I’m speaking at the NACD Small-Cap Forum this morning in San Antonio, TX on strategy and risk. Here is a preview.
“Small cap companies are immune-suppressed versions of their larger counterparts,” Adam Epstein observed in his 2012 book The Perfect Corporate Board. This is a big problem; 80 percent of US-listed public companies are small-cap (by definition, less than $500 million). It’s strange that so little attention is paid to the governance of these companies, when what gives a large-cap company a cold can so easily kill a small-cap.
Even a small decision can have business-ending consequences for a small-cap company. They have smaller staffs, narrow profit margins, and limited resources. In addition, these companies are typically entrepreneurial and oriented toward fast growth, which exposes them to greater risk—financial, existential, and competitive—than large-cap companies. How can small-cap companies overcome these unique challenges?
Build a Forward-looking Board
The secret weapon of the small-cap company is its board of directors. Small cap demands a board that keeps its eyes on the road ahead, not the rearview mirror, and works hard to anticipate need for changes to strategy and risk management approaches.
Traditional boards are often locked on the rearview mirror. The agenda is comprised of reviewing lagging indicators, rather than focusing on matters crucial to the direction of the company in leading indicators – such as the organization’s strategic digital presence, disruptive innovation, and the next generation of its human capital assets. In the small-cap company, strategy must be more nimble, capable of resisting “blowing in the wind” but able to direct definitive course correction. Traditional boards consider slivers of information—regulatory compliance, fiduciary matters, performance reports. Forward-looking boards are able to think holistically.
They commit more time to their role, and use that time to educate themselves and to add value by bringing their specific expertise. They review the competitive landscape; they get out in the field to understand the company’s customers, production, and innovation. They consider the long-term talent needs of the firm, understanding that in a fast-growing firm, today’s team will not satisfy tomorrow’s impending or yet to be created needs. They work on strategy throughout the year, not just at an annual meeting. They actively help management define broad options, winnow them down, and choose a final strategy to implement, as each year wheels by.
Focus on “O-Ring Decisions”
It’s a given that small-cap organizations are in growth mode. Dozens of decisions must be made to shape the future—about strategy, investment, M&A, leadership development (both staff and board), and risk management. These are make/break decisions that impact growth and ability to execute. I call these “O-ring decisions”— the kind made by the US space program engineers who ignored the impact of cold temperature on the O-rings of the Challenger shuttle disaster. Forward-looking boards focus on what the unintended consequences of a decision might be. The forward-looking board becomes expert at killing good ideas, in order to focus the company’s limited resources on the best ones.
What Risk Are You NOT Seeing?
Risk can be current, impending, or unforeseen. The forward-looking board must have the ability to spot the existential risk lurking in even good ideas, even if those risk lies far in the future.
Compared to directors, the CEO’s tenure is short. Most CEOs must focus on the near term, in order to meet performance expectations. In many cases, only the board can afford to take the long view. Existential risk—the business-killing kind, like insider trading, corruption, or a product recall—is a huge focal point for board members.
The Forward-looking Board and the Three-Year Rule
While forward-looking directors should focus on the long-term view, they must see their own role as a relatively short deployment. When they begin to sense they are no longer adding value, they should begin recruiting their successors.
If in roughly three years the company is not in a dramatically different position than when a director came on board, he or she should be moving on. And if it IS in a dramatically different position, the company’s needs in terms of director expertise have probably changed, too. Again, time to move on. A large-cap company can have dozens of directors with dozens of years of tenure. A small-cap cannot.
Small-cap companies may be “immune-suppressed,” as Epstein put it, but that vulnerability is NOT a death sentence. The best investment a small-cap firm can make to survive—and thrive—is to develop a forward-looking board. By doing so, it gains a weapon that shoots better decisions at better-identified risks, resulting in better strategy.
- Small cap firms must develop a forward-looking board focused on the external landscape, not lagging indicators of operational performance.
- High-growth mode puts high pressure on decision-making. A forward-looking board helps the firm make critical decisions while avoiding unintended consequences.
- The forward-looking board excels at identifying existential risk, even on the far horizon.