On the Board: The value of boards of advisors and directors for electrical distributors

Farmington Consulting Group, Farmington, Conn., recently conducted online surveys with senior leaders of electrical distributors and manufacturers to understand why companies have a board of directors and/or a board of advisors. Senior leaders from 56 of the 100 largest electrical distributors and 24 manufacturers (one from each company) participated in this FCG online research project. A summary of what we learned follows. If you would like to discuss the study in more detail, please contact me at [email protected] or 860- 614-2631.

A board of directors versus an advisory board: An important distinction. As a matter of law, a corporation must have a board of directors elected by the stockholders. There is no limit to the number of directors a corporation can have.  The CEO of a corporation reports to its board of directors, which is a group of individuals who are supposed to determine the company’s strategy and are responsible for its performance.

A board of directors has formal legal authority over a company, a fiduciary responsibility to its shareholders, and is governed by the corporation’s bylaws. Boards are regulated by the Sarbanes-Oxley Act of 2002, which is intended to protect shareholders and the general public from accounting errors and fraudulent practices in the enterprise, as well as improve the accuracy of corporate disclosures. Directors are elected for established terms. Board members have three-year terms and can be expected to be re-elected three times.  Directors are structured by functional committees (audit committee, compensation committee, nominating committee, etc.).

A board of directors should be installed to help guide an electrical distributor or electrical manufacturer in a broad, strategic way, drawing from the combined experiences of many backgrounds.  A board of directors should be made up of both owners and investors along with other outside professionals with specific operating experiences and background in finance, marketing and/or operations.  At least one outside board member should have deep experience within the electrical channel either as a manufacturer or distributor. 

Inside directors versus outside directors. Once you form a corporation, you automatically have a board of directors.  Each member of the board of directors has voting rights and the board as a whole is ultimately liable for the company’s actions. An inside director is a board member who’s also a stakeholder, officer, employee, or someone similarly connected to the company.  An outside director is a board member who is not otherwise employed or engaged by the company.

Private companies aren’t obligated to have outside directors. Inside directors are insulated and the boards of private companies are often packed with yes-men who rubber-stamp decisions. Outside directors can provide much-needed objective advice from a healthy distance. As independent oversight, they keep a watchful eye on the inside directors and on the way the organization is run.

Many independent electrical distributors and manufacturers have a board of directors just made up of family members or friends as the outside board members. These companies typically are run as monarchies, and the only way for someone to ascend to the presidency of these companies is to be a family member.  One major benefit of having outside board members is to ensure that the next president is the best qualified candidate for the job, and is not selected based solely on nepotism.  If a company is interested in continuing a corporate monarchy, this can be a deterrent to not have outside directors.

The independent voice or a board of advisors. A board of advisors is very different from a board of directors.  They provide non-binding strategic advice to the senior management of a company.  The board of advisors does not have authority to vote on corporate matters or bear legal fiduciary responsibilities.  A board of advisors cannot be held liable for mistakes made in connection with their duties.  It has no legal responsibilities, no authority and no voting rights. There is flexibility in term length. 

A board of advisors is most often assembled to acquire expert advice on the specific challenges and opportunities a company faces as it attempts to grow its business. Electrical distributors and manufacturers who create advisory boards should look for people who have already experienced what their company wants to experience.  For instance, if you are an electrical distributor with sales of $100 million and want to grow to $200 million in sales revenue, you select advisory board members who have had that experience, whether they have served as a president, COO, CFO, V.P. of sales and marketing, V.P. of operations, or V.P. of human resources for a non-competing distributor. 

If you are unable to find individuals currently functioning in senior leadership roles for your advisory board, recent retirees are the second-best picks. FCG recommends against asking professional advisors such as lawyers, accountants, and bankers to serve on your advisory board.  Your lawyer, accountant and banker already have established relationships  with your company that result in personal gains for them, so they cannot be totally objective.  They might be reluctant to bite the hand that feeds them, so to say.  The right number of board members should be either an odd number such as three or five so they cannot be easily swayed toward mutual agreement.

Feedback from the front. Two electrical distributors that had neither a board of directors nor a board of advisors had this to say. “We were a pioneer in having outside board members and they were instrumental in our early growth years,” said one distributor executive. “We do have a board of directors, as all companies must, but it is my father, brother and me, and we fulfill the legal requirements. That’s about it.

“Replacing the board, we have formed a large leadership team of 15 of our top executives that is in effect an advisory committee. The president makes all of the major decisions after consultation with this group and on acquisitions. We also consult with ownership.”

Another distributor who had decided against setting up an active board of directors or board of advisors said, “Up to this point in our evolution I thought it would do nothing but slow us down.  I am now beginning to rethink this. I could probably be convinced that we should have some form of a board or a more formal advisory group.”

One other respondent said they found employees to be “a more relevant source of advice than someone who has no experience in this business.” Another distributor executive said while the company doesn’t have a formal board, “We do have an executive management team that formally meets with the owners twice a year for review and planning.  All of our executive management team members regularly network within our industry for best practice sharing and we often bring in consultants to assist us on special projects.”

