SME GOVERNANCE

GUIDEBOOK

IN PARTNERSHIP WITH
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SME
Governance
Guidebook
Contents

Foreword v

Acknowledgments vi

Executive Summary vii

Guidebook Structure viii

1. SME Governance: What Is It? Why Is It Important? 1

Meet Rami Bahgat 3

What Is Corporate Governance? 5

What Makes SME Governance Different? 5

Why Bother? The Benefits of Good Governance for SMEs 6

Better Governance Is a Good Investment 7

2. SME Governance Framework 9

SME Stages of Growth: How Is My Business Evolving? 11

Stage 1: Start-Up 12

Stage 2: Active Growth 14

Stage 3: Organizational Development 16

Stage 4: Business Expansion 19

Tool: Identifying My Company’s Stage of Evolution 20

SME Governance Matrix: Identifying Recommended Actions 22

for My Company

3. Key Governance Topics and Leading Practices 25

Topic A: Culture and Commitment to Good Governance 27

Owners’ Awareness and Commitment 27

Organizational Structure 28

Key Policies and Processes 29

Leading Practices: Culture and Commitment to Good Governance 30

SME Governance Guidebook i

 Topic B: Decision Making and Strategic Oversight 34

Management Decision Making 35

Advisers/Advisory Board 36

Board of Directors 37

Succession Planning 41

Human Resources Planning 45

Leading Practices: Decision Making and Strategic Oversight 48

Topic C: Risk Governance and Internal Controls 52

Internal Controls 53

Audit 60

Leading Practices: Risk Governance and Internal Controls 61

Topic D: Disclosure and Transparency 65

General Guidelines 66

Financial Disclosure 66

Nonfinancial Disclosure 66

Leading Practices: Disclosure and Transparency 68

Topic E: Ownership 71

Shareholder Participation 71

Founder/Family Role 74

Shareholder Dispute Resolution 75

Leading Practices: Ownership 76

Conclusion 79

Appendix 81

SME Governance Action Planning Tool 82

Step 1: My Company’s Primary Stage of Development 84

Step 2: Governance Leading Practice—Identify Relevant Practices 86

Step 3: My Company’s Governance Action Plan 94

References 97

ii
 Boxes, Figures, Tables, and Worksheets

Boxes

Box 3.1: Qualities of Good Delegators 35

Box 3.2: Investor Perspective 39

Box 3.3: The Art of Letting Go for Successful Entrepreneurs 44

Box 3.4: Control Activities Examples 55

Box 3.5: Control versus Trust Continuum 58

Box 3.6: Benefits of Sustainability Reporting 67

Figures

Figure 1.1: The Principal Actors: Shareholders, Board of Directors, and Management 4

Figure 2.1: The Four Stages of SME Evolution 11

Figure 3.1: Internal Controls Elements 53

Figure 3.2: Conflict of Interests: Most Common Forms 59

Figure A.1: Governance Topics and Subtopics 82

Figure A.2: Example Worksheet for Leading Practices and Change Actions 86

Tables

Table 2.1: Evolution of SMEs 21

Table 2.2: SME Governance Matrix 23

Table 3.1: Types of Investors 73

SME Governance Guidebook iii

 Worksheets

Worksheet A.1: Identifying the Stage of Development 95

Worksheet A.2: Topic A. Culture and Commitment to Good Governance 97

Worksheet A.3: Topic B. Decision Making and Strategic Oversight 98

Worksheet A.4: Topic C. Risk Governance and Internal Controls 100

Worksheet A.5: Topic D. Disclosure and Transparency 102

Worksheet A.6: Topic E. Ownership 103

Worksheet A.7: Short-Term High-Priority Action Items 105

Unless otherwise indicated, all boxes, figures, tables, and worksheets were produced by the authors.

iv
Foreword

Private companies seek to maximize profits, enhance growth, and ensure long-term sustainability. Regardless of a
business’s size, there is overwhelming evidence that effective corporate governance is an essential element for achieving
these outcomes.

Yet when asked about corporate governance, owners of small and medium enterprises (SMEs) often are skeptical of
its value add. They either believe that the business is too small or that it is too early in its development to benefit from
building out corporate governance systems and processes.

For those interested small business owners, most corporate governance principles and standards are not fit for their
business. Implementing policies and procedures designed for larger companies can represent an overly complex and
resource-intensive effort for the typical resource-strapped SME.

This Guidebook specifically addresses the challenges and opportunities faced by SMEs at the various stages
of their lifecycles, offering tailored corporate governance recommendations for these smaller businesses.
The guidance provided is designed to help SME owners, investors, and managers take a pragmatic approach
to governance, as a means of strengthening their businesses over the long term. The Guidebook is designed
to enable SMEs to move at their own pace on governance upgrades, depending on market context, growth stage,
resources, and degree of organizational development.

The Guidebook builds on more than two decades of IFC leadership in corporate governance. Our even longer record of
supporting SMEs in emerging markets includes a range of initiatives, from advice on improving business practices to
enabling increased access to finance in partnership with banks, private equity, and other financial intermediaries: in 2017
alone, IFC clients provided more than $351 billion in SME loans.

As the primary source of private sector growth and job creation in many emerging-market countries – and the innovation
pool from which tomorrow’s big businesses will emerge – well-run SMEs represent a powerful driver of economic
expansion and job creation.

We hope this Guidebook will help you develop governance policies, practices, and structures that will enable your
company or your investees to grow sustainably, generate wealth for shareholders, and benefit your employees
and communities.

Mary Porter Peschka, Director

Environmental, Social and Governance Department
International Finance Corporation

SME Governance Guidebook v

Acknowledgments

(Presented in alphabetical order.)

