Armando (0:00 – 1:04)
Hi, I’m Armando Roman, host of the Founder’s Guidepost. You’ve built your business over decades and now it’s time to think about that once-in-a-lifetime exit. You’ve come to the right place.
Here, you will hear business exit professionals talk about what you should know before exit. Besides hosting the Founder’s Guidepost, I’m CEO and founder of Axiom Founder’s Family Office, a Scottsdale wealth management firm helping founders and their families preserve their American success story. We oversee and coordinate a network of vetted professional advisors to help maximize their probability of achieving everything that is most important to you.
And we host the Scottsdale Founders Forum, a biannual live event for the founder considering exiting in the next 36 months. Here’s to your hard work and your American success story. Enjoy.
Hello, Armando Roman here with the Founder’s Guidepost here today with Michael Montelongo. Michael, thank you so much for your time this morning. How are you doing?
Michael (1:04 – 1:07)
I’m doing well. Thanks, Armando. Appreciate it.
Hope you are as well.
Armando (1:08 – 2:02)
I am. Thank you. So Michael, you’ve got such an impressive record with your career and where you’ve been.
You’re a West Point graduate, a Harvard Business School graduate. You are on the boards of some of America’s largest corporations for governance to help them have good governance there. You were the chief financial office for the United States Air Force, appointed by President Bush.
You’re a retired Air Force, a U.S. Military Air Force person as well. And so you’ve served the country and you serve corporate America. And you’ve got a phenomenal track record.
So I imagine your role now as a corporate board director in corporate governance, I imagine that what you’ve done previously up to this point has really positioned you well to be able to help govern an organization as it should be. Does that sound about right?
Michael (2:03 – 2:33)
It has. And I think like with everyone, the totality of one’s experiences over time, I think can be very helpful in activities that occur going forward. So in my case, the various experiences that I’ve had before that some of what you’ve chronicled have been for me very helpful in the kinds of things that I’m doing now, especially with board governance.
Armando (2:33 – 3:41)
Yeah. And so Michael, our goal with this podcast series, The Founders Guidepost is to help those founders who are starting businesses from scratch, growing the companies to some level, and that at some point they have to transition out of that business. And many of America’s and the world’s biggest household names like Amazon, Hewlett Packard, Facebook, and many others started from a person or a pair of people and their concept.
And now they are global entities that have had to understand corporate governance and adopt corporate governance at some point so that they can maintain that world leadership role that they’re in. And what I’d like you to do if you could is just talk about just corporate governance in general. What does that really mean to that founder who has a business and maybe they’ve never had a board of directors or an advisory board of directors and they’re trying to get their arms around corporate governance for their company?
What is corporate governance?
Michael (3:42 – 4:31)
Sure. Thanks for asking that question, Armando. Before I dive into that, let me first say thank you to you for this opportunity to be with you and your audience and to cover this particular topic because it’s something that I’m very, very passionate about because it deals with leadership, particularly senior leadership and excellence in organizations.
And just one quick factoid, or not factoid, but fact that I’d like to correct is that I did a career in uniform with the army, but I also served as a senior civilian in the Air Force, as you pointed out. So I’ve had the good fortune of actually being part of those two branches in the army as a civilian in the Air Force.
[Speaker 3] (4:32 – 4:32)
Okay.
Michael (4:32 – 5:58)
Thank you for serving. So with respect to governance, corporate governance, I think some will characterize this as an act or process of governing or overseeing the control and direction of an organization. Others will describe it as a process of organizational decision-making and the process necessarily by which decisions are implemented.
I’d like to think of it as a process that’s formal, a formal process of directing an organization to achieve goals that are moral, ethical, and legal. So at the end of the day, I think that if things are generally going okay, they’re going right in an organization, it’s probably because that organization has good governance hygiene. If they’re not going as well as they should, perhaps it’s because something in the governance structure, something in the processes is misaligned.
So in business, and that’s what we’re talking about here, a typical governance model is designed to guide how an organization’s board is structured and how that business ultimately functions. Okay.
Armando (6:00 – 6:48)
Okay. And so you’ve been in a corporate governance role as a board director for probably at least two decades now and been with different size companies, different companies that are maybe solely in the US as well as global companies. And so you’ve seen a lot in that space, and I’m sure your board conversations at times can get very heated about good corporate governance and good hygiene within the corporate governance.
What are some of the, I guess, basics of corporate governance that a founder who is new to this in exploring how to get his or her own board set up so they can grow and be one of those big name companies? What are some of those common things that you think they might be surprised about or need to understand?
