From the February 14, 2003 print edition

Private lessons

Experts: Sarbanes-Oxley's impact to go beyond public companies

Tom Witkowski    Journal Staff




Bard Salmon knows all too well that a strong leader is not always a good thing. He once worked at a company with a weak board and a strong chairman - a chairman who did not take outside input well.


"It was too oriented to views of one individual. I learned from that how having complete control can be unhealthy," says Salmon, who today is the CEO and chairman of Realitywave Inc. of Cambridge.


When Salmon established Realitywave, a strong board was an early priority. The board was organized to have three inside and three outside directors.


It's akin to any one of the case studies of best practices for board governance that have made their way to the forefront in light of corporate shenanigans that have brought down the likes of Enron and WorldCom, but with one difference: Realitywave is a private company.


The recently passed Sarbanes-Oxley Act of 2002 has a far-reaching say on how public companies must conduct themselves, but the federal law says nothing about how privately held companies should be organized and governed. Even so, many experts agree that in the current corporate environment, private companies will likely be paying as close attention to ethics and governance as their public counterparts.


Companies that don't take governance seriously could be viewed as less attractive candidates for merger or acquisition, or may see a delay in the time it takes them to stage a public offering, experts say. In other cases, shoddy governance standards could harm a business in terms of the talent it attracts or how seriously the company is viewed by vendors and customers.


"When you raise money, people want to make sure that things are handled honestly, fairly, objectively," says Salmon, who has raised $4.4 million in angel funding for his company, which makes technology that streams large models over the Internet.


Venture-funded companies with clear exit strategies are the most likely private companies to be aware of governance issues. But a board of advisers, a board of directors, outside auditors and codes of ethics have a place in many types of private companies, even in the family business.


"When you're working at a company day in and day out, quite frankly, you lose perspective. You lose sight of how things might be at a higher level," says Salmon.


At the very least, more private companies will be setting codes of ethics, says Tom Leonard, managing director of the Boston office of Huron Consulting Group LLC, a firm specializing in forensic accounting and litigation support.


Sarbanes-Oxley will have a trickle-down effect, he says. "It sets the de facto standards for all companies."


And experts say that while private companies may be spared the specter of comparable legislation, they are likely to face more exacting expectations from a vigilant set of critics: customers, vendors, creditors and employees.


Following standards is the easiest way for an entrepreneur or investor to stay out of trouble, says Tom Black, president of Easton Investment Co. of Waltham, which invests in private companies.


"There's a certain discipline and structural framework, if you will, that sooner or later companies need to adapt to if they are going to grow to the size where these companies are going to go public or be acquired by public companies," says Black.


But even if the owner's exit strategy is to retire and pass the business on to children, good corporate governance can ease that transition, says LARRY STYBEL AND MARYANNE PEABODY OF STYBEL PEABODY LINCOLNSHIRE, a Boston-based management consultancy.


For smaller private companies though, especially family-owned ones, there are obstacles to adhering to such rules. The first is cost.


"When you are bringing in a board member, you're bringing in someone for the long term. Typically you can't pay somebody equity, so you have to pay them a meeting fee. That goes down on the budget," Stybel says.


A second cost issue is insurance to protect directors and officers from financial liability in the event of lawsuits, Stybel says.
An even stickier issue in family business, he says, is power.

"There's always the concern, 'I have a board of directors and they could take control from me,' " Stybel says. The legal side of that is more clearly settled than the psychological, he says.


"If I have a board of directors and it becomes clear I'm not taking their advice, the board of directors should resign. And if all my outside board of directors resign, that's going to get out into the community and my competition will use that against me," Stybel says. For these reasons, he counsels some companies to set up boards of advisers that don't have legal and financial ties to the business, he says.


A small family business may not even need to go that far, says Gerald Kehoe, a partner at Bingham McCutchen LLP of Boston.


"What I don't see them focusing on yet, and they may never, are the more pure corporate governance issues ... things like the independence of directors, whether you have a majority of independent directors, whether you have an audit committee made up of financial experts," Kehoe says.


"I can think of examples of companies that are quite large that have no one other than family members on the board," he says. "I know of examples of where there are family members and there are a handful of independent directors on the board. If the family doesn't think they're making a contribution or thinks they're making a negative contribution, they can be removed."


The first step for most companies is a code of ethics, and then, if the company is large enough and successful enough, hiring an outside auditor, Salmon says. Small-business owners also need to give potential employees clear offer letters, use noncompete agreements and have written contracts with customers, he says.


"It's nice to do things with a handshake, but you don't do that except in northern Nebraska," says Salmon.


Private companies with a possible public market future need to be concerned about the same things public companies are, experts say. Entrepreneurs busy with technology development and raising seed money also need to be thinking about a corporate structure, experts say.


"It's not that they don't want to do it, it's just that a little company with a few employees has a pretty full boat. They're first job is the product and get some sales coming in the door," Easton Investment's Black says. "We try to broaden their thinking a little bit."



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