Members of the core editorial team are Vladislava Ryabota and Alexey Volynets of IFC, and Helen Carrington and
Axel Kravatzky of Syntegra/Tailored Governance.

The Guidebook is based on IFC's SME Governance Methodology and tools that were developed by Yuliya Holodkova,
Yehia El Husseiny, Alison Kibirige, Kiril Nejkov, Sheela Rahman, Vladislava Ryabota, Ashraf G. Shenouda, and
Alexey Volynets.

The team wishes to acknowledge the internal IFC peer reviewers: Amira El Saeed Agag, Chinyere Peace Almona,
Khawar Saeed Ansari, Jorge Echeandia, Yehia El Husseiny, Yuliya Holodkova, Oleg Kalchenko, Rose Lumumba,
Oliver James Orton, Keirsten Nicole Pedersen, Lopa Rahman, Sheela Rahman, Chris Razook, Magdalena Rego, and
Madina Zhanuzakova.

The team also thanks the external peer reviewers: Yılmaz Arguden, Sorana Baciu, Marcos Bertin, Rami Camel-Toueg,
Carolynn Chalmers, Hetal Dalal, Juan Carlos Fernandez, Peter Francis, Jo Iwasaki, Margaret Jackson, Rani Lakhan-Narace,
Jozeph Liventz, Bassem Mina, Nell Minow, Irina Naoumova, Chris Pierce, Ashraf Shenouda, Leslie Spiers, John Sullivan,
and Olli Virtanen.

Special thanks to IFC’s SME Ventures program for supporting the early development and piloting of the SME Governance
tools, and to the governments of Canada and Japan for supporting the work needed to finalize the tools and the
development of this Guidebook.

vi
Executive Summary

Small and medium enterprises share distinctive sustainable growth of their companies. The SME
challenges that require specific governance practices. Governance Methodology in this Guidebook represents
However, resources on corporate governance have a governance innovation by tailoring specific
mostly focused on large and publicly traded companies. recommendations to the evolutionary stages of SME
This Guidebook is written with SMEs specifically in growth: Stage 1: Start-Up; Stage 2: Active Growth; Stage
mind and provides insights into the particular risks 3: Organizational Development; and Stage 4: Business
that these businesses traditionally face. It proposes a Expansion. The recommendations are grouped around
tailored governance framework with structures, policies, five governance topics: Culture and Commitment to Good
and practices that mitigate these risks and support Governance, Decision Making and Strategic Oversight,
sustainable growth of business while recognizing the Risk Governance and Internal Controls, Disclosure and
resource constraints typical of SMEs. Transparency, and Ownership.

For many SMEs, the initial incentive to improve their

governance practices is an increase in access to cheaper
Research and empirical evidence show
financing options. Investors analyze governance that good governance improves business
practices of companies to evaluate their risk exposure
performance and increases the chances of a
and to determine a proper value to the shares of the
company. However, benefits of good governance go company’s long-term survival.
beyond increased access to finance. Research and
empirical evidence show that good governance improves
business performance and increases the chances of a
company’s long-term survival (IFC 2018). Easy-to-use tools help SMEs learn more about key
governance concepts, understand recommended
In practice, the most common SME governance governance practices specific to their stage of growth,
challenges involve decision making, strategic oversight, and apply practical solutions. Throughout the Guidebook,
recruitment and retention of qualified management staff, worksheets and action-planning templates help translate
succession, and establishing standardized internal control intentions into actions.
mechanisms and policies. These challenges stem from
the very nature of SMEs, many of them family businesses, This Guidebook provides an international perspective—
which typically experience organic growth, and more often focusing on characteristics that are common to small
than not, the systems, policies, and processes required and midsize businesses in many different countries.
for the proper governance of the business lag behind. This When applying the Guidebook’s recommendations,
organic growth—combined with ambiguity in business companies also need to be considerate of the practices
roles (with key personnel wearing multiple hats), an and regulations of the countries where they operate.
informal approach to business, family involvement at
various levels, and an often insular leadership focus—is We hope that implementing these leading practices will
unsustainable in the long term. go a long way toward ensuring SMEs’ sustainability—and
their attractiveness to future investors, employees, and
The objective of this Guidebook is to help SME other stakeholders.
entrepreneurs and their investors develop a highly
tailored governance improvement plan to support

SME Governance Guidebook vii

Guidebook Structure

Chapter 1—SME Governance: What Is It? Why Is Chapter 3—Key Governance Topics and Leading
It Important? This chapter explains what corporate Practices takes a deep dive into select governance
governance is and how it differs for SMEs. It also concepts and practices for each of the five governance
discusses the benefits that SMEs can derive from good topics. Discussion of each topic ends with specific
governance, including access to finance. recommendations for each stage of SME development.

Chapter 2—SME Governance Framework defines the Appendix—SME Governance Action Planning Tool
stages of growth for SMEs as well as governance-related distills the key recommendations of the SME Guidebook
risks and opportunities associated with each stage. and presents them in the form of worksheets to help you
It provides a tool to help companies determine their identify high-priority actions appropriate to your SME’s
stage of growth, then it introduces the SME Governance stage of growth.
Matrix, which aligns the SME growth stages with
recommended actions on five governance topics.

viii
 Chapter 1
SME Governance:
What Is It? Why Is It Important?

SME Governance Guidebook 1

 “If management is about running business,
governance is about seeing that it is run properly.
All companies need governing as well as managing.”