Michael (6:51 – 11:02)
Well, something that I think flows from the comment that you just, or the comments that you just shared with us is that context matters. And by that, I mean, the situation that a particular organization or company finds itself in, in its evolution, in its maturity as a company matters. So the governance needs, the governance imperatives of a particular company or organization is in many ways a function of and is determined by where it is in its life cycle.
In other words, the needs, the governance needs of a startup are going to be dramatically different than those that would be present for a much more mature company. Also, size matters, right? So a very small organization is going to have a different set of governance needs than one that’s much larger, say a fortune 50 company as an example.
So context does matter. Now, in terms of governance structures that a company might think about in its evolution, in its maturity, you can think about these structures as formal policies and systems and operational frameworks. That help the company, particularly its management in doing what it does on a daily basis.
Most corporate governance structures consist of a board of directors, an executive management team, and then departments that are organized according to function, division, or a combination of both. The board of directors in particular usually represents the highest level of control and authority in that organization or company. And the most common governance model is something that’s called the Carver board, which basically consists of the board, as I just mentioned, the CEO and his or her management team, and then the committees of the board.
And typically those committees will be comprised of the audit committee, the compensation committee, and the nominating and governance committee. And we can talk about any of any of that in more detail a little bit later. But models like that Armando help an organization, particularly the CEO and the management team, define strategy for the organization, help mitigate risk, engage stakeholders and shareholders, and require accountability.
It helps ensure ethical and responsible market practices. Structures like these, models like these, promote equity and fairness among shareholders and stakeholders. And they develop trust.
That’s a biggie. We can talk more about that if you’d like. Trust through transparency and accountability.
And very importantly, and something that I’m very much sensitive to, helping to identify, mitigate and manage risk. So when an owner or founder of any kind of company, regardless of the size, I believe, and I would recommend that that person be mindful of these types of governance structures that can be helpful to that founder, to that owner, in executing what needs to be done to make that organization successful.
Armando (11:05 – 12:06)
Okay. And you made a distinction between, you know, what are the company is in its life cycle, the startup that’s going through this for the first time versus a company that’s been around for maybe a hundred years, very different to what they may need. So Mike, you’ve talked about a board of directors as part of that model, and them being at the top of that chain, the top of the hierarchy.
And the board of directors, which is what you are, a board director, and you’ve got, of course, companions that are on that board with you. And you’re talking about policy so that the company can run its day-to-day operations and be ethical, legal, and have that good framework. How does that really work?
You come together as a board on a regular cadence. And what do those meetings look like? What are you doing in those meetings?
Michael (12:07 – 13:25)
Sure. And maybe just to amplify or expand on what I was mentioning a little earlier, and then what you were getting to in terms of the maturity of a company and what its needs are, depending on what its maturity is, it really, what I’m referring to is the level of sophistication and professionalism that a company will have in its particular development cycle to then incorporate formal and professional board governance practices.
So if you’re a startup, if you’re just an owner of a company, and you’re just starting out, the level of sophistication and professionalism with respect to board governance at that stage is going to be very different than what it will be in later and more mature stages. So that’s what I was referring to, just mentioning that as a clarification. Okay.
Now, what you’re fundamentally asking is, what do boards do? And, and what issues or topics do they typically engage in?
[Speaker 3] (13:25 – 13:25)
Right.
Michael (13:26 – 14:19)
So what I will tell you, at a very basic level, it’s important to understand the roles and responsibilities that different constituencies in this structure, this governance structure have. So with respect to the board, it has a distinct set of roles and responsibilities that are different from those of the CEO and the management team. And it’s really, really important, Armando, I will tell you, that regardless of size of company, or the state of its maturity, it’s really important to fully appreciate and understand what those roles and responsibilities are and the differences and to respect them.
Armando (14:20 – 14:39)
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Michael (14:39 – 24:12)
There is a term, an acronym that has been coined over the years by the National Association of Corporate Directors, the NACD, and the acronym is NIFO, N-I-F-O, Noses In, Fingers Out. And what that refers to, Armando, is that the role of the board, fundamentally, is to represent the interests of the company shareholders and exercise oversight of the management team. It is not to run the company.
That is management’s role. Management is supposed to run the business, the daily operations. And as I said, the board is there to, I guess, you could say, supervise management and making sure that management is indeed doing what it is supposed to do.
And as I mentioned earlier, in a moral, ethical, and legal way. So that distinction between these two constituencies, boards and management teams, is a very critical one, and one that needs to be well understood. Because if it is, then there won’t be any particular tension about one or the other doing the other’s job, so to speak.
And you can imagine how it can be quite, how can I describe it? It could lead to dysfunction. If, for instance, the board is doing management’s job, as an example.
