Note: This article is part of an ongoing series on Board Directors. To learn more about their roles and responsibilities, download this free eBook today Director's Guidebook: How to be an Effective Board Director in Early Stage Companies or purchase our books at Amazon.com.
One of the key areas in which Board Directors help to protect shareholders is by adequately overseeing the company’s financial affairs. This can be detail-oriented work, but the oversight is critical. The key to establishing sufficient oversight, and managing risk, is ensuring that the company has an adequate set of financial controls at each stage of its development.
Attributes of Great Financial Controls:
- Appropriate for the Stage – good controls are ratcheted up over time
- Process-Based – proper controls baked into the systems and processes of the company
- Transparent – regular reporting through management dashboard
- Proper Oversight – Audit committee responsible for ensuring adequate skills and resources
Attributes of Poor Financial Controls:
- Excessive – burdensome and unhelpful for the stage of growth
- Informal – Not well documented, or based on established routine
- Poor Oversight – Under-staffed, under-skilled, or not adequately reviewed
One very important step is to ensure that the company keeps current in its payroll and taxes (all forms of tax, including payroll tax), or the liability for unpaid amounts can come back to directors. (In a business failure situation, these taxes must be paid before the company’s funds are fully depleted.) An Audit Committee consisting of one or more members with accounting and finance knowledge and a good working relationship with the company’s accounting/financial advisors is very important for well-run companies. Ideally it will be established at the first board meeting. Here is an overview of controls which might be appropriate at different stages of company development.
Basic Controls for Seed R&D Stage: Controls and approval thresholds around contracting, purchasing and disbursements, payroll, treasury management, any fixed assets, and stock administration. An awareness of fraud risks (smaller companies typically have fewer people making segregation of key financial duties more challenging to achieve) and an understanding of the company’s key financial processes, monitored appropriately, layered on top of the Board’s review of financial metrics, should normally cover the typical risks.
Controls for Early Commercializing Stage through Growth Stage: Previous controls, plus, establishment of an Audit Committee (may consist of one member at first), critical accounting policies, including a policy on revenue recognition, regular review of accounting staffing for adequacy and competence, a collections policy and write-off thresholds, fraud controls, and understood methods for forecasting and factoring of the sales pipeline. Establishment of key financial metrics is helpful at this stage if not already in place.
Controls for Pre-Exit Companies: Previous controls, plus a significant effort toward better documentation of internal controls, organization of information for presentation (possibly in a data room if a deal is possible within months), and the beginnings of a lightweight set of Sarbanes Oxley type controls and disclosure controls. While this level of control may not be essential, fluency with the concepts will be critical in getting through a successful due diligence process with a large buyer at anything other than a fire-sale valuation.
Special Controls for Struggling Companies: If a Company is approaching financial crisis, special spending controls and additional board process may be appropriate. In insolvency situations, directors owe duties to creditors and should proceed with caution. Read about Legal Duties for more detail.
Keeping it All in Perspective and Bringing it Back to Value-Add: While it is important to understand your legal and fiduciary duties and the importance of basic controls, it is not in the shareholders’ interest to allow them to overtake the entire board process and drive the board into habits of fiddling with policies, focusing on compliance activities, or focusing on past operational or financial performance. Although these are important tasks, they can easily grow to dominate all of the board’s time and leave little room for adding real business value to the company as set out in this Series. Remember, thriving companies are much less likely to give rise to liability than failing ones, so try to keep the board’s focus balanced on both controls/governance and driving the business to succeed. Form committees to dig into policies and compliance and report back to the board on a regular basis, but don’t allow the routine and tactical to overtake the important and strategic.
- A good and appropriate set of controls will drive proper financial oversight
- Well-designed management dashboard makes regular review easy
- Controls should be reviewed and adjusted for adequacy regularly
Want to learn more about the roles and responsibilities of Directors? Download this free eBook today Director's Guidebook: How to be an Effective Board Director in Early Stage Companies or purchase our books at Amazon.com.