Tricker 1984 1

1. SME Governance:
What Is It? Why Is It Important?

At the end of this chapter, you should have a better understanding of the following:

XX The importance of SME governance, and

XX How SME governance helps you secure and grow your business.

THIS CHAPTER sets up a case study – the experience of Rockstar

Clothing Company, a fictionalized story based on a real company – to
illustrate the material we’ll cover. Then we will review what
corporate governance is and explore why SMEs have specific needs.
Finally, we will look at some of the benefits that SMEs derive from
good governance, including access to finance.

1 Bob Tricker is an expert in corporate governance who wrote the first book to use the title 'Corporate Governance' in 1984.

2 Chapter 1: SME Governance: What Is It? Why Is It Important?

 Case Study: Meet Rami Bahgat2
Today’s the big day! Rami Bahgat, the chief executive officer of Rockstar Clothing Company,
dreams of expanding his clothing business from its current 12 stores to 100, and he’s about to meet
with Sandstone Equity Group to discuss what he sees as a win-win for all parties involved. For 29
years the company has provided high-quality men’s clothing to the Egyptian market with much
success. Rockstar has proven itself with great products already tested on the market, but only with
a significant investment can the potential for growth be realized. To attract investment, Rami put
together his proposal, intending to offer up to 30 percent of equity in his company to investors. He
thought he had done everything necessary to be ready to discuss the product, company strategy,
and finances.

However, Rami was not prepared for some of these questions: How are key decisions made? Who
are the people with essential knowledge and expertise, and how do you plan succession for these

SME Governance: What is it? Why is it important?

key risk positions? How do you manage risks? How can I see what’s happening with the company?
How can potential investors be sure the information provided is correct and complete? What
relationship do you offer to your shareholders?

These are some of the questions the potential investors raised, and they all speak to the issue
of governance within Rockstar Clothing Company. These investors wanted to understand how
committed the company was to good governance, how decisions were made, and whether
there were structures in place for oversight. They were also interested in knowing what kind of
controls were in place to protect the company from risks and whether Rami would be committed
to practicing transparency and sharing information with outsiders. Finally, they wanted to
understand how they, as external investors, would fit in with this close-knit family company.

In his search for answers, Rami discovered that he did have some of the governance structures,
processes, and systems in place. Like most businesses, he was already practicing governance
without even knowing it! However, his meeting with investors made him realize that he needed to
address governance in a more structured and effective way.

1
With that in mind, Rami is setting out on a journey to assess and improve governance in his
company. He is confident that this process will lead the company to perform better, grow, and
become more sustainable—and make it more attractive to investors. This case study will help us
illustrate key governance challenges for SMEs—and potential solutions.

2 All the names and some details have been changed to protect the identity of the company.

SME Governance Guidebook 3

 Figure 1.1: The Principal Actors: Shareholders, Board of Directors, and Management

SHAREHOLDERS
Shareholders set the overall
vision for the company

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eh

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ar

en
sh

ta
or

Ele
lf

nd
l

ct
ita
ita

re
an
ap
ap

p
or
dd
ec
ec

tt
ism
id
ag

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iss
Pr
M

Report periodically and implement strategy

Guide and supervise

MANAGEMENT BOARD OF DIRECTORS

Management develops The Board of Directors reviews and
the strategy and runs the approves the strategy and
company's daily operations oversees management

4 Chapter 1: SME Governance: What Is It? Why Is It Important?

What Is Corporate Governance? To survive and grow, all businesses need to be properly
governed. SMEs, many of which are family businesses,
“Classic” corporate governance—developed initially differ from larger organizations in more ways than just
for large publicly traded companies—is defined as size. To be effective for SMEs, a governance framework
the structures and processes by which companies are must include the additional complexities that are part of
directed and controlled. It focuses on the interaction their nature.4
among three key decision-making bodies: shareholders,
board of directors, and management. (See Figure 1.1.) For example, corporate governance in large organizations
is often associated with the “principal-agent” issue,
Shareholders own assets, provide capital to the in which the interests and incentives of the agents
business, and appoint the board to oversee it. The board (managers) may not be perfectly aligned with those of
sets strategic direction, supervises the performance the principals (shareholders). However, in the in the early
of management, and reports to shareholders on its stages of SMEs, the issue is less likely to arise, and when
stewardship. Management uses the assets and capital they evolve further, the principal-agent problem takes
provided by the shareholders to realize a positive return on a different form. The majority shareholder typically
for them, and reports on its performance to the board. remains involved in operations as managing director, and
Increasingly, good governance also includes active there is a danger that minority shareholders' interests are
engagement of other stakeholders. not fully respected.

SME Governance: What is it? Why is it important?

Over time, corporate governance codes and guidelines Another way SMEs differ from their larger counterparts
have expanded beyond listed companies and now cover is their highly dynamic nature. Challenges faced by
a broader range of organizations, including family SMEs change dramatically as they grow in size and
businesses, state-owned enterprises, and even charitable as they experience changes in their organizational,
organizations. According to the European Confederation
3
management, and ownership structures.
of Directors Associations (ecoDa), good corporate
governance for unlisted companies “is about establishing a Also, many SMEs operate with less-formal structures,
framework of company processes and attitudes that add policies, and processes. Without some formal
value to the business, help build its reputation and ensure guiding framework—and with key personnel often
its long-term continuity and success” (ecoDa 2010). wearing multiple hats (manager, board director, and
shareholder)—a growing SME faces significant challenges
What Makes SME in the decision-making process in several critical areas,
such as financial management and succession planning.
Governance Different?
Add to this the implications of family involvement
(including intergenerational) at the various levels in