So I think it’s really important, particularly for your audience to understand and appreciate that there are these roles and responsibility distinctions that one should internalize. Now, boards of directors have fiduciary duties and very formal duties. The two major ones are the duty of care, and the duty of loyalty.
The duty of care, very basically, there’s a much more detailed definition, and certainly a legal one as well. But fundamentally, when you talk about the duty of care, that means that you have an obligation as a director, to be as fully informed about the business and all the aspects of the business, so that you can make informed decisions. And the duty of loyalty fundamentally means that there are no conflicts of interest, that ultimately, you are there for the benefit of and the interest of the company, not your own.
So that’s the duty of care and the duty of loyalty. In addition to carrying out and fulfilling those duties, boards provide guidance and advice to the CEO and the executive team. As I mentioned, boards exercise general oversight of the operations.
But again, without getting involved in day-to-day operations, stay out of the weeds. So ultimately, I’ll close on this particular item by saying that boards are responsible for governance, oversight, major decision making, and representing, as I said, the interests of the shareholders. Now, in carrying out those duties and responsibilities, Armando, there are a number of topics that you’ll find boards dealing with in all the meetings.
Now, again, the number or the specific topics that are on the agenda, in many ways are dictated by that company’s needs, its strategy, and its maturity level in the business. So the agenda of a startup, the agenda of a family-owned company is going to be different than the agenda of a Fortune 50 company, a Fortune 1000 company, as an example. But overall, I’ll offer you and your audience these points to consider.
Companies or boards will typically have meetings about strategy and risk, and they should, because those are the key elements that all organizations, regardless of where they are in their evolution or maturity cycle, need to have full awareness about and are on top of strategy and risk. The second major bucket, if you will, is something I call TLC. Now, that acronym is not what you think TLC stands for.
It stands for Talent, Leadership, and Culture. Talent, Leadership, and Culture. So when boards and their management teams are talking about strategy and risk, you have to then also have a conversation about those three areas.
Because think about it, the way that an organization is going to be capable of successfully executing its strategy and being mindful of and mitigating the risks that are inherent in that strategy is because they have the talent to pull it off, is because they have the leadership to make it happen, is because they have a culture in the organization that supports all of that, that supports excellence.
So that’s the second major bucket. The last major bucket is something I call GRC, which by the way, happens to be the name of my small little firm, as you know. GRC stands for Governance, Risk, and Compliance.
So I mentioned strategy and risk, and risk in the sense of the areas of risk that arise specifically from the strategy. The second bucket really dealing with human resource management issues. The last one, Governance, Risk, and Compliance, those in many ways are infrastructural items that probably have a bit more relevance for organizations that are more mature in their lifecycle development.
It’s not to say that a startup would not be mindful of those areas, Governance, Risk, and Compliance, but they take on perhaps a little less of less importance at the early stages of a business than they would later on. But what I’ve tried to provide here in this particular section of our conversation is that strategy and risk, talent leadership and culture, Governance, Risk, and Compliance are typically the areas that you’ll find on board meeting agendas. Now, when you peel the onion, so to speak, one level, other topics that are very current in a lot of agendas are items like cyber risk, data privacy, generative AI, are compensation issues.
In other words, what the executive team is going to be compensated for, etc., compensation plans. So, oh, I guess I should mention, and this is an area that I’ve spent quite a bit of time in my career, a particular risk that is front and center, especially if you’re a larger company that has global operations, and that’s geopolitics. And that’s on many agendas now.
Armando (24:13 – 24:50)
Okay. Well, it sounds like a whole host of areas that are being addressed. But as you said, depends on what’s happening within the company, the size of the company, the level of sophistication and complexity that might be in there.
And so it really, it really, what I think about when you say that, Michael, is that, that board of directors, for that founder who is going to have his or her first board of directors, they want to make sure to pick people who are relevant to that stage of the life cycle for the business.
Michael (24:51 – 27:13)
Oh, exactly. What you’re talking about, Armando, does very well with another phrase that comes from the NACD, which is fit for purpose, fit for purpose, meaning that the individuals that are exercising senior leadership in an organization, whether that’s the founder, the owner, the executive team, or the board, the individuals that are there should be selected on the basis of how their experiences, their background, their skills, and so forth, fit with the needs of the company at that particular juncture, and its strategy. So you hit on a very important point. And by the way, this is something that I think owners and founders are attuned to, because think about this, an owner or founder, and his or her shelf life, in some instances, can be limited.
By that I mean this, their ability to bring the organization together and birth it may be very relevant at the birth, but then as the company scales, that owner or founder may not have the appropriate skill sets to take the company further in its evolution. So the same is true with the senior team, the executive team, and the board. There will be instances where different backgrounds, different experiences are going to fit just right with where the company is and where its strategy is.
