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GOVERNANCEEmbargoed until 12.30pm, ISSUES Monday 17 September 2012. IN PRIVATE Article

Embargoed until 12.30pm, Monday 17 September 2012.

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GOVERNANCE ISSUES IN PRIVATE COMPANIES Embargoed until 12.30pm, Monday 17 September 2012.

THE ASX COUNCIL CORPORATE GOVERNANCE PRINCIPLES AND RECOMMENDATIONS ARE ONLY REQUIRED TO BE FOLLOWED BY LISTED COMPANIES (ON AN ‘IF NOT, WHY NOT’ BASIS FOR THE MOST PART). NEVERTHELESS, THEY SET OUT GOVERNANCE PRACTICES AND ISSUES WHICH CAN BE VERY HELPFUL TO PRIVATE COMPANIES AND SERVE AS A BENCHMARK FOR GOOD GOVERNANCE. THE IMPORTANCE OF GOOD GOVERNANCE IS JUST AS GREAT FOR PRIVATE COMPANIES - IT IS JUST THE IMPLEMENTATION WHICH WILL USUALLY BE LESS COMPLEX.

The basic precepts of good governance are fundamental to What is the Nature of Private Companies? all organisations – having a board charter, well defined roles A private is a company that is registered and responsibilities for board members, appropriate financial as, or converts to, a under knowledge, accountability and transparency to members, the Act 2001. Directors of proprietary shareholders and stakeholders. companies have legal duties and responsibilities A survey of the regulation of corporate governance in SMEs under the Corporations Act 2001. Under that Act, highlights a number of policy conclusions (see Clarke T a proprietary company must: & Klettner A, ‘Governance Issues of SMEs’, inJournal of • be limited by shares or be an unlimited company with Systems, Governance and Ethics (2010)): a share capital

• The need for corporate governance guidelines to • have no more than 50 non-employee shareholders include flexibility, particularly for companies early • not do anything that would require disclosure to in their life cycle investors under Chapter 6D of the Act

• The need to reinforce the robustness of the ‘if not why • have at least one director who must ordinarily reside not’ approach and educate the market that disclosure, in not uniformity, is important Directors of a private company should be aware of se • The fact that corporate governance demands upon 111J of the Corporations Act 2001. That section, entitled companies develop as they increase in scale and ‘Small business guide’, summarises the main rules in the complexity with more diffuse shareholders Corporations Act 2001 that apply to proprietary companies limited by shares . • The fact that companies may carry with them problems of inadequate corporate governance and dysfunctional The main difference between private companies and boards if these are not resolved early in the company larger public companies is the lack of distinction between life cycle owners and managers. In private companies, they tend to be the same people because of the small size and lack of • The existence of a critical period in corporate governance complexity of operations. They often have a quite informal when private companies become listed entities with approach to governance. wider accountability and a corresponding need for a more Reporting and disclosure requirements for private independent board companies are lower than those for listed companies but • The importance of legal and regulatory guidance and there is still a considerable regulatory burden surrounding directorEmbargoed education for companies until preparing12.30pm, to list Mondaythe daily operations 17 ofSeptember a small business. 2012.

