Pearls of wisdom Spotlight on non-executive director talent

Legendary banker JP Morgan said that when two non-executive directors (NEDs) agree, most of the time one of them is unnecessary.

A century after he bailed out the US financial system, his words still carry weight and in a post-Enron age the topic of NEDs continues to spark controversial exchanges.

The introduction of more stringent legislation concerning corporate governance means that the responsibilities of NEDs are coming under increasingly intense scrutiny, fuelling debate over performance, pay and culpability.

Yet, against a backdrop of intense global competition for talent, securing the right NEDs to help turn an emerging company into a world-class player has never been more critical whether you are an investor, entrepreneur or chief executive.

Scottish Equity Partners (SEP), hosted a special one-day seminar to debate the role of NEDs, attended by a distinguished group of some fifty NEDs with a wide range of experience on both private and public company boards, including SEP former and existing portfolio companies.

The seminar provoked lively exchanges and informed insight into what it takes to be an effective NED and offered valuable tips on handling delicate boardroom situations.

What makes a good NED?

One delegate who has a wealth of experience as a NED on the boards of a number of life sciences companies, offered a wry comment on the ideal mix of personalities. “You need one dreamer, one business man, and one son-of-a-bitch,” he said.

His comment deftly identified the critical issue of making sure that the NED selection process focuses on what stage a company has reached and what particular skills and contacts its board needs to attain the next level of achievement.

Another delegate from the banking community stressed that NEDs are not appointed to run a company but to focus on strategic issues.

An ability to be alternately understanding and tough with management is a prerequisite, she said. “One day you’re cuddling them and the next you’re gripping them warmly by the throat,” she joked. She summed up the essential characteristics of an NED (both from an investor and entrepreneur standpoint) as a good listener who can be supportive and also challenging. She added that persistence is needed to probe to the heart of an issue as well as skills as a team player to ensure a management team is not over shadowed - a real fear for bright but inexperienced teams.

A measure of bravery is needed both inside and outside the confines of the boardroom and contrary to some misconceptions, the role of an NED is not for the faint-hearted. “My plea is to be brave. Running out of money is most stressful and that can happen for a young company,” said a delegate.

The right NED at the right time

There is no one-size-fits-all solution when it comes to becoming an effective NED or conversely appointing the right one. The variants include personal dynamics; maturity of a company; whether it is likely to list on public markets; geographic or sectoral strategy; and also issues such as expectations on remuneration or length of service.

Boards tend to be small when a company is at an early stage, with perhaps just one or two NEDS, but as it matures and focuses more intently on exit strategy, the composition of a board should reflect that.

For example, if a trade sale is the identified strategy, an NED who can make vital introductions to potential purchasers or partners within a sector can be invaluable, the seminar heard.

However, if a company plans an Initial Public Offering (IPO), its advisers and shareholders are more likely to push for the appointment of NEDs with City credentials and listed company experience.

Good personal chemistry is just as vital as strategic concerns. Experienced NEDs advise prospective NEDs to ask themselves searching questions before taking on a directorship. These should include whether they can get on with the Chief Executive and other board members as well as their view on shareholders and the company’s growth prospects.

The reality of working with young companies is that it can be stressful, demanding and time-consuming so finding a person temperamentally suited to this kind of work is also important.

The role of an NED chairman in particular is viewed primarily as a mentoring role, supporting and encouraging the chief executive. It is a critical relationship to get right if a board is to function effectively. However, an NED chairman must also retain his or her independent stance and be strong-minded enough to take action should a chief executive fail to deliver.

There was lively debate over whether NEDs (regardless of whether they are company chairmen) are truly capable of being agents of change in a company when the going gets tough. It is an issue which perturbs investors and entrepreneurs alike.

Agents for change?

“If you are there initially as a strong supporter of the CEO how do you make change happen when you need it? How do you hit the change lever? “ asked one delegate.

One NED on the boards of five companies, offered the following advice: “Do it with confidence and after having given the CEO every opportunity to succeed.”

He added: “When you’ve got to cut, do it quickly, legally and courteously.”

Getting the balance right between being a shoulder to lean on, a sounding board, and an agent for change is tricky.

“I say to companies,’I am the grit in your oyster which allows the pearl to form.’ If you’re not the grit you shouldn’t be there,” said one delegate.

A delegate with many years experience as an NED on the board of growing technology companies said it is vital to have a robust recruitment process when it comes to NED appointments. Relying on informal networks can limit a company’s options.

There was some disquiet expressed over the practice of appointing observers to a board rather than NEDs, with several delegates expressing a view that even without voting rights they can end up as ‘shadow directors.’ This status carries the same level of accountability as bona fide directors.

Another topic raised was whether venture capital investors should have a presence on the board in their own right, or, if they appoint an independent NED, whether that person can be regarded as truly independent.

SEP has the right to appoint an NED on portfolio companies and often appoints suitably qualified external candidates, but its own investment team also undertake the role in cases where they believe it is the best way to add value.

‘Skin in the game’

Remuneration and reward provoked lively debate, with several delegates unhappy over UK tax treatment of share options, limiting the attractiveness of options packages as performance incentives.

The issue of whether NEDs ought to hold shares in a company also polarised views.

One delegate commented: “There is an argument for an NED to have some ‘skin in the game’.”

Young companies are less able to offer hefty cash rewards, so use options as a more affordable option in the short term. Debate centred on whether having shares in a company meant having aligned goals or whether it might result in conflicts of interest. There was also a suggestion that NED pay should be performance-linked, with regular appraisals and benchmarking against company milestones.

Length of tenure and the number of NED positions a single director should hold are also key issues.

In terms of longevity, there was consensus that the first couple of years are a learning curve for an NED and that their contribution becomes more valuable thereafter.

The issue of when an NED should be considered to have passed his or her shelf life is also pertinent and the answer depends largely on circumstances.

One experienced NED and company chairman suggested: “When they stop making a difference it’s time to go. I think it should be reviewed at three years.”

As for plurality of positions, it was suggested that it was difficult to add value once a NED’s portfolio exceeds more than half a dozen directorships. From a company perspective, entrepreneurs need to ensure they are getting their fair share of attention while NEDs need to ensure they are not over-stretched.

Training is important to maintain high performance standards, whether it be formal professional development or sharing of best practice.

The characteristics of NEDs are necessarily as varied as the companies they serve but no matter how complex a company’s business, they must share the common denominators of integrity and an independent spirit to fulfil their important role.