So that whole fit for purpose phrase is a very apropos one, when an owner or founder is thinking about, let me see who it is that I should invite to be part of my executive team. Let me see who it is that I should invite to be part of my board.
Armando (27:14 – 27:43)
Yeah. And Michael, when you said fit for purpose and described it, the first thing I thought about was when our first United States Surgeon General became Dr. Richard Carmona, somebody who jumped out of helicopters before military service, and he was the first of his kind in that spot. But at that time, as you described at that time, that was very pertinent, very relevant to what was happening within our country at that time.
Michael (27:44 – 28:04)
Right, exactly. So that’s a very good example of being very intentional, being very mindful of doing a match with the backgrounds and skills and experiences of an individual to the need at that particular time.
Armando (28:05 – 28:51)
Okay. Well, that makes a lot of sense. So a new governance structure being implemented in a company for the first time, and what I really mean is a board of directors being put into a company for the first time, when that founder, owner, management team is wondering who to bring on board, they really want to look at their current strategy and the current risks as they see them and identify people who can help them address those areas.
Does that sound about right?
Michael (28:52 – 31:51)
Precisely, yes. Okay. And what you’re talking about is selecting very intentionally, very mindfully, the right people with the right skills, backgrounds and experiences, and the right attitude, at the right time, we talked about this several times, at the right time in the evolution of the company’s cycle, doing the right things, right, in the right environment, led by the right leaders.
Now, I know that perhaps sounds like a catchy phrase of sorts. So, but let me unpack that a little bit. And we’ve talked about this already, in some of the previous responses.
Seek out the right people with the right background skills and experiences, and with the right attitude, because at the end of the day, in that boardroom, you want to be able to get along with all of your peers and your colleagues. There is a sense of collegiality that has to exist. And trust, by the way, that must exist in that boardroom.
So yes, begin with people that have the right skills and backgrounds, and the right attitude. People that are motivated to contribute. People that are selfless, you know, that they’re in it, not for themselves, but they’re in it to leave the organization better off than they find.
Okay. So that’s the right attitude. Then I’ve already said a number of times, it’s important that you bring in those right people at the right time, right, the right fit, fit for purpose.
And I like the way you connected the strategy, because it really ought to be connected to that company strategy. Now, the right people, the right time, doing the right things. Okay, so gosh, especially today, Armando, I will tell you, particularly with larger companies, the number of issues and topics are just growing exponentially.
I mean, whoever would have thought in 2019, that we would have had to deal with something we call the pandemic?
[Speaker 3] (31:51 – 31:52)
Yeah.
Michael (31:53 – 32:14)
Who on truthfully, on New Year’s Eve 2021 would have thought that two months later in February, we would be dealing with a war in Europe.
[Speaker 3] (32:15 – 32:15)
Right.
Michael (32:17 – 34:05)
So and then look at the interest rates. This is a world that you know about quite a bit. So the plethora, the array of topics and issues that boards are dealing with, it just continues to multiply.
So when I talk about the right things, boards have to be very select, boards and management teams have to be very selective about where they’ll spend their very limited time. So let me pause here for a second and tell you, or share with you and your audience, that unlike the management team that is present for duty, every single day, boards formally only meet perhaps once a quarter, maybe one and a half times, they have phone calls and meetings, zoom meetings and such in between those formal meetings, but they’re not there on a daily basis. So what does that mean?
That means that the management team and the board has to make the most of the limited time that they’re together, which means that they therefore have to be very selective about what they choose to focus on. Because you can’t cover everything. It’s just too much out there.
The inbox is oversubscribed, overflowing. So to repeat, the right people, right skills and attitude, at the right time, doing the right things, which means being selective about what you choose to focus on, but doing those things right.
Armando (34:15 – 34:25)
You’re cutting out there, Michael. Yeah, it’s a little bit garbled, but it just kind of cut out a little bit there.
Michael (34:26 – 37:04)
So what I was saying is, is you have to have the right people, right skills at the right time, doing the right things, right, by the right things, as I mentioned, being selective about what you focus on, and doing that all morally, ethically and legally, because the one critical element, an asset that a company has that is tremendously valuable is reputation. You cannot fritter that away, because it’s so hard to get it and to maintain it. So just to complete the phrase that I had mentioned a little earlier, the right skill, the right people, skills, right time, doing the right thing, right, in the right environment.
I mean, an environment that is collegial, welcoming, where there is trust among all the constituents, all the players, all the colleagues, where everyone feels and is treated and respected and dignified as they would like to be treated, respected and dignified, and led by the right, whether that’s the CEO, and or the chairman, and by the right leader, I’m talking about someone that is afraid of your you and your audience have heard the term servant leader.
