employees sitting in a board meeting
Establishing a board of directors allows business owners and executives to manage the day-to-day operations while the board governs company policies. — Getty Images/FangXiaNuo

A board of directors governs an organization. Its authority and responsibility are determined by government regulations and the bylaws of the corporation.

LegalZoom advises that, for the most part, incorporated businesses are required to establish a board of directors, but there are some states that permit a company to have shareholders fill the role instead. However, even a sole proprietorship or LLC may benefit from the guidance and accountability a board can provide.

While some requirements vary by state, such as the number of directors, consistent across all is that directors must be elected by shareholders and the board must hold an annual meeting and document meeting discussions and actions. Understanding the purpose, structure and challenges of a board can help you decide if your business needs one, and, if so, establish one in a way that advances your business.

The purpose of a board of directors

Whether legally required or not, companies establish a board of directors to help steer the business, fill experience and knowledge gaps, and strengthen investor confidence. A board is ideally comprised of experienced professionals with a variety of personalities to enable it to govern with wisdom.

[Read: Getting Ready to Launch? How to Choose the Right Business Structure]

The board bears legal responsibility and makes high-level financial decisions for the company while the officers — such as the CEO, CFO, president and vice president — manage day-to-day operations.

Some responsibilities of the board include:

  • Governing the company.
  • Setting corporate policy.
  • Appointing company officers.
  • Setting executive salaries.
  • Answering to shareholders.
  • Overseeing finances, financial reports and audits.

Corporate governance establishes how the business is run. Governance includes processes, policies and rules for managing the company while ensuring that it’s trustworthy and attends to the wellbeing of all parties. Some governance is mandated by laws and regulations, while other components are more subjective regarding roles and interactions of shareholders, directors and officers.

BizFluent explains that because the U.S. doesn’t have a national corporate governance code to hold companies accountable to, and too much governance can be seen as an impediment to growth, some of the ideals of corporate governance may be difficult to uphold in the realities of day-to-day business.

Whether legally required or not, companies establish a board of directors to help steer the business, fill experience and knowledge gaps, and strengthen investor confidence.

How to choose your board of directors

The way in which you build your board has a big impact on its success. Some rule-of-thumb tips when building a board are:

  • Small companies should not exceed seven directors on their board. The Balance suggested this is to ensure there are enough directors so there’s still a quorum when a few cannot attend a meeting but not so many that decision-making gets bogged down. Also, electing an uneven number of directors helps prevent ties when voting.
  • Identify directors who can fill knowledge and experience gaps. Forbes suggested identifying candidates who have board experience, bring new perspectives and challenge you. There are different views on choosing people with direct industry experience, but you may want to consider directors with networks that could benefit your company.
  • Consider including executive officers. For small companies, executive officers, e.g. the CEO and CFO, likely serve on the board. The Sarbanes-Oxley law sets requirements for the number of directors not affiliated with your company and those who must have specific financial knowledge.

Assignment of board positions depend upon the board’s size. The chairperson is the highest rank and is in charge of facilitating meetings and ensuring the board performs its duties. The vice chair runs meetings in the chair’s absence and is likely the next chair. In small companies, secretary and treasurer roles are often combined and have legal and financial responsibilities. Other directors may chair committees and all can vote, bring motions and receive updates.

Potential challenges to having a board of directors

While there are benefits to establishing a board, it also can create challenges. Some include:

  • Conflicts of interest: Board participation should not personally benefit a director, such as giving their company access to bids or being influenced in their voting by a personal relationship with a company employee, etc. You can mitigate this by having your attorney draft a strong Conflict of Interest policy outlining procedures to address conflicts of interest. This should be signed by all board members. Additionally, members should disclose potential conflicts before joining the board and can be kept from voting on related motions. Require yearly discussion of any new potential conflicts and re-signing of the policy statement by all directors.
  • Relational strife: While a board may provide shareholders a sense of security, company founders can struggle with the loss of control and potential to be removed from their positions. To lead the company successfully, there must be healthy relationships between all parties and a balance between shareholder and stakeholder interests.
  • Expense: While you may be unable to pay directors the same salary as a large corporation would, it’s common for directors who aren’t affiliated with the company to be reimbursed for board-related expenses and receive stock options. You may also need to purchase liability insurance to protect directors as they can be held personally liable for company actions.

If you plan wisely to avoid the challenges and seek out the right directors, a board can drive growth and profit. If you’re not incorporating but want the benefits of a board of directors without the restrictions, you can set up an advisory board. That could be all you need, or it may be a starting place while you assess the benefits of establishing a board of directors.

[Read: Do You Need a Board of Directors? Here’s How You’ll Know]

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