1
Definitions of SMEs vary, but typically they are described the business, and it becomes clear that traditional
as registered companies with fewer than 250 employees governance frameworks need to be adjusted to meet the
(OECD 2005). In some instances, definitions also include distinct needs of SMEs.
revenue thresholds, but these vary widely by country and
industry. For consistency throughout this Guidebook, we Most governance guidance for SMEs has traditionally
use the definition based on the number of employees, amounted to “simplified” versions of practices
which places the vast majority of companies in the recommended for larger companies, but recently there
SME classification. have been several important efforts to change this. For
example, Corporate Governance Guidance and Principles

3 For examples, see IFC Governance Tools at https://bit.ly/2s6wkGq. 4 For helpful insights on this topic, see ACCA 2018.

SME Governance Guidebook 5

for Unlisted Companies in Europe (ecoDa 2010) uses a A better approach is for entrepreneurs to start—early
phased approach, making a distinction between the on—governing their business based on the fundamental
use of a basic framework that applies to all companies, principles of good governance, using the solutions
including the smaller ones, and then more sophisticated and tools appropriate for their company’s stage of
measures for larger and complex organizations. Some development. Good governance is a long journey,
codes and guidelines analyze how the core governance and the sooner SMEs start adopting good
principles can be interpreted for SMEs (for example, practices, the more benefits they can reap along
see IoDSA 2010). Finally, some guidelines go further the way.
and aim to account for the heterogeneity of SMEs by
varying recommendations depending on key company Good governance is not a panacea for all of the
characteristics, most commonly size, organizational problems SMEs face, but studies have shown that it is an
complexity, and shareholding structure. For a great undeniably important ingredient for their success (OECD
example of this approach, see HKIoD 2009. 2010).5 Conversely, research findings consistently show
poor governance practices to be directly linked to poor
IFC has built on this foundation by adding another business performance, fraud, and catastrophic failures.
element—firm growth. As a development institution,
IFC strives to help SMEs not only survive but also grow Implementing good governance practices helps SMEs
and prosper. IFC developed the SME Governance address a number of the distinctive challenges (ACCA
Matrix, presented in Chapter 2, which serves as the 2015; ecoDa 2010). For example:
basis for this Guide. It is a growth-oriented governance
model, which tailors governance recommendations to XX Effective policies, structures, and processes help
evolutionary stages of SME growth. The governance reduce overreliance on a few “key persons."
tools in this Guidebook do not push entrepreneurs
toward common “best practices.” Instead, entrepreneurs XX Companies with sound governance have better access
learn how to identify the stage of development of their to finance, as they appear more attractive and less
business and to find practical governance solutions that risky for investors and banks.
are coherent and practical for their stage—to promote
the further sustainable growth and long-term success of XX Family-run businesses increase the chances of
the business. long-term survival through proactive succession
planning and managing the family-versus-business
relationship.
Why Bother? The Benefits
of Good Governance for SMEs XX Prudent governance reduces risks and improves the
managing of conflicts among various shareholders
and stakeholders
SME business owners often delay improving governance
until some point in the future—when they’re “big XX Well-structured management bodies (and later,
enough.” As a result, these businesses miss out on key boards of directors) provide critical stewardship,
tools and solutions that could improve their competitive strategic direction, and business connections for
survival and growth. Also, delaying implementation of sustainable growth.
governance until the business is large and fully formed
can mean that, when that implementation does come, XX Good governance is a common regulatory prerequisite
the business may find the process to be a radical and for an IPO (initial public offering).
disruptive shock.
5 For instance, see Brunninge et al. 2007 and Abor and Biekpe 2007.

6 Chapter 1: SME Governance: What Is It? Why Is It Important?

XX Prudent internal controls help companies enhance risk governance threshold for investment decisions (Khanna
management and build greater resistance to fraud, 2010). Moreover, good governance allows entrepreneurs
theft, and mismanagement. to receive substantially more money for shares in
their companies. In the same survey, 100 percent of
XX Good governance practices help the founders recover respondents indicated that they would pay a higher
some freedom in their lives. They can control and investment premium for well-governed firms in emerging
direct the business without having to be directly markets; 55 percent said they would pay at least 10
involved in all operational decisions. Well-governed percent more, and 38 percent were willing to pay 20
companies attract and retain higher-quality staff that percent more for well-governed companies.
the founders can rely on.
These findings support a 2015 report indicating that
MENA6 institutional investors identified good investee
governance as one of the top three challenges for the
Good Governance industry (IFC 2015b). They also noted the effects of good
Is a Good Investment governance on their investee clients. For example, one
investor cited a recent strategic sale exit that attracted
a 40 percent premium over market price, due largely to
Access to finance is a key constraint to SME growth. good governance. A technology investee company of

SME Governance: What is it? Why is it important?

SMEs are less likely than large companies to secure bank another investor increased its profitability by 20 percent
loans and instead rely on internal or “personal” funds to over a two-year period as a result of improvements at the
launch and initially run their enterprises. According to board level and several changes in management control.
one study, “about half of formal SMEs don’t have access to
formal credit” (World Bank 2018). In summary, improving governance practices upgrades a
firm’s performance, enhances risk management, builds
One key way an SME can increase its access to finance trust among stakeholders, and increases the ability to
is by strengthening its governance practices. Further, access outside capital. That’s why investors are willing to
SMEs interested in attracting investors can use better pay a premium for well-governed firms—and to dedicate
governance as a core value proposition. Various providers energy to improving the governance of companies they
of risk capital for SMEs, such as private equity and have already invested in.
venture funds, understand that good governance means
greater security as well as better return on investment.