Yeah, someone who leads by serving others first, someone who puts the welfare of others before his or her own. In the military, two phrases that guided my own leadership style were mission first, people always. The second was troops first.
So think about that mission first, people always. That very succinctly captures what I think leaders ought to be doing. Yes, mindful of getting the job done, but always mindful of the welfare of their colleagues.
And then troops eat first. What that is, is that the leader puts the interests of others well ahead of his or her own. So the leader does not eat first.
Never.
Armando (37:05 – 37:15)
The troops do. Okay, he’s putting he or she’s putting the interests of the people at the front line, the troops ahead of his own or her own.
Michael (37:16 – 37:41)
Absolutely. So again, to try to describe there, and I know that it was a little bit lengthy, is that owner and founder selecting the right people with the right attitude at the right time, doing the right thing in the right environment and led by the right leader. Okay.
Armando (37:42 – 37:43)
Well connected.
Michael (37:43 – 37:49)
Then more often than not, I think you basically built something that’s going to succeed.
Armando (37:50 – 38:55)
Okay. And Michael, I would suppose that even when you get the best people who are all of those that you described, the board might be eight people, 12 people, whatever that may be. I imagine, as you said, issues and topics keep growing exponentially.
I imagine at times you still have to bring in an outside expert to help educate the board on certain topics. AI suddenly became everything, everywhere. And we’re all understanding how to grasp it, what the challenges are, what the opportunities are.
And it’s new to literally everyone, except people maybe who are in that space or been in that space. So when you have that board leadership team, and there are situations that come up that really need the expert, how do you engage that expert to help inform the board so the board can enact on its good governance goal?
Michael (38:57 – 43:20)
Glad you brought that up, Romando, because the composition of the board, which is what we were just talking about, right, in terms of the right people and so forth, in addition to the composition, you want to be mindful of the number of people. You don’t want to have a board that’s too large, because a larger number of people will make it more difficult to exercise good governance. And so typically, the number of people on a board of directors is dictated by the complexity and size of the organization.
So a small company typically will have a smaller board. A much larger global enterprise might have more. But I will tell you that on average, boards are not going to have much more than 10 to 12 people.
And that’ll be smaller for smaller enterprises. So you’re pointing out a very good, you’re making a good point is that what if there is expertise or insight that is not available in the boardroom? Where does the board tap it?
Well, it’s through external advisors. And boards, I mentioned earlier that boards typically will have most of its work done in committees. So, but those committees are typical in more mature companies, you know, companies that are more mature in their lifecycle.
And I mentioned the three typical committees, the audit committee, the compensation committee, and the nominating and governance committee. And the first two, the audit committee and the compensation committees, both of them have advisors that help each of those respective committees. For example, a will have the external or independent auditor that the committee, and particularly the committee chair can tap into for financial statement and accounting expertise.
The and mind you, just a quick blurb on that the compensation committees, typical role, it’s expanding as we speak, but it’s typical role is to oversee the compensation plans, oversee and approve the compensation plans for the senior executives. So in carrying out specific, the compensation committee will typically be advised by a compensation consultant. So the point that you’re making is a very good one in that, in addition to having a standing board, companies as they mature in their development, will tap into from time to time, subject matter experts and consultants, and they should.
Because think about it, if you tried to get every expert, that one meeting, and you would put that on the board, you’d have an unwieldy number of people on the board. It’s just not really practical. You have to rely sometimes on advisors.
Let me mention one other advisor that’s very critical, particularly to much larger companies, and that is outside consulting. So some companies will have their own internal on the staff, and this is a much larger company, but those same companies will have and retain an outside legal firm to help them with legal matters, legal, ethical and compliance matters.
[Speaker 3] (43:20 – 43:20)
Okay.
Armando (43:23 – 43:46)
So within a, depending on the size of the company, they may have their own in-house general counsel, and yet their, which is their own in-house attorney or a team of attorneys, and yet they may need to reach out to other attorneys who are subject matter experts, depending on what’s happening and what the needs are in that business. Right.
Michael (43:47 – 43:48)
Indeed. Okay.
[Speaker 3] (43:50 – 43:50)
Okay.
Michael (43:50 – 44:16)
But again, early on, we were talking about context and the state that a company finds itself in. A company that is in its infancy is not going to have the resources to basically have a large staff or even tap into too many advisors.
[Speaker 3] (44:16 – 44:17)
Right.
Michael (44:18 – 44:37)
But as that company, then they then begin to get the resources to be able to bring on some of those assets. And by the way, this brings up a good point that I’ll mention here. Earlier, I said, I introduced the acronym NYFO, right?
Noses in, fingers out.