Two distributor respondents who rely on a board of directors and/or a board of advisors offered some insight into the make-up and responsibilities of their boards. “We have had a board of directors for over 25 years,” said one distributor. “Our board includes directors (voting) and advisors (non-voting). Voting directors include four stockholders, two of which are the CEO and the executive V.P.; two are non-employees and chairman (non-employee, business consultant). Non-voting advisors include V.P. of sales, CPA/city councilman (non-employee) and corporate attorney (non-employee).  The chairman is paid a quarterly retainer, and the CPA and attorney are paid their hourly rates.”

Another distributor who had both a board of directors and a board of advisors said they are “predominately driven by multiple shareholders.” That company has a five-person board of directors with representation from all shareholders, and an advisory board internally called a steering committee. “This committee of nine meets formally each quarter and provides guidance/feedback to the general manager, who works directly for the board of directors,” they said. “Essentially, this committee contains all active shareholders and department heads.”

Manufacturer comments on boards of directors and boards of advisors. Three manufacturer respondents whose companies had neither a board or directors nor a board of advisers had different reasons for their decisions. One executive said in his company the president’s staff and leadership team in many ways act as a board, but it does not have voting power. Another company is considering using an outside board of advisors, and the other manufacturer respondent says his company is a family-run business that keeps all business decisions within the family.

Generally speaking, the manufacturer respondents whose companies have boards of directors or boards of advisors value the fresh perspective outside advisors offered.  One respondent said they used a board “to ensure we are making financially prudent decisions, both internally as well as externally, as well as to provide input/feedback/ resistance to company direction so as not to rely one individual.”

Another respondent gave several reasons for using a board. “Honest feedback for the CEO,” they wrote. “Assist in setting strategic direction, assist shareholders in corporate governance, assist in the M&A process, and bring diverse backgrounds of skill sets that have helped them rise to the CEO level along different paths in their own companies.”

General recommendations from the FCG study. Best-practice electrical distributors and manufacturers adopt a working board with outside board members to help them successfully navigate an increasingly complex and volatile electrical channel landscape. Corporate governance at these companies takes the form of official policies promoting oversight and accountability in corporate strategy; corporate performance; financial reporting and planning; risk management; executive performance and compensation; and talent management/management succession.

While formal corporate governance is mandatory for public companies, it’s not a regulatory requirement for most privately-held companies. Rather, privately-held electrical distributors and manufacturers are embracing corporate governance, primarily as they look to increase value for their stakeholders and keep pace with new electrical channel realities, including the five major “Sea Changes” as identified in FCG’s earlier research and outlined in a series of articles in Electrical Wholesaling available online at www.ewweb.com (Jan. 2014-March 2014 – “Sea Changes in the Electrical Channel" Part I, Part II, Part III).

• Technology;
• The multi-generational workforce;
• Competition for electrical distributors from new online sources of supply and alternative channels;
• Challenges and opportunities for electrical manufacturers in the form of globalization, consolidation and alternate channels; and

The changing faces of the electrical manufacturers’ reps, with 30% becoming extinct, 30% being new entrants

A move toward boards. According to this research, 71% of survey respondents who do not have either a board of directors or board of advisors are “very likely/likely” to install a board within the next five years.  Only 40% of survey respondents currently serve on any electrical channel boards, but 71% of these executives envision serving on an electrical channel board within the next five years. While it may not exactly be a sea change within this channel, our research uncovered momentum toward establishing working boards in the electrical market. 

The right board member composition and structure of a board can lead to a sustainable competitive advantage.  A board composed of qualified outsider directors will bring a very useful perspective to bear on behalf of your company. A strong board of directors will often spot problems not immediately obvious to management, and can point to solutions that are not easily seen by the inside board members.

Having professional governance practices in place will add value to your company.  If done correctly, the result will be a more effectively run, more profitable company with management’s efforts being more tightly focused on those matters that will propel the company to the next level. 

SIDEBAR:

1O Key Findings in the FCG Study on Boards of Directors and Boards of Advisors

1. 64% of survey respondents have a board of directors, 15% have a board of advisors, and 21% have no functioning board of directors or board of advisors.

2. 71% of survey respondents who currently do not have either a board of directors or board of advisors are “very likely/likely” to install a board within the next five years.

3. Only 40% of survey respondents currently serve on any electrical channel boards, but 71% of survey respondents envision serving on electrical channel boards within the next 5 years.

4. 67% of survey respondents compensate their board members.

5. The “full board” identifies candidates to serve on the board with 41% of the survey respondents. The CEO/president selects board members with 37% of the survey respondents.

6. 64% of survey respondents do not have a formal written document that outlines the skills, competencies and experiences required for board members.

7. 51% of survey respondents believe it’s “moderately difficult” to evaluate whether a prospective board member will be a good choice in terms of chemistry, experience and knowledge, while 47% said it would be “not difficult” to do this.

8. 61% of survey respondents have a document that clearly defines the responsibilities and authorities of a board member.

9. Survey respondents in privately-held electrical distributors and manufacturers found the most value in a board of directors or a board of advisors  that offered expert strategic input and guidance and created accountability. These boards tend to advise business owners against a lifestyle family-run business model that does not create growth opportunities and shareholder value. Respondents claim the greatest accomplishments of their boards are higher shareholder returns, strategic direction to drive further profitable growth and accountability for the senior leadership team.

10. Survey respondents claim the greatest challenges of their boards are finding outside board members with the fortitude to challenge the senior leadership team on company initiatives; having incompetent family members serving as voting board members; and succession planning with family members in leadership positions.