Today, an increasing number of investors include

good governance criteria as part of their investment

1
determination process. In a 2010 IFC survey of
institutional investors in emerging markets, 41 percent
stated that their companies had a certain minimum 6 MENA = Middle East and North Africa region.

SME Governance Guidebook 7

 NEXT: Chapter 2 takes a close look at the evolution
of SMEs and introduces the overall framework for
building sustainable, well-governed businesses.

8 Chapter 1: SME Governance: What Is It? Why Is It Important?

 Chapter 2
SME Governance Framework

SME Governance Guidebook 9

 2. SME Governance Framework

At the end of this chapter, you will be better able to do the following:

XX Understand some of the typical driving forces behind SMEs’ progression from one
stage to another.

XX Identify the stage of development for your own business.

XX Understand the overall framework of recommended governance to support your

company’s development.

THIS CHAPTER defines the stages of growth for SMEs, plus governance-
related risks and opportunities associated with each stage. It provides
a tool to help you determine the stage of growth for your own business.
Then it introduces the SME Governance Matrix, which summarizes key
governance actions recommended for each stage of SME development.

10 Chapter 2: SME Governance Framework

SME Stages of Growth: Figure 2.1: The Four Stages of SME Evolution

How Is My Business Evolving?

Stage 1

At the end of this section, you will be better able to do the following:

XX Differentiate between the different evolutionary stages of SMEs.

XX Identify your business’s primary stage of development.

START-UP
BUSINESS
XX Appreciate the needs and risks associated with each SME stage.

XX Discover the role of governance in mitigating stage-specific risks.

Stage 2
There is a lot of literature on the topic of company growth and
evolution, largely under the broad umbrella of organizational
lifecycle models.7 Although there is no academic agreement on
the number, the sequence, and the movement of stages, there is
broad consensus that the conditions vary along similar patterns as
the SMEs grow, and that there are common challenges at various
stages of their development. ACTIVE
GROWTH
This means that over the life of their business, SME owners will
experience definitive moments when critical decisions have to be

SME Governance Framework

made to move the business to the next level. Owners should view
governance as an evolutionary process, where the systems and Stage 3
processes need to remain fit for purpose as they progress along
with the business.

Based on our analysis of the literature, as well as IFC's own SME

advisory experience, we suggest that you think of successful SMEs
as evolving through four distinct stages of growth. (See Figure
2.1.) Stage transitions—from Start-Up to Business Expansion—are
ORGANIZATIONAL
DEVELOPMENT
defined not only by traditional factors, such as ownership

2
structure, size, and the enterprise focus, but more importantly by
the increasing internal complexity that comes with growth. No
single factor defines the exact point of stage transition, but rather Stage 4
the combination of stage characteristics will indicate the SME’s
primary evolutionary stage. It’s also important to note that the
stages are dynamic—a company might be “between stages,” in the
process of moving from one stage to another.

For short and practical literature reviews on the topic,

7  BUSINESS
we recommend Matejun and Mikoláš 2017 and Nordstrom EXPANSION
et al. 2012.

SME Governance Guidebook 11

Transition points between SME stages are often present risks commonly associated with each stage—
identifiable by the way they push the owner into from the perspective of the enterprise and of potential
making decisions that are beyond “business as usual.” external investors that might be needed to fuel further
In Stages 1–3, the catalyst for these changes is most growth. We then demonstrate that by adopting stage-
often the increasing business complexity precipitated by appropriate governance practices, owners can mitigate
exponential growth. In the later stages (Stages 3–4), the (take actions to minimize or eliminate) these risks and
transition is usually stimulated by a significant change in help the company move to the next stage.
ownership (for example, a new shareholder, investor).
Note that this stage-progression narrative presents an
In the following pages, we will take a closer look at optimistic scenario. In practice, stagnation and even
each evolutionary stage, using the Rockstar Clothing decline can happen at any stage and for a variety of
Company as an illustration. The SME stage scenarios will reasons, including failure to address governance risks.

Stage 1: Start-Up

Case Study: Rockstar Origins

It’s 1985, and Rami Bahgat is starting a clothing venture, Rockstar Clothing Company.
It will specialize in men’s casual and formal wear. Its business model is to create the
designs in-house, outsource the production and dying of cloth, and distribute the end
product. Rockstar’s ownership is confined to Founder/Chief Executive Officer (CEO)
Rami Bahgat and his wife (controlling share) and a couple of minority shareholders.

Rami is developing his product line and testing various designs on the market. The
team is small, with his wife providing the main support. Everyone pitches in as
needed to keep things moving. There is a board of directors, as was required by law,
but it is purely a formality.

In fact, Rami personally controls every aspect of the business and is designing the
business systems as he goes along, making all decisions, and doing whatever it
takes to meet customer demands.

In Stage 1: Start-Up, SMEs are focused on product development and testing the markets. With
this single-minded focus and limited resources, SMEs typically put little effort into organizational
development. At this stage, operations are pretty straightforward and simple, encouraging an
informal and agile approach to managing them.

12 Chapter 2: SME Governance Framework

 The management style is individualistic—the owner and the business are effectively one and
the same. The business is growing organically, with systems designed “on the go,” and distinct
roles are defined as individuals lend a hand, as needed, to get the job done.

At this stage, the owners/managers are required to be primarily entrepreneurs—having the

overall vision and making new things happen. They thrive in the unrestricted nature of Stage 1
operations—with its flexibility, open communication, and generally informal business approach.