[Speaker 3] (44:38 – 44:38)
Yeah.
Michael (44:39 – 47:42)
I don’t want to in any way convey to your audience you and your audience that that is sacrosanct. It’s a general rule of thumb, but the board’s intensity on intervening in operations is really dictated by what’s happening with that company. So for example, during the pandemic, boards of directors became much more involved and maybe so because of what was going on in the operations of their companies.
Then I was in the rear view mirror, they then stepped back, they loosened up. So that’s one example. The other example is that when a founder or owner establishes a board of directors for the first time, and you’ll find this typical Armando in the private equity or venture capital world, where private equity folks and venture capitalists will obviously have a CEO and senior executive team heading up a company, and they’ll have a board, but that board will play a much more operational role than what’s typical in more mature companies. In other words, the board that’s there, the people that serve on that board serve sometimes as a proxy for management team.
In other words, they supplement the management team. They bring particular skills and experiences that the management team does not have. And because that company is in its infancy, it doesn’t have resources or many resources at that stage.
In many ways, the directors double as daily contributors to the organization as well as exercising oversight. So I just wanted to clarify that when I mentioned earlier about understanding the distinction of roles and responsibilities between management and the board, that is yes, as a rule of thumb, it’s very important. But I also want to leave the impression that that general set or that general framework can and will be modified depending on what the specific needs are of the company at a particular point in time.
Armando (47:46 – 48:08)
And that makes sense. As you said, a company in its infancy is building out systems and the board they bring on, maybe they have a very, very experienced chief financial officer and they lean on him or her heavily to help build out and grow that sophistication the company needs to get to that next stage of their own life cycle.
Michael (48:08 – 48:12)
Exactly. Yes. That’s very typical.
Armando (48:13 – 49:50)
Okay. So I had a conversation with a board director at one point where the company the board that he served on the company had a very, very public disaster and it was damage control. It was all hands on deck.
And he’s very aware of the board governance role, as you said, noses in fingers out. But because of the situation, he did step more into, I wouldn’t say operations, but what did happen is in their board’s conversations, it made sense for him as the board chair to reach out to the biggest constituents, the biggest investors, so to speak, of the company to assure them that the board was addressing the issues and actually explaining what they were doing to address the issues, because it was such a significant, very public disaster that it warranted that type of contact. And everything ended up as well as it could be. But as you said, as things happen, the board will have to address certain things, sometimes very quickly, very suddenly, and might have to get into a role that maybe they’re not expected to, but maybe is necessary to do that for the sake of the company.
Michael (49:51 – 50:46)
Right. No, that’s true. Because there are instances, particularly during crises, and whatever you can, you can, gosh, in that term crisis, you can put all sorts of scenarios in that, depending on what the crisis is.
It’s not uncommon for the board then to be in an all-hands-on-deck posture to assist the management team and assure the company’s shareholders that adult leadership is on the job, making sure that they’re very mindful of what needs to be done, and how it will get done.
Armando (50:47 – 51:59)
Okay. So Michael, let me ask you if you can, this of course is 2023, we’ve had some of the biggest bank failures happening this year. And as some of those failures were dissected, you as in board governance, as a board director, you have your perspective on what could have been done to possibly help avoid what happened.
But can you speak to the board’s role in, for example, Silicon Valley Bank, First Republic Bank, were both very big banking failures in our American history. And those are very, very recent. And there were boards, obviously, you cannot foresee everything, you cannot head everything off.
But as the board is addressing issues that come up for the company, I wonder what you think maybe systems that could have been in place, or things that could have been done that might have helped to avoid those failures in the banking industry?
Michael (52:02 – 55:29)
Yes, those case studies are very interesting ones. When you do an autopsy, or postmortem, on what occurred there, that’s not very long ago, as you point out, that was happening in the late spring, or I should say, late winter, early spring. And mind you, as the phrase goes, hindsight is always 2020.
It’s a lot easier to basically do these autopsies and postmortems than to foresee, or to be mindful of and do something about some of the red flags that arise. But when you peel the onion on these scenarios, there have been a number of commentators that have looked at these and concluded that these are textbook cases of mismanagement. Both institutions suffered liquidity problems, and dangerously high ratios of uninsured deposits.
And in the case of the First Republic, they sequentially followed on the heels of Silicon Valley Bank’s public debacle. And First Republic faced even more mistrust and skepticism about its ability to be a going concern. More specifically, SVB, as the acronym goes, that was a bank run.
That was a classic asset liability mismatch. They had loans where the terms had minimal collateral or due diligence. The bank invested heavily in securities with long dated maturities.
That’s critical, long dated maturities. Half of its assets were in these securities. And normally, in most bank balance sheets, it might constitute a quarter of the balance of the assets on a balance.
