A couple of weeks ago, I sat down and had a chat with one of my lawyers. The subject was when and why small business owners and entrepreneurs should contemplate incorporation. I think the complexity of the question can lead many entrepreneurs to not only consider when incorporation makes sense for their venture but to also seek clarity about corporate structure and its components. The size and diversity of corporate structure as it relates their business will vary. I thought this would be a good opportunity to review the basics of corporate structures.
CEOs, CFOs, Presidents, and Vice Presidents – what’s the difference? With the changing corporate horizon, it has become increasingly difficult to keep track of what people do and where they stand on the corporate structure. Should we be paying more attention to news relating to the CFO or the Vice President? What exactly do they do.
Corporate governance is one of the main reasons that these terms exist. The evolution of public ownership has created a separation between ownership and management. Before the 20th century, many companies were small, family owned and family run. Today, many are large international conglomerates that trade publicly on one or many global stock exchanges.
To create a corporation in which stockholders' interests are looked after, many firms have implemented a two-tier corporate hierarchy. On the first tier is the Board of Directors or Governors. The shareholders of the corporation elect these individuals. On the second tier is the upper management: the Board of Directors hire these individuals. Let's begin by taking a closer look at the Board of Directors and what its members do.
Board of Directors
Elected by the shareholders, the board of directors is made up of two types of representatives. The first type involves inside directors chosen from within the company. This can be a CEO, CFO, manager, or any other person who works for the company daily. The other type of representative encompasses outside directors, which are chosen externally and are considered to be independent from the company. The role of the board is to monitor a corporation's management team, acting as an advocate for stockholders. In essence, the board of directors tries to make sure that shareholders' interests are well served.
Board members can be divided into three categories:
- Chairman - Technically the leader of the corporation, the board chairman is responsible for running the board smoothly and effectively. His or her duties typically include maintaining strong communication with the chief executive officer and high-level executives, formulating the company's business strategy, representing management and the board to the public and shareholders, and maintaining corporate integrity. The chairman is elected from the board of directors.
- Inside Directors - These directors are responsible for approving high-level budgets prepared by upper management, implementing and monitoring business strategy, and approving core corporate initiatives and projects. Inside directors are either shareholders or high-level managers from within the company. Inside directors help provide internal perspectives for other board members. These individuals are also referred to as Executive Directors if they are part of company's management team.
- Outside Directors - While having the same responsibilities as the inside directors in determining strategic direction and corporate policy, outside directors are different in that they are not directly part of the management team. The purpose of having outside directors is to provide unbiased and impartial perspectives on issues brought to the board.
As the other tier of the company, the management team is directly responsible for the company's day-to-day operations and profitability.
- Chief Executive Officer (CEO) - As the top manager, the CEO is typically responsible for the corporation's entire operations and reports directly to the chairman and the board of directors. It is the CEO’s responsibility to implement board decisions and initiatives, as well as to maintain the smooth operation of the firm with senior management's assistance. Often, the CEO will also be designated as the company's President and therefore be one of the inside directors on the board (if not the Chairman). However, it is highly suggested that a company's CEO should not also be the company's Chairman to ensure the chairman's independence and clear lines of authority.
- Chief Operations Officer (COO) - Responsible for the corporation's operations, the COO looks after issues related to marketing, sales, production, and personnel. Often more hands-on than the CEO, the COO looks after day-to-day activities while providing feedback to the CEO. The COO is often referred to as a Senior Vice President.
- Chief Financial Officer (CFO) - Also reporting directly to the CEO, the CFO is responsible for analyzing and reviewing financial data, reporting financial performance, preparing budgets, and monitoring expenditures and costs. The CFO is required to present this information to the board of directors at regular intervals and provide it to shareholders and regulatory bodies such as the Ontario Securities Commission. Also, usually referred to as a Senior Vice President, the CFO routinely checks the corporation's financial health and integrity.
Together, management and the board of directors have the ultimate goal of maximizing shareholder value. In theory, management looks after the day-to-day operations, and the board ensures that shareholders are adequately represented. But the reality is that many boards include members of the management team.
When looking at corporate structure, it's always a good idea to see if there is a good balance between internal and external board members. Other good signs are the separation of CEO and Chairman roles and a variety of professional expertise on the board from accountants, lawyers, and executives. It's not uncommon to see boards that consist of the current CEO (who is Chairman), the CFO and the COO, along with the retired CEO, and family members.
While this corporate structure concept and its applicability may be in its infancy with most small business owners and entrepreneurs looking at incorporation, aspiration and success may see you there some day. It is prudent for business owners to understand corporate structure, not only in respect of their own ventures, it is an important understanding for successful interaction with larger corporations. Knowledge and comprehension are two aspects of Keeping Life Current.