Non-execs

Word from the wise

Non-executive directors can tell small companies what they don’t want to hear. And the evidence suggests their advice adds significant value
By Matt Farquharson

One clear lesson from the global credit crunch, according to Financial Services Authority (FSA) Chief Executive Hector Sants, is that non-executive directors (NEDs) failed. In a speech given in May last year, he said they “struggled to fulfil their role of providing strong independent oversight of executive management”.

But his comments come with caveats. He was speaking solely about companies in the financial industry, the vast majority of which are publicly listed. For smaller, private equity-backed firms, the situation is a little different.

Research released in 2008 by the London Business School found that boards in private equity-backed companies are significantly more effective than those of public companies. In lengthy, structured interviews, the researchers spoke to 20 chairmen and CEOs who had served on both kinds of board. Some 15 of these 20 felt that private equity-backed boards were superior in the value they added. So, what could explain the differences?

Angela Toner is a Partner with Baker Tilly Corporate Finance. “Listed businesses need to follow The Combined Code on Corporate Governance,” she says, “which stresses that their boards are required to have independent, non-executive directors, whereas a private company can choose to have them.” A firm that voluntarily brings in an NED is perhaps more likely to be open to their suggestions.

Sticking to the strategy

Bob Stott is the former CEO of Wm Morrison, one of the largest supermarket chains in the UK. Now semi-retired, he holds a number of non-executive directorships, including seats on the board of Leeds Building Society and two sports governing bodies. Another of the companies he works with shows a good example of the difference non-execs can make. It is a food manufacturer with turnover of around £70 million, which was founded in the nineteenth century.

Its shareholders are all family members, who, says Stott, “haven’t always agreed on the best way forward.” In 2008 they brought in a non-exec chairman who, “has been instrumental in convincing the family that they are fortunate in having their current MD and management team”. But more significantly, the Chairman, supported by Stott, has changed the board’s way of working by agreeing a clear strategy and introducing an inclusive culture that sees the board “constantly cross-referencing decisions against the strategy to see if they are being consistent, rather than every decision being a one-off.”

The Institute for Family Business reckons that family companies account for 65%, or three million, of the 4.6 million private sector enterprises in the UK. Most are SMEs, with board membership often coming down to a family link rather than industry experience. It’s here that independent advice can make a real difference, and is perhaps one reason why SME non-execs are more effective.


The area where plc boards seem to outperform their private equity counterparts is in corporate governance. While NEDs with private companies only have to satisfy the board that employs them, reporting for plc NEDs is much more strict. The London Business School report found that, “given the need in public companies to protect the interests of arm’s length shareholders and to ensure accurate and equal information flow to the capital markets, governance issues such as audit, compliance, remuneration and risk management inevitably (and appropriately) loom much larger in the minds of plc boards”.

Whatever the impact, hiring non-execs is a big investment for smaller companies. Paying someone five figures a year for what might only be 20 days’ work can seem counter-intuitive. But David Clipsham, who was named 2008 NED of the Year at the North East Business Executive of the Year Awards, suggests that small companies should hire an NED, “as soon as they can afford it”.

He explains: “One of the most difficult parts of managing any business is the process of managing growth, and management needs someone to talk to who has been through that process.” And in the current climate, having the advice of someone who has been through a couple of recessions can be hugely useful and reassuring.

It’s important that firms know what to expect from their new NED. “Non-execs will attend board meetings,” says Angela Toner, “but it’s not just about that. A non-exec will be particularly useful in an SME, where their skills will help complete the board’s skill set. A lot of SME businesses are family owned, and you can’t expect a board of an SME to cover all the bases in terms of skills. Non-execs bring a fresh set of eyes, they’ll be independent, and challenging. They’re there to ensure the success of the business and that tends to come at the higher strategic level,” she says, “and often, a good non-exec will bring contacts in the same sector.”

There are questions, too, about whether the post credit crunch world will bring extra regulation for private equity NEDs, but Toner considers it unlikely, given the governance rules already in place.
“What we don’t want,” she says, “is stricter corporate governance meaning that NEDs aren’t able to do their job and add that fantastic value that they do”.

But NEDs will have expectations of the firms they come into as well, explains Clipsham. “Routine communication is important, and honesty – admitting to problems or lack of experience – makes the whole process so much easier than when it has to be dragged out of management by confrontation.”

For an SME to achieve value from a non-exec, honesty is key, even if it means some painful truths. These advisers are paid, often very well, to improve your business. Hiding information from them would be like lying to the doctor about where it hurts.