And then interest rates rose quickly. And as a result of that, bond prices fell rapidly. And it’s just classic economics, the longer the tenor of the bonds, then the greater decline in the value of those bonds.
And ultimately, for SVP, they decreased significantly. I think one billion was an amount that I had read. So the word of the bank’s losses caused the bankers to start withdrawing their money.
And then to meet the withdrawals, SVP had to sell even more of the bonds, but at a substantial loss. And it just was a vicious cycle that spiraled. And then the equity dried up.
So this was an unfortunate set of circumstances that occurred, and in many ways, a perfect storm. The red flags, they had tremendous growth in the sector and the region that they did business in. They grew very rapidly.
Their deposits, Armando, tripled from 2019 to 2021. In 2019, they had $62 billion in deposits. And in 2021, it was $189 billion.
[Speaker 3] (55:30 – 55:31)
Holy smokes. Wow.
Michael (55:32 – 57:13)
But here’s the thing, their business was concentrated in a single sector, the venture capitalist world, in tech and healthcare, and in a single region in Northern California. And as I said earlier, most of their deposits were uninsured. So it lacked safety and trust by deposit holders.
And ultimately, as things started to spiral, they lost confidence because people were looking at that and saying, oh my gosh, I can’t trust this institution. So yeah, risk management 101, asset liability mismatch, interest rate, risk exposure. And the other thing that I think most people were surprised at is financial institutions are supposed to have a chief risk officer.
That position at this bank for months, not to say that one person could have foresaw or alleviated this debacle, but if you have staff, someone whose main role is to risk like this, then you’re further exacerbating the risk that’s there. And here’s a conflict of interest that I was surprised to hear about is that that bank CEO served on the board of the San Francisco Fed, the very organization that’s supposed to regulate the bank. That’s a clear conflict of interest.
I’m sorry, go ahead.
Armando (57:13 – 59:10)
I was just going to bring up, Michael, that the public, we look at banks as being very highly regulated. And they are, they are highly regulated. You mentioned the Federal Reserve, they’re highly regulated institutions.
So it kind of seems to me that there would have been two layers of oversight, the regulation required by the Feds and or the state, but then also had there been good corporate governance, that could have been helpful as well. You mentioned, of course, there was a key executive management role that had been vacant for quite some time, which would be a third set of eyeballs looking at, or at least hoping to look out for such risks. But I guess getting back to the board and the board’s role in that, I don’t know where that really falls, but it was such a big public failure of a banking institution in the United States that it got a lot of people’s attention and the right behind it was First Republic.
So I’m wondering from a board governance standpoint, as you said, they’re sticking their noses in, but keeping their fingers out. They’re not in operations. I suppose, as you said, hindsight is 20-20, but with public confidence being hit so hard because of those bank failures, then I wonder what might have changed going forward in terms of board governance or the state and or federal regulators, so that we as the public do feel that we can have confidence keeping our money in the bank.
And how has maybe the board of directors for any bank institution, what might they have changed going forward so that that doesn’t repeat itself?
Michael (59:13 – 1:05:21)
All good questions, Armando. And what these two case studies certainly reinforce are, in fact, some of the lessons that came out of the scandals back in the early 200s with the Enron and MCI scandals. Or even take a look at what happened at a recent episode with Theranos.
That board was a board of comprised of individuals that were celebrities, high-profile people. Folks that you would think would know better. And by the way, the board of Enron also had very distinguished, competent people on their boards.
I don’t know who was on the SVB or First Republic Bank boards, but for the sake of making an assumption here, I would imagine that they were probably people that were successful and accomplished and so forth. And so then you wonder, what happened? Who was minding the store?
So when you look back and do, as I said, the autopsies and the post-mortems, it’s very critical that companies and boards, in particular board chairs and CEOs, be mindful of the fundamentals of the basics. When it comes to board composition, be very intentional about who you have serving there in terms of their backgrounds, their skills, and their experiences. So in a bank environment, I would think that you’d certainly want to have individuals there that have fluency with financial management system, among other things.
You want to also have people who, in many ways, are experts in risk management. You comment about you can’t foresee everything, and that’s a truism because as human beings, we can’t. But you are able, through the right protocols and policies and processes, install infrastructure in the company to help both the management team and the directors stay on top of a company’s most significant, most impactful, most likely, and most, I’ll call it dangerous risks.
So that on a regular basis, both the management team and the board are making sure that they keep tabs on, they’re monitoring the level of risk and vulnerability and exposure that the organization has at a particular point in time. So you want to have on that board people who are sensitized to risk, live it and breathe it all the time. You, as a board member, you want to exercise respectful and healthy skepticism and challenge the management.
