobility and openness to the future. Responding to these challenges in the old managerial forms will be more and more difficult.