Risks for the enterprise

The informal nature of an SME at this stage may lend itself to a rush to implement rules, systems,
and procedures that can inadvertently slow the company’s product development and agility.
Premature moves to do too much delegating may lead to the founder’s loss of control. On the
other extreme, a complete refusal or inability to start delegating may lead a founder to become
dictatorial and to fail to make good use of the company’s managerial and technical talent. There
is also the risk that the founder will not communicate effectively, leading to information gaps in
the team. Also, Stage 1 SMEs often have long-term investment goals but short-term financing
capabilities, which can spread cash and resources too thin and increase uncertainty.

Risks for external investors

Investors are concerned that start-ups don’t intend to develop accountability structures and
don’t have in place even the most basic systems and policies. Related to this is the risk that the
founders are making all of the decisions and aren’t seeking advice on business strategy from a

SME Governance Framework

third party, or even internally. Overreliance on the founder creates a big key-persons risk. Another
factor is a mixing of family and business interests. This brings an increased emotional component
which tends to result in a lack of clarity or transparency in decision making, especially in financial
matters. Also, communication about business performance can be biased and unreliable;
founders may not be ready to include other shareholders in the business.

Focus of mitigating actions

An SME can begin to address these risks by adopting informal mechanisms for incorporating
external advice, implementing cost-effective systems for cash flow management, identifying

2
core functions needed for further growth, and starting a gradual shift toward more inclusive
management and longer-term strategic thinking.

Stage Transition: Stage 1 to Stage 2

Once the SME develops and tests a successful product or service offering, selling becomes
the number-one priority. Despite the transition from Start-Up to Active Growth being
highly desired by an SME owner/founder, it is often essentially unplanned. In fact, the
business may begin ballooning with increased staff numbers but little or no change to the
business structures and processes.

SME Governance Guidebook 13

 Stage 2: Active Growth

Case Study: Rockstar Today

As of writing of this Guidebook, it has been 32 years since the establishment
of Rockstar Clothing Company, which now has 12 stores across Egypt and 60
employees working in a number of functional departments: stores, finance,
accounting, warehousing, and administration. The company reported a sales
turnover of 10 million Egyptian pounds ($1.5 million). Rami’s vision is for
Rockstar to have 100 outlets across Egypt in 10 years.

The company has a basic organizational chart but with no job descriptions or
reporting lines in place. Rami has admitted to running a “one-man show” but
feels he has little choice, given the reported “lack of good staff.” Aside from
his son, Sherif (the merchandising executive), he consults only with the sales
manager, Mahmoud. Interviews to hire a professional human resources (HR)
manager have been unsuccessful thus far. Also, his son sees his own role in the
business as temporary, and he has shared his view that his father is a better
designer than manager.

Monthly senior manager meetings (when they occur) are informal and focus on
operational issues only. But with an eye on sales, Rami meets frequently with
Mahmoud, who says incentives are offered to staff to stimulate sales, but the
company has never communicated how these are calculated.

The company set up a basic system of checks and balances for monitoring
inventory, but a physical inventory is performed only once a year, at best. No
major internal discrepancies have been identified, but there is concern over
cash flow shortages and payment defaults, because of high inventory.

When asked about the vision of the company’s future, neither the senior
managers nor the staff were aware that Rockstar even had a vision—or a
strategy to implement it. With no concrete business plan and poor cash flow,
it will be a real challenge to finance an expansion and hire sorely needed
professional staff.

14 Chapter 2: SME Governance Framework

 By Stage 2: Active Growth, the basic product offering has been developed, and SMEs are
focusing on sales, sales, and sales! The company is rapidly growing in size and complexity.
However, this growth often remains largely “organic” and unplanned—it is based on a broad
“vision” but with little attention to the development of a defined strategy .

Risks for the enterprise

Companies struggle to balance the need for flexibility with the growing demand for strategic
focus, defined structures and policies, and effective controls.

HR issues become increasingly apparent. Companies often build structures, functions, and
processes around available people as opposed to hiring specifically qualified people to perform
predefined functions. With the rush to meet rising demand, SMEs often hire too many employees
and draft people into roles outside of their current qualifications. Reporting lines, authorities,
and responsibilities remain vaguely defined.

At this stage, the business already has a track record of success, and that can lead the CEO to
become overconfident and to lack focus in decision making. There is a lot going on! With the
formation of functional divisions, growing staff, changes in products and services, and new
opportunities for growth, the founders can find themselves pulled in various directions as they
struggle to hold onto control and focus on strategic development.

A common complaint in this stage is the limited or “silo” approach to communication, where
there’s good communication within departments and functions but limited communication

SME Governance Framework

between them. Internal controls begin to emerge to deal with increased delegation and
company size and complexity, but they remain rudimentary.

Risks for external investors

Unclear systems and policies are a major risk factor; and with the excessive concentration
of power in the founder/CEO, the key-person risk remains high and internal company checks
and balances can be ineffective. The risk of unequal treatment of some shareholders is also a
major concern.

2
Focus of mitigating actions

Governance practices recommended for this SME stage focus on developing basic organizational
structure and processes. The company also needs to start defining its approach to operational
and strategic decision making. The founder/CEO has to learn to delegate and to consult
with key personnel and external advisers—even if on an informal basis—before making
important decisions. Internal controls need to be introduced to promote accountability and to
secure assets.

SME Governance Guidebook 15

 Stage Transition: Stage 2 to Stage 3

After focusing on the product in Stage 1 and sales in Stage 2, the owner, driven by the
challenges of increasing business size and complexity, realizes it is time to invest in
developing the company itself: Stage 3.