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Companies operating in certain industries (e.g. the part requirements for disclosure, reporting and exposure of the financial services sector regulated by the Australian to external scrutiny. Prudential Regulation Authority) are required by law to : have boards. • Relationships within many private companies are based TheEmbargoed needs of a company will until change as12.30pm, it moves into new Monday 17 September 2012. on trust with family, friends, suppliers and customers. stages of development. A start-up company’s needs are Fraud can occur and the company needs protection with quite different to a mature company’s needs. As a company with all relevant parties. There should also be grows, a stricter governance framework will be required. business continuity plans in case of crises, such as the succession planning issue referred to above. What Governance Issues Do Private Company Boards Face? When Should a Private Company Consider Simple governance issues for SMEs can include managing Creating a ? intellectual property and legal risks, e.g. registration of trademarks, contracts with employees and family members, Many private companies will start, and continue for contracts with suppliers and customers. some time, with the one director required by law. Company Director has suggested that the need for Other issues include: the addition of other directors and the formation of a Owner-related issues: board is triggered by certain events, rather than being determined by size of the company. • Owner’s lack of time. Owners often run the business and have few staff. They struggle to find the time to view the These events can include when the company: business and market from a governance standpoint. They • Is making a transition from being family-owned may lose opportunities due to a lack of time for strategic to more professional management planning • Wants to more readily raise capital. It may consider • Reluctance of owner/founder to let go. As the company listing on the ASX to achieve this grows and considers including independent directors, the owner may feel challenged when altering his or her role • Is experiencing rapid change in the organisation. It can be hard to let go of the daily • Is planning significant expansion and needs outsiders operations to become more strategic and entrepreneurial to guide it strategically • Succession planning. Many small suffer • Is dealing with generational succession issues from key person risk – the success of the business is dependent on one person. If anything happened to that person, the organisation would change significantly. All What are the Benefits of Adding businesses need a plan for dealing with an unexpected Outsiders to the Board? loss of the owner, e.g. becoming ill or dying and for the owner retiring. Refer to the Q&A on Succession Planning Adding outsiders to a small company where key players have close and well established relationships will be Limited resources: challenging. However, the opportunities this can create can • Private companies may have only a small staff, take a company forward to its next stage of development. often lacking in specialist skills and knowledge, and Independent directors appointed from outside sometimes a limited cash flow. While some may the company can: want to improve governance by adding independent directors, they may feel that they cannot afford this • Bring a fresh perspective and focus

Growth and expansion: • Identify strategic issues

• As a company grows, its needs to change. There may • Create more credibility in the market and make be a greater need for strategic skills and knowledge the company more attractive to investors than management team can provide. Small companies • Show a commitment by the company to corporate may be used to meeting compliance requirements governance and regulatory compliance (completing forms for ASIC, etc) but will need toEmbargoed become more strategic until to deal with12.30pm, greater Monday• Act as a sounding 17 boardSeptember for the CEO and management 2012.

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Of course, having independent directors on a board does a company on the type of information to make available not guarantee success but it does make it a lot easier to in order to attract a candidate to your board. focus on corporate governance issues. What should be considered when adding board members? A company Do Independent Directors Have to Be Paid? consideringEmbargoed the appointment until of new 12.30pm,board members Monday 17 September 2012. recognises that it lacks the skills, knowledge and experience When contemplating the addition of independent directors, needed to push it forward. The key step then is to identify many private companies are concerned about whether they company needs in the short and medium terms. Consider can afford to pay an appropriate amount to their directors. especially what will be happening in that time, e.g. According to the Corporations Act 2001,directors are to expansion into a new market (industry or geography), be paid the remuneration that the company determines by broadening the product or service range, etc. Potential resolution (sec 202A). Because cash flow is very important candidates should be matched against these criteria. Friends to SMEs, it may be worthwhile considering payment in and family, unless they possess this specific knowledge, will the form of shares. Corporate governance experts do not probably not be the best choice. endorse this practice but it may be the only option for smaller companies. Refer to Selecting a New Director when considering what skills, knowledge and experience will benefit your company. Sources and further reading Expect that anyone offered the opportunity of sitting on your company’s board will do their own to Clarke T & Klettner A, ‘Governance Issues of SMEs’ in evaluate the opportunity. To assist this process, it would Journal of Business Systems, Governance and Ethics (2010). be wise to supply procedural information such as what information they can expect to receive in advance of board Feedback meetings, the arrangements for remuneration and Directors’ We encourage members to provide feedback on this Q&A & Officers (D&O) Insurance, frequency of meetings, by emailing [email protected] appointment terms, board evaluation procedures as well as information on financial performance, industry trends, Updated January 2013 etc. Evaluating an organisation prior to joining will guide

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All Embargoeddetails were accurate at the until time of printing. 12.30pm, The Australian Institute Monday of Company 17 September 2012. Directors reserves the right to make changes without notice where necessary. Publication Date: February 2015 (04829-2_15)

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