Recently I heard a major shareholder of a scale-up company challenging a NED that they would have more confidence in them if they were also a shareholder.
“I don’t trust you as a NED if you are not a shareholder.”
This shareholder did not question the competence or commitment of the NED but thought their interest was better aligned if all Board Members were also shareholders.
Has this shareholder got a valid point? Should all board members, including NEDs, of SME Boards be also shareholders?
Well, from my experience and talking to other Chairs and NEDs I would answer this question with: it depends. I’m typically a big supporter of all Board Members being fully aligned, including having “skin in the game” as shareholders. However, I’ve experienced that the same approach does not apply to all companies. It depends on the stage, shareholder composition, as well as the strategic direction of the business. A VC-backed company aiming for an exit has a different board perspective from a family business looking at the long-term sustainable growth and survival of the business.
Let’s look at some of the pros and cons of having all board members, including the NEDs, as shareholders.
Pros
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- Aligned interests and long-term focus. The alignment of financial interests ensures that directors have intrinsic motivation for the company to succeed. Shareholding directors are likely to have a long-term perspective, which is crucial for the growth and stability of SMEs.
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- Increased commitment and motivated decision-making. Their personal investment drives directors to make prudent and careful decisions that benefit the company.
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- Enhanced credibility and increased market confidence. Shareholding can increase trust with investors and stakeholders knowing that the directors have their own capital at risk.
Cons
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- Conflict of interest. The risk of self-serving decisions, as shareholder-directors may make decisions that benefit themselves over the company or other shareholders.
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- Reduced objectivity. The challenge of maintaining objectivity is heightened in small companies where personal relationships and financial stakes are closely intertwined. Furthermore, personal investments can lead to decisions driven by emotion rather than rational analysis.
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- Governance Issues. The concentration of ownership and power in the hands of a few individuals can lead to governance challenges and potential abuses of power. In family-owned businesses shareholder-directors are often family members, adding another layer of complexity to the governance dynamics. In essence, where relationships are more personal, perceived favouritism or power imbalances can cause significant tensions and affect teamwork.
Balancing these pros and cons requires careful consideration of the specific context of the company and its governance structure. Effective measures, such as clear conflict-of-interest policies and transparent decision-making processes, can help mitigate some of the potential downsides.
The question of whether all NEDs of SME boards should be shareholders is complex and context-dependent. While aligning the financial interests of NEDs with those of the company and its shareholders can foster increased commitment and enhanced credibility, it also carries risks such as potential conflicts of interest and reduced objectivity.
Ultimately, the decision should be based on the specific circumstances of the company, including its stage of development, shareholder composition, and strategic goals. For some companies, particularly those with a clear exit strategy or those seeking to boost investor confidence, having NEDs as shareholders may be beneficial. For others, especially those prioritising long-term sustainability and balanced decision-making, maintaining a degree of separation between board roles and shareholding might be preferable.
As with many governance issues, there is no one-size-fits-all solution. Companies must carefully weigh the pros and cons, considering their unique context, to determine the best approach for their board structure. By doing so, they can ensure that their governance practices support their overall mission and objectives, fostering growth and stability in the long run.