The owner notices that sales growth may have slowed down while the company has
grown dramatically, with new divisions, products, and people. The internal structure,
policies, and practices have remained similar to what they were when the company was
small. Therefore, the transition to Stage 3 often comes with the owner’s realization that
he or she can no longer control and manage it all.

Stage 3: Organizational Development

Case Study: Professionalizing Rockstar

Based on the action plan provided to the company by IFC Corporate Governance
Services, Rami has taken action to professionalize Rockstar as he pursues his
vision for dramatic expansion. Heeding his son’s advice, he has relinquished
operational control of the company to his new chief operations officer,
Mariam Awad. He can now focus on what he does best—design—as well as on
developing Rockstar’s long-term strategy, giving Mariam and her executives
full responsibility for operational decision making. With a more collaborative
approach to management, Mariam meets weekly with her team, ensuring
effective communication across departments.

Rockstar’s internal controls have also been substantially upgraded, including

the introduction of inventory and sales monitoring and a dashboard system
that allows Rami to get a high-level snapshot of the company’s performance.

Three years after Rami started professionalizing the business, he successfully

negotiated a much needed investment from Sandstone Equity Group. It
provided the capital, as well as business connections, necessary for expansion.

16 Chapter 2: SME Governance Framework

 In Stage 3: Organizational Development, SMEs are working on professionalizing their structure
and processes, after having passed through the period of initial growth in Stage 2.

Characteristic at this stage is the increasing need for professional management, specialized
expertise, and proper systems and controls. HR becomes strategically important as the SME
aims to hire professional staff and optimize organizational structure and policies.

Risks for the enterprise

At this stage, the company is coming off of a dramatic growth period, with largely expanded staff
and product offerings, but its internal structure, policies, and processes remain rooted in the start-
up stage. Therefore, this stage lends itself to many inconsistent practices. For example, incentive
systems may not correlate with the company’s performance, and policies often are not followed or
sometimes are excessive.

This stage is often very hard for the entrepreneur, as it requires good management and administrative
skills, in addition to entrepreneurial skills that fueled the company at Stages 1 and 2. It is possible to be
a great entrepreneur and bad administrator, and vice versa.

Staff-related issues are common. Professionalization of management may lead to conflicts

between “old” and “new” teams. Ongoing organizational, staff, and operational changes may
affect employee morale and motivation. As the business begins to operate less on personal
relationships and more on defined policies and procedures, some may find the transition difficult.

SME Governance Framework

SMEs in this stage may experience frequent power shifts or changes in key management
positions; decentralization and delegation may be unstable or unclear. Checks-and-balances
risks may include the lack of controls and accountability and an excessive focus on process.

Risks for investors

In this stage, investors are wary that the professionalization is not complete and personal
relationships prevail. It can also happen that, despite having formal checks and balances in
place, there is the risk of continued direct interference by the founders to “check and control”
the business, bypassing the new structure and policies in the process. The focus on internal

2
development can—and often does—lead to a slowdown in growth and decision making. Another
possible red flag is family members crowding out professional staff.

Conflicts may arise between founding partners, new management, and investors, which can be
heightened by poor communication between these parties.

Focus of mitigating actions

Governance practices support the need for good administration, documentation of processes
and procedures, structured decision making, and professional management. The owners must

SME Governance Guidebook 17

 either develop management and administration skills or hire and empower people who have
them, such as a chief operations officer.

Overall, the decision making needs to become more decentralized and collaborative. For
example, an executive body, often called the executive board or committee, meets regularly
to coordinate activities and help the CEO handle operational decision making, and to provide
periodic input into strategic decisions. Also, a formalized advisory board may support the
owner/CEO on strategic issues.

Systems that provide proper checks and balances need to be formalized, and the company should
establish an internal audit function.

Stage Transition: Stage 3 to Stage 4

With systems and processes in place, good administration, and professional
management, a Stage 3 SME is now a more professional business and is ready to focus on
further growth. Internal capacity itself, however, is not enough for business expansion:
the company needs capital. This prompts many entrepreneurs to reach out to external
investors—either related, such as family and friends, or professional, such as private
equity funds. New shareholders will require effective governance mechanisms—such as
a functional board of directors—for the control and direction of the company. Stage 3
focused on improving management; in Stage 4 the emphasis is on governance.

Another driver for stage transitioning might be that the founder is getting out of the
active management role for personal or business reasons—to start a new company, to
hire a professional CEO to manage further business expansion, to pass the baton to the
next generation, and so on. Even if the business remains in the same hands, the need for
better governance may arise.

Finally, businesses increasingly choose to establish a board of directors and other

governance mechanisms, even if no change in ownership structure is imminent. They
realize that a professional board brings valuable expertise, diverse perspectives, and
business connections—crucial ingredients for sustainable growth.

18 Chapter 2: SME Governance Framework

 Stage 4: Business Expansion

Case Study: Rockstar Business Expansion

In the famous founder’s dilemma, “to be king or to be rich” (Wasserman 2008),
Rami chose the latter. Instead of tightly holding onto a small company, he opted
to fuel the growth with external investors and cash in. Rami, now retired, is no
longer involved in the day-to-day operations of the company but rather sees the
years he invested in the organization reflected in his dividends and rising value of
the company.

Rockstar Clothing Company has become an institution with defined governance

processes and procedures. The board of directors has fully taken up its role of
providing strategic oversight, and Mariam, formerly the COO, has been promoted
to CEO. Sandstone’s representative now has a seat on the board of directors. Rami
continues to chair this more professional board, as he and his family members
remain controlling shareholders.

