Corporate governance, and what it really is
“Every action can be ultimately measured by its utility”. Popular management styles, like “lean”, do not bring benefits just because they exist, but because they lead to value increase for the internal and external recipient. Author of the opening statement – philosopher Carl Menger, was most definitely right. So you got to hustle – but always hustle smart. That’s why you will find 5 basic lessons to remember, which you can find at the bottom of this article!
However, let’s narrow our focus – onto the utility inside the organization. A solid foundation for any activity in an organization, even a rapidly scaling one, is good corporate governance. As far as definitions, there are many. But in the broadest sense, corporate governance is a set of rules, which are especially important to decision-makers. Corporate Governance refers to the way a corporation is governed. Basically, all companies have some form of it – although in small and mid-size companies often it is a bit of a free-for-all.
Doing business is always risky, and that risk can be mitigated through size. Larger organizations with their scale and assets can weather storms that little companies cannot. Therefore, it is even more important for small and mid-size companies to diversify the risk factors in areas unrelated directly to the anticipated return on investment.
We are going to focus on several contributors/elements to corporate governance:
- Legal and organizational factors
- Decision making
- and Processes
Legal and organizational factors
Factor 1: Partners (shareholders) structure
How exactly the organization is owned is an important topic – especially since many founders quickly offer shares to early co-workers or to outside investors.
This is often done with the best intentions and prognosis of some gains for the organization. Despite this, there are some risks and unintended consequences. An underappreciated problem can be the atomization of ownership. In the long run, it can strip a company of a key early asset of startups with consolidated ownership – flexibility.
Let’s remember, that:
- Paying out a dividend,
- Paying out an advance on a dividend (often a form of compensation),
- Acknowledgment of fulfillment of duties by members of the board,
- Approval of the financial statements,
- or approving certain investments,
all may legally require a resolution by the shareholders. Aside from the burdensome procedural requirements, all it takes to sidetrack such resolutions is a conflict between associates. Consequences may vary from purely business difficulties, up to termination the organization by a court!
Factor 2: Board composition
Who is on the board is very important as well. It is key that resolutions are passed in with all the right signatories, which is defined in the articles of association. Even if the representation of the board is one person, some documents need broader approval. For example, the management activity reporting to be approved by the associates is always a report by all members of the board, so all of them need to know and accept the contents.
Making business decisions
Any board and every shareholder has stuff to do. However, in some areas duties are specified, limited and determined by law or internal order (e. g. Sub-delegation of responsibilities or work to do).
Business decisions must be taken by the right group of people. The responsibility for the decisions needs to be addressed and understood so that future actions have an owner and are executed properly. This is harder to achieve if there is no harmony in the organization – where many stakeholders care deeply about their own areas and compete for resources.
Large organizations frequently have a very formalized process of making key decisions. For example, they ground their activities in a yearly budget, which is a compromise by the whole management. Next, such a document undergoes an approval process by leaders responsible for all the different organizational areas, is reviewed by the board and sometimes, to the supervisory board.
Too small to fail
For smaller organizations, extensive, multi-step processes may be overkill! Still, many startups that are undergoing a transformation and scaling up, struggle with establishing good norms of decision making
Along the path of scaling up, there comes a point where CEOs or the board loses the whole picture. To fully process, analyze and predict the full scope of most possible outcomes and their consequences is taxing at first, and later impossible. Well paid managerial positions very often come with working in a high-risk environment, after all. Some risks are unnecessary, though, and should be eliminated from the picture! Through a more cross-sectional outlook, which analyzes the organization as a living, connected organism.
To use a metaphor, having three patients next to each other, they all may seem separately sick. Only when looking from a perspective, you may see that three grave illnesses may still require prioritization and should be put in a hierarchy. Good practices in regard to business decision making that entail looking at the bigger context allow diversifying the risk of bad choices. And this is where the early management norms and practices, created frequently at the startup level of a company, may fail. Outgrowing them and forcing the management to be more strategic can become a source of competitive advantage.
An illustrative list of practices that can help you get the big picture:
- Calculate the financial impact of costs one department generates for any others. Then, make sure all your organization’s members play along,
- Think, who is the first to be impacted by the changes you implement – for example – general growth of costs obligates sales department to increase results,
- Imagine, how much focus on one area reduces the focus on other fields. For example – if your marketing team focuses on one product or area more, the rest of your product lineup might have problems in the long run.
Corporate governance is also about processes – enabled by the right technical solutions, like automation. While a blog post may not be enough to cover the topic, let’s jump into the crucial areas anyway to get some awareness. Processes (also technology-enabled) are extremely important, as they permit granular authorization to perform important activities. Not only that – but also keep those activities within the law, the mission, vision and business model of the organization. An accessible example could be for example issuing invoices!
When a reputable outside auditor enters a company, before opening the accounting books, they analyze the completeness and efficiency of processes and internal controls. Such analysis gives you insights into the areas, where the substantial risk of an unintended (accidental) or intended (embezzlement) screw-up. Depending on the risk level, a minimum dataset that enables proper control over the financial statements is codified.
Illustrative effects of lack of control or incomplete processes:
- Ineffectual process of invoice issuing and can lead to incomplete income and have a significant impact on final results,
- Inadequate process of payments’ implementation and acceptance can lead to fraud or cash flow difficulties,
- Ineffectual process of sales can lead to lawsuits – e.g. lost because of formal deficiencies.
Fortunately for most small organizations, the criteria for when a company falls under more rigorous audit requirements are pretty high. Many of them would have real trouble with the risks inherent in their current management model. This is a direct effect of keeping management practices alive when the organization has long outgrown them. What worked for a couple of friends at the outset of their startup journey can be painfully inadequate for even a 15-strong team. Often, this is first noticed in the area of expenditure accepting and invoicing.
There are several easy to do procedures that you can adopt, that will ensure a most basic level of accountability and certainty to the processes.
- Create a structure of information sharing (who needs to know exactly what at which point in the process)
- Create a detailed process of documentation flow (which documents go to which person, what happens to them and where they go next)
- Institute a “double-check” or “4 eyes” procedure (ensuring that most important documents are not sent without additional oversight. One person is responsible for the input of data, another is responsible for data review)
EXAMPLE – Payments
Modern banking systems allow detailed permission systems, with different roles given to different employees. A “double-check” system protects the organization from hasty decisions and ensures that consultation must be done beforehand. In smaller organizations, where co-owners may use the company assets for private purposes as well, this can be crucial in avoiding conflict, too. Mistake-ridden invoices can in the long term be a cause for the tax authorities audit, where irregularities may doom the organization or at least sap its ability to generate profit.
In conclusion – what to remember about corporate governance?
The above-chosen examples are only the tip of the iceberg. Corporate governance is a broad subject, and different organizations face quite different challenges. It touches on processes, organizational culture, oversight, and auditing. Good governance practices immunize organizations from many ills – from legal trouble, organizational chaos, managerial and employee misconduct and many more. While many will inevitably prefer the old ways – the less organized, unprocessed way of running a business – big ships turn slower, so they need to look further ahead. After all, changing course is still easier than rescuing a ship that is stranded in the shallows.
PS. I invite you to read two fantastic interviews we did recently with two knowledgeable individuals – Hung Lee and Zuzanna Przybyła. With Hung, our Dawid asks him about the state of recruiting industry, and Zuzanna tells us all about preparing your company to the challenge of remote teams!