In a business run by its owner, the board is often a formality. There may be one, because the company's documents require it, but it consists of the owner, perhaps a spouse, perhaps the company's accountant, and it meets when a signature is needed. The owner decides, and the board records the decision afterwards, if at all. For most decisions this does no harm. For distributions it creates a problem a yield buyer sees at once: when the person who decides the payout is the person who receives it, nobody can tell a distribution from a withdrawal.
Board Governance solves it by putting each distribution in the hands of a board that includes an independent member and records its tests, so that the payout becomes a governed decision.
Where Board Governance sits
Three drivers turn a payout into a promise. This essay covers the second.
FCFE less reserves
- Distribution PolicyTurns the payout into a ratio sized to a stress case, with cut and restore rules written in advance
- Board GovernanceThis essayPuts each distribution before a board with an independent member, with its four tests attached
- Distribution MechanicsMakes each payout lawful, correctly allocated and tax-complete under an owners' agreement
Declared distributions
A member who is not the payee
The board needs at least one member with no family, employment or commercial tie to the owners, who has served long enough to have a record, and a charter that reserves the distribution decision to the board.
The independent member is recruited against a written brief: finance or operating experience in a comparable business, a fixed term, a fee, and indemnity cover. The brief exists because the usual mistake is to appoint someone convenient. The company's long-standing accountant, a trusted supplier, a retired employee or a family friend may each be an excellent adviser, but each has a tie to the owners that a buyer will notice, and the seat exists for someone who has none.
Independent, or not?
Illustrative candidates for the independent seat. The test is no family, employment or commercial tie to the owners. Guess which pass, then select each to see why.
Select each item to see the verdict.
A commercial tie: the firm is paid by the business, and a buyer will see a reviewer reviewing its own client.
The right experience and no tie to the owners. This is the profile the written brief describes.
A family tie, however capable he is.
A commercial tie, and a conflict: the supplier benefits from the business's spending decisions.
An employment tie, and likely still a personal loyalty to the owner who employed them.
No tie to the owners, and experience of exactly the governance a yield buyer expects.
The board then adopts a charter. It lists the matters reserved to the board, among them distributions, the policies, the budget and senior appointments, and it sets a quorum that requires the independent member for any vote on a distribution. If the independent member is absent, no distribution can be declared.
Length of service matters as well. An independent member appointed shortly before a sale is decoration. One who has sat through a long run of distribution votes, including at least one bad quarter, has a record, and their name in the minutes counts as evidence. That is what lets a buyer expect the policy to hold: its guardian is not the person it constrains.
Minutes with the tests attached
Every distribution in the history should be approved in minutes that attach four tests and record any dissent. The tests are the reserve test, the capital spending test, the covenant compliance check and the solvency test.
Before each meeting a distribution pack goes to the board, holding the worksheet from the distribution policy and the four tests, sent early enough that the independent member can read it, ask questions and arrive with a view. The minute book is kept in one place and in order from the adoption of the policy, each pack attached to the minutes that approved it.
Is this a governed distribution?
The checks a buyer's counsel makes on each distribution in the minute book, in order. The first that fails means the distribution cannot be told from a withdrawal.
Over time the minute book becomes the most persuasive document in the file. A buyer's counsel opens it at random, finds a distribution, and sees the worksheet, the four tests and the vote, prepared days ahead and signed by a person with no stake in the outcome. Seen quarter after quarter for years, that is proof the payout is governed, and the buyer no longer has to guess whether the next one will be.
A report to the owners
Each quarter the owners receive a report showing cash available for distribution, trailing coverage, reserve balances against the rule and capital spending against the floor, in the same format every time.
The format is fixed once: one page, the same lines every quarter, prepared by the finance lead from the monthly package. It serves two readers. Owners, particularly those who do not work in the business, see the yield they own the way a buyer will see it, which is not how it looks as a figure arriving in a bank account. A buyer gets years of it in one format, a history it can read in an afternoon.
What independence is for
Owners sometimes read this driver as an imposition, a stranger placed in the room to second-guess them. The role is much narrower than that.
The independent member does not set the policy; the board adopted it, and the owners appoint the board. Nor do they decide the business's strategy. At each distribution vote they check that the payout complies with the policy the owners themselves adopted, and they say so in the minutes. Their only power is to say that the policy is not being followed.
That protects the owners too. In a family business with several owners, some working in it and some not, the independent member can tell a family member that a request for a special distribution does not fit the policy without it turning into a family argument. When an owner is under pressure, they can say that a payout should wait for the reserve to refill. Many owners who appoint an independent member reluctantly find that the seat shields them from requests they would have found hard to refuse.
What it does to value
Board Governance ranks fourth on the bridge. Its value is the reduction in the probability of a governance failure, such as a distribution made outside the policy, a payout cut because a reserve was raided, or a dispute among owners about what was paid, multiplied by what that failure would cost a holder, and discounted.
It also changes who can bid, which the framework does not count as value. Many institutional yield buyers will not buy into a business whose distributions are not governed by a board with an independent member, so governance is what lets them bid at all. The change in who bids, and any narrowing of the buyer-pool component of the discount that comes with it, is price.
The chair is paid for the driver: in full when every distribution was approved with all four tests and every scheduled meeting was held with the independent member present, and nothing when any approval lacked a test.
What has to be in place first
Counsel must first confirm that the owners' agreement allows a board with an independent member and the reserved matters, or amend it until it does. The independent member's fee and indemnity cover need a budget agreed before the search starts. And the board needs the distribution worksheet from Distribution Policy, because what it approves is a computation; without one, the vote is on a number with no basis.
Knowing that it works
The driver is tracked by the share of distributions paid that were approved with all four tests attached, which should be all of them; by board meetings held on the calendar with the independent member present; and by the time between the pack and the vote, which should leave the independent member room to read and question it.
The owner can be tested twice. Once, on purpose, arrange a vote in which the independent member argues against a distribution, and record afterwards whether the policy or the owner decided the outcome. And open the minute book at random and find a distribution and its four tests without help.
Why it slips, and what holds it
Two things wear the driver down. The independent director leaves and is not replaced, and the board drifts back to being the owners. Or owner or family pressure goes around the board, as a quiet request to the finance lead for cash that is handled as a favour.
The charter answers the first with a named process for filling the independent seat within a set period, and distributions pause if the seat is still empty when that period ends. The second is answered by a rule that owners' requests go to the board and not to the finance lead, so any request for cash outside the policy is minuted and decided against the policy.