SME Governance Framework

With all systems and controls in place, including having external auditors providing
third-party assurance, the business has achieved more than Rami had envisioned.
He’s especially proud of his grandson, Asaf, who was hired by the company after
completing his college degree. Rami hopes that one day a member of the Bahgat
family will again be at the helm of the organization. However, with the new
employment policies, Asaf will have to work his way up—like any other high-
potential employee.

2
In Stage 4: Business Expansion, SMEs start resembling large companies in business structures,
management, and governance practices. The decision-making style within the organization can be
defined as institutional, and companies enter the territory covered by the traditional connotation
of “corporate governance.”

Risks for the enterprise

Too much administration, with decision making concentrated on processes and not on growth,
runs the risk of bureaucracy. Increased reliance on hard, measurable data minimizes the role of
judgment and can adversely affect decision making and agility. Management may become risk

SME Governance Guidebook 19

 averse, reducing entrepreneurial drive, innovation, and creativity. There also is a risk of increasing
overhead as a percentage of revenues.

Risks for investors

In Stage 4, there is the risk that the professional management team that the company hired is
just “window dressing,” with control still resting with founders and family members. If suitable
assurance is not in place and not independent of management, investors will be wary.

Tensions may arise from unequal treatment of shareholders and employees—for example, between
family members and non-family members.

For family-owned SMEs, the company may lack a clear strategy to distinguish between employment and
ownership, leading to growing tensions within the family as well as the business.

Focus of mitigating actions

The practices presented for this SME stage provide support for building “traditional” corporate
governance structures and policies (such as a board of directors) to balance interests of various
shareholders, to bring in new expertise and perspectives, and to support development of long-term
strategy. If there is a change in ownership structure, external investors will expect to have a “seat
at the table”—representation on the board of directors—which of course will influence how the
company is managed.

External investors and professional boards require strong risk management, good internal controls,
and reliable financial and nonfinancial reporting.

Tool: Identifying My Company’s the earlier stage) before moving to the requirements for
Stage of Evolution the next one.

Table 2.1 assumes that investors are most likely to join

Table 2.1 summarizes the evolution of SME governance the company when it has demonstrated its potential for
over the four stages of SME growth. When using it to growth—Stage 3, or late in Stage 2. The entry of external
identify your company’s stage of growth, please keep investors has a profound impact on how the company is
in mind that the elements in each stage (column) are governed and managed. However, investors can enter
interrelated; so if a company is between stages (or has at any stage, including Start-Up, which would typically
features of several stages), it is important to select the imply an accelerated push toward Stage 4 regarding the
earlier stage designation as the primary SME stage. You key governance practices. (For more on the investor’s
need to address the risks in the lagging categories (from perspective on SME governance, see Box 3.2 on
page 39.)

20 Chapter 2: SME Governance Framework

Table 2.1:

Evolution of SMEs
Defining Factors/ Stage 1 Stage 2 Stage 3 Stage 4
Parameters START-UP ACTIVE ORGANIZATIONAL BUSINESS
GROWTH DEVELOPMENT EXPANSION

Size* Small Small to Medium Medium Medium Growing

(# of employees) (e.g., <50) (e.g., 50–75) (e.g., 76–150) (e.g., 151–250)

Enterprise Focus Developing products, Sales and growth, Optimizing own Further growth,
testing the market increasing variety of structure/processes after supported by improved
products, creating client growth internal organization and
base processes

Culture and XX Small multitasking team XX Team is growing— XX Increased XX Continuation of trends
Commitment to XX High degree of informality distinct functions and professionalization of started in Stage 3
Good Governance organizational structure functions
XX Few systems, established
(Policies, processes, start emerging XX Formalizing
“on the go”
and organizational XX Simple systems to enable organizational structure,
structure) functions to collaborate policies, and procedures

Decision Making and XX Highly centralized XX Emergence of delegation XX Professional managers XX Separation of strategic
Strategic Oversight decision making by the to management are hired and operational decision
founder(s) XX Consultative leadership XX Decentralization of making
(Decision-making
process and bodies, XX Autocratic leadership style—largely autocratic authority through division/ XX Institutional decision-
leadership style.) style but with input from key functional management making style, based on
managers and advisers XX Collaborative defined org. structure,
management style roles, and procedures

SME Governance Framework

Risk Governance XX Founders are fully XX Introducing internal XX Detailing authorities and XX Focus on proactive
and Internal Controls involved in operations— controls to support accountability and strategic risk
(Internal checks and limited need for checks delegation of authority XX Systems are formalized management
balances) and balances and automated
XX Developing practices to
control main operational
risks

Disclosure and XX Everyone knows XX Silos—good within, but XX Internally: improving XX Internally: management,
Transparency everything challenging between silos cross-divisional / board, and shareholders
(Communication with XX Basic external info shared functional information communicate
internal and external on products offered sharing XX Externally: targeted
stakeholders) XX Enhanced external information for different

2
business-related stakeholders
information

Ownership XX Single owner or couple of XX New minority XX New minority XX Common options:
(Founders/ individuals shareholders possible shareholders possible a. Founders, private
Shareholders/Family) XX Founders personally (internal or related) (internal or related) equity, and other
control every aspect of XX Founders remain XX New investors informally investors
business dominant and fully influence strategy but are b. G
 rowing family
engaged not directly involved in ownership/
XX Increasing number of operations generational change
family members getting XX (If a major investor enters, c. G
 o Public (IPO)
involved in operations company moves to
XX Investors require tools for
Stage 4)
control and direction of
the company.

* May vary by industry, so this guidance is intended to be broadly indicative.

SME Governance Guidebook 21

SME Governance Matrix: issues related to risk management and
Identifying Recommended control, cash flow management, information
technology (IT) management, