The Art of Recording Board Meeting Minutes
Small Cap

Board Composition Through An Investor’s Lens

Adam J. Epstein, Founder of Third Creek Advisors, shares his expert insights on three critical evaluations small caps should consider when creating, expanding, and strengthening board composition.

According to Activist Insight, the majority of shareholder activist campaigns in 2019 were waged against companies with market capitalizations below $2 billion, and most of those overtures involved corporate governance issues. The moral of the story for small-cap boardroom occupants is clear: the buy-side is intent upon what you are doing, and how you are doing it.

For institutional investors, the starting point in assessing governance efficacy is always composition; that is, does the board have the right people around the table to effectively oversee management. Seasoned investors have learned – often the hard way – that board composition is directly correlated to long-term shareholder value creation.

But institutional investors analyze board composition through a unique lens, so small-cap officers and directors should consider adjusting their apertures accordingly.

Objectivity. Just because a director is deemed independent, doesn’t necessarily mean that they are sufficiently objective to represent the interests of all shareholders. For example, investors place a premium on board members who lack personal or professional relationships with other officers and directors, because they are more likely to engage in rigorous, proactive, informed boardroom debate.

Litmus test. Every company has a handful of key strategic imperatives, a handful of impediments to achieving those objectives, and a handful of key customers or vertical market segments they are focused upon. If you list each of the salient goals, risks, and product/service targets down the left side of a page and then list each director’s background down the right side of the page, institutional investors gauge the degree to which the two sides match. Where material gaps exist, red flags are raised. Simply put: board members can’t adroitly oversee that which they don’t understand.

Tenure. Though there are no definitive rules in the United States about how long is too long for a director to serve on a board, institutional investors tend to analyze director tenure on a sliding scale. That is, the longer a board member has served, the more uniquely qualified they should be. The level of scrutiny rises for directors who have served on a board for more than ten years. Instructively, the United Kingdom Corporate Governance Code assumes that board members are no longer independent after serving on a board for nine years.

Companies with well-comprised boards can still end up inviting heightened investor scrutiny, if they communicate poorly in that regard.  To avoid such attention, officers and directors should treat the annual proxy as an invaluable storytelling opportunity, versus a formulaic securities filing that can be outsourced to third parties. If your company has a great board, then thoroughly explain that – in plain English – to both existing and prospective investors.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Adam J. Epstein

Adam advises the boards of pre-IPO and small-cap companies through his firm, Third Creek Advisors, LLC. He’s a mentor at the Nasdaq Entrepreneurial Center and serves on the editorial advisory board of Small-Cap Institute, Inc. Previously, he was an institutional investor, and authored “The Perfect Corporate Board” (McGraw Hill, 2012).

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