Capability Creates Governance

The owners of an international energy investment company believed they had established good corporate governance. Based in Japan and accustomed to American regulatory expectations, they treated board meetings seriously. Each project was held through a separate company, meetings were formally convened, decisions were recorded, and the minutes were prepared to a standard intended to support the requirements that might eventually be expected of a publicly accountable business.

The structure looked convincing. The records were orderly. Yet one of the group’s operating companies in Vietnam received US$4 million of working capital intended to support two years of activity and spent the entire amount within seven months.

The exhaustion of the funding came as a shock to the investors. During those seven months, the board had never conducted a meaningful review of the chief executive’s performance against the approved business plan. It had not tested whether expenditure remained consistent with the assumptions on which the investment had been made, whether the original plan was still achievable, or whether management intervention was required. The company had held board meetings, but the board had not exercised oversight.

The failure revealed a distinction that is often missed in entrepreneurial and privately owned businesses. Governance is sometimes understood as the visible machinery surrounding a company: boards, meetings, minutes, policies and formally recorded decisions. Those things matter, although they do not in themselves ensure that anyone understands what is happening, challenges management, follows decisions through or intervenes when performance begins to depart from plan.

The energy company had the form of governance without the management capabilities needed to make governance effective.

Creating visibility before creating structures

A solar energy developer in HCM faced a different challenge. The company developed projects, managed construction and maintenance, operated completed systems, billed consumers and distributed returns to investors. Its activities crossed an operating business and a portfolio of separate investment companies, creating a need for transparency across procurement, contracts, project delivery, cash and investor obligations.

The first improvements were practical rather than constitutional. Procurement processes were redesigned so that sourcing decisions became more visible and could be examined. Contract signing was subject to stronger review and vetting, reducing the risk that commitments could be made without sufficient understanding of their financial or operational consequences.

Weekly management meetings were introduced with agendas, minutes and action plans. These meetings gave the chief executive a regular view of whether agreed decisions were being implemented. They also created a forum in which priorities could be communicated to the management team and translated into specific responsibilities. Strategy began to move beyond the chief executive’s intentions and into the activities of the people expected to deliver it.

Monthly financial reporting was established for both the trading company and the individual investment companies. The reports were presented to the chief executive and to investors, creating a common understanding of performance rather than several competing versions of the business. Once the financial information became sufficiently reliable, cash-flow forecasts could be prepared and emerging solvency pressures could be discussed with the management team before they became immediate crises.

No single change created good governance. Transparent procurement did not do it by itself, nor did stronger contracting, regular meetings, financial reporting or cash forecasting. Their combined effect was more important. Decisions became visible, responsibilities became clearer, results could be compared with expectations, and both management and investors could see where intervention was required.

The company was developing the substance that governance depends upon.

Preparing an entrepreneurial company for its next stage

The same process can begin much earlier in the life of an entrepreneurial business, long before its founder considers establishing a formal board.

The founder of a growing manufacturing company wanted eventually to move away from daily management. Within approximately five years, he hoped to have the option of selling the business, bringing in a substantial investor or continuing to own a company that could operate with less dependence on his personal involvement. His immediate request, however, was not for corporate governance.

He wanted practical management advice.

One of the early requirements involved designing and implementing a tax structure that would support the company’s future international operations while remaining compliant with transfer-pricing requirements. This required more than obtaining tax advice. The structure had to be understood, documented and supported by operating processes capable of showing what each entity did, how value was created and how transactions between companies should be recorded.

Another project used the company’s email traffic to improve management of delivery performance. Much of the evidence explaining why orders were delayed, changed or placed at risk existed inside poorly structured correspondence. Extracting that information allowed management to identify the operational conditions affecting delivery in full and on time, rather than relying only on the explanations offered after a shipment had already been missed.

These projects gradually led into monthly financial reporting and twice-monthly cash-flow forecasting. The founder gained a clearer view of profitability, working capital, commitments and the consequences of current decisions. Management discussions could increasingly be based on shared information instead of individual recollection, personal relationships or whichever problem happened to be most urgent on a particular day.

The company had not completed a formal governance programme, and it did not need to create an advisory board in order to make substantial progress. It was building the ability to understand its own operations, comply with external requirements, identify risks, review performance and make decisions using evidence. At the same time, the founder was beginning to create the conditions in which responsibility could move away from him without the business losing direction or control.

This is the situation faced by many growing companies. Their owners may speak about selling, raising capital or stepping back, although those ambitions depend on capabilities that must be developed several years before any transaction or transition becomes realistic.

A prospective investor will want reliable accounts, clarity over tax and legal structures, visibility of operational performance, confidence in management and evidence that the company can function beyond the founder. A successor will need many of the same things. The work required to create them begins with management, not with the appointment of a board.

When formal governance becomes useful

A family-owned manufacturing company eventually went further.

The family was considering how to reduce the business’s dependence on its founder and prepare for a future transition between generations. The company had grown through entrepreneurial leadership, rapid decision-making and the founder’s close involvement across the organisation. Those strengths had created the business, although the next stage required a company whose direction, performance and risks could be understood by people beyond one dominant individual.

Over time, management and oversight were strengthened. The company developed more structured review of monthly performance, more disciplined strategic discussion and clearer arrangements for examining risk and management action. An advisory board was then established to provide independent challenge and support the family in considering the company’s future.

The advisory board was valuable because it had something meaningful to work with. It could review performance, test assumptions and consider strategic alternatives using information produced by the business. It also provided a setting in which issues that were difficult to resolve within the family or management hierarchy could be examined more objectively.

This became particularly important when a multinational company expressed interest in investing in the business. The family faced questions extending beyond valuation. It needed to consider control, strategic alignment, the expectations of a new shareholder, the future role of family members and the longer-term consequences of accepting outside capital.

The governance structure did not make the decision for the family. It improved the quality of the discussion and increased the family’s ability to evaluate the opportunity from several perspectives.

This is one possible destination for an entrepreneurial company, although it is not the only one. Many businesses can progress a considerable distance through stronger management information, clearer responsibility, better meetings, improved controls and more disciplined decision-making without establishing a formal advisory board. A board becomes useful when the company’s needs justify it and when the underlying organisation is capable of supporting it.

What the four companies reveal

The international energy company had formal board processes, yet the absence of meaningful performance review allowed US$4 million intended to last two years to disappear within seven months. The solar developer created transparency and accountability through procurement reform, contract review, management meetings, financial reporting and cash-flow forecasting. The entrepreneurial manufacturer began preparing for future investment or sale through practical projects addressing tax compliance, operational visibility, management reporting and liquidity. The family-owned manufacturer eventually added an advisory board to support succession and strategic decision-making when the company had reached a stage at which independent challenge could add value.

The structures differed because the problems differed. The underlying progression remained the same.

Reliable information allowed people to see what was happening. Regular review created the opportunity to compare performance with expectations. Clear responsibilities made it possible to hold managers accountable. Action tracking connected decisions with implementation. External reporting increased transparency to investors and other stakeholders. Independent challenge became more valuable as the quality of information and management discussion improved.

Good corporate governance therefore begins before a formal board is created. It begins when a business develops the ability to understand itself, question its assumptions, make informed decisions, carry those decisions into action and recognise when results are moving away from plan.

Boards, advisory boards and other formal structures can strengthen those qualities. They cannot replace them.

Capability creates governance