Apr 01, 2014
From the Audit Committee Institute
Board Perspectives Series
Private companies are transitioning again. In 2013, the number of initial public offerings in the United States was the highest since 2000. M&A activity surged beyond post-crisis lows. Even buyouts returned.
Such an environment suggests that entrepreneurs, executive teams and directors of private companies -- from startups to mature businesses -- would benefit from assessing the current state of the company's governance structure and processes.
Such an assessment would help them ensure they are keeping pace with the company's strategy and expectations, adding real value, and preparing the company for short-term challenges and long-term opportunities.
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Key elements of a governance structure will vary depending on the size, complexity and maturity of the company -- and where it is in its life cycle. For mature private companies, the key elements of the governance structure will include strategic planning, financial reporting processes and internal controls over financial reporting, external audit, risk management, ethics and compliance, internal audit, the overall control environment and a board with independent directors.
For an entrepreneur building a private company, consider what elements of the governance structure are most important, and how the governance structure should evolve as the company matures. It is particularly helpful to consider these questions in the context of the life cycle of a company.
For example, in the pre-revenue stage, when entrepreneurs are focused on developing an idea for a new product, service or technology -- and building a business around that idea -- they often do not focus their attention on governance.
"No revenue" means that controls are typically limited to issues around disbursements and remunerations as well as accurate records of capitalization, ownership and contracts. Directors, shareholders and management are often essentially the same, though questions about corporate governance begin to arise when outside investors and capital are brought in.
As the company begins to generate revenue, it will need to adopt accounting policies, develop accounting and finance expertise, and put in place processes for financial reporting and controls. The key elements of the company's governance processes begin to take shape, and management needs to regularly assess the adequacy of the governance processes as the business matures.
What types of internal controls does the company need around financial reporting and disbursements? How does it safeguard corporate assets, and minimize the risk of money, goods and intellectual property "walking out the door"?
As the company grows and becomes more complex, it is critical that its governance processes not only "keep pace" with the business, but anticipate tomorrow's needs.
How should the company's governance policies evolve to set strategy; grow the company and enhance shareholder value; ensure management accountability and financial transparency; maintain legal and regulatory compliance; and address dealings with business partners, investors, customers, suppliers, regulators and employees?
Independent directors often play a key role at this stage and can provide a broader perspective -- in strategy setting, in supporting the CEO and in filling management gaps. Moreover, a sophisticated audit committee can play an important role in assessing and strengthening the company's governance structure and processes -- including its global financial reporting processes, the control environment and managing the external auditor relationship.
In short, as private companies grow and become increasingly complex, they often adopt many of the governance practices that are mandated for public companies -- including independent directors and key board committees.
Another important stage for many private companies is planning for an initial public offering or other public financing. In determining a company's readiness for an IPO, the company's entire governance structure and processes is a key area of focus.
In the case of the company's governance structure, early preparation is particularly important. The company will need to examine the composition of its board and board committees and its internal controls and disclosure controls with an eye to bringing them in line with the standards required of public companies, a process that may take a significant amount of time.
Also, as there is tremendous focus on risk management and compliance today, the company will need to assess and, where appropriate, strengthen these key governance processes.
Throughout the various stages of a private company's life cycle, it is important to periodically assess the company's governance structure and processes and whether they are keeping pace with the increasing complexity of the company.
How do changes in the operating environment impact governance processes? Can technology improve the effectiveness of controls? Could the company benefit from the perspectives of independent directors? And finally, does the company have the right tone at the top and culture throughout the organization?