Not browbeat them, but when they present whatever they’re presenting, ask probing questions, test the assumptions. In the banking world, in the financial world, you’ve heard, I’m sure your audience as well has heard, of stress tests that banks have to go through. Well, boards and board directors should stress test management’s forecasts and assumptions.
At the end of the day, the board is there to hold the management team accountable. So those are some basics that chair people and CEOs should be very mindful of when they’re putting boards, when they’re tapping individuals to join the board and so forth, so that they minimize as much as they can possibly do the risk of, gosh, these kinds of catastrophic incidents. Because with these two organizations, beyond the fact that they lost value and assets for many people, they created second and third order implications and consequences throughout the financial system.
In other words, there were cascading reverberating effects that went beyond just those banks and their depositors and their customers. And when that happens, those organizations that lose credibility and they lose trust, and that is so difficult to rename.
Armando (1:05:24 – 1:05:57)
Yeah, that makes sense. So, Michael, we’ve talked about a lot. Anything you as a board of director that is helping to create and foster good corporate governance, good hygiene in the corporate governance, anything that we didn’t touch on in this conversation that a founder who was thinking of creating a board to actually formalize and become a more sophisticated company that will help enable it to grow, anything we haven’t touched on that you think that founder should really hear?
Michael (1:05:58 – 1:11:55)
Just a couple of things, Armando, and thank you for asking that question. And a little bit of a caveat to the discussion that we had today, we really just touched the surface of this particular topic. As you might imagine, depending again on the complexity of the company, we’re talking about a discipline that is board governance that can be quite involved beyond some of the perhaps generalizations that we talked about today.
But I think that some of the basics that you had shared today can be very helpful in helping an owner or founder determine whether this is a path that will be beneficial to him or her. My advice to someone that’s considering this is the following. Do explore what the benefits can be of having a group of accomplished individuals essentially be your advisors.
There are some CEOs, whether they’re private, family owned, or publicly traded companies that look upon the board almost as a necessary inconvenience. I think that’s an unfortunate perspective. Some of the best CEOs and those that are very successful, again, whether it’s a private company or a family owned company or publicly traded one, are those CEOs that their egos are not so what is it?
Overextended that they can’t form good, respectful, and professional relationships with a board and utilize the, frankly, the tremendous insight and experience that likely a board can bring to an owner or CEO or founder. If you put together five or six people who have diverse experiences and backgrounds, and they’re there committed to helping you succeed, and their sole duty, as I mentioned, is to do just that, to help you be successful, boy, that can be very, very beneficial. I would advise a founder and owner to seriously consider looking at what benefits that can bring to that person if they took the time to intentionally bring on a group of people like that to help his or her organization.
The other point that I’ll make is that, and this is a general point that I’ll make overall about directorship, is that certainly over the last two decades that I’ve been involved with it, it has become and it has matured into a discipline like law or accounting or medicine, and is every bit of profession like those professions, meaning that directorship is an area that requires knowledge, skills, education, and the commitment to stay current in one’s profession.
It’s another way of saying that that is an area that’s become much more professional over time and will continue to be as the complexity of the issues continues to grow. You talked about the fact that AI now all of a sudden has hit the marketplace, has hit the interest of society at large. Well, there’s going to be another area or topic that will do the same as we continue to grow and going forward, and so in that regard, it’s going to require people that are serving as directors to be current in all of those areas.
And finally, I will say that those of us that are serving in this profession, it should always be treated, in my opinion, as a privilege, a privilege to participate in the nation’s economic vibrancy and sustainability, because America’s economic power and economic sustainability and vibrancy is a function of each and every individual company being healthy and succeeding. So for those of us that have the honor and the privilege of serving on boards, it’s our obligation to help those companies succeed, because when they succeed, the sum of all those companies contributes to America’s success.
Armando (1:11:55 – 1:12:11)
Very well said, Michael. Michael, thank you so much for this conversation. Very, very excellent information for really any company that wants to have good governance.
They can learn from this conversation. So again, thank you so much. Really, really appreciate the conversation with you today.
Michael (1:12:12 – 1:12:16)
Armando, thanks for the opportunity to you and also to your audience.
Armando (1:12:16 – 1:12:53)
Thanks a lot. Hope you enjoyed this episode of the Founders Guidepost. Whether exit is on your immediate horizon or maybe 10 years down the road, there’s something here for you.
And remember, we all have an expiration date. We just don’t know when that will be, which is why planning ahead is critical. And if you’re wondering if you’ve missed anything in your planning, contact me to schedule your founders strategy call.
You may call our office at 480-367-9000 or schedule a call at axiomcorp.com. Here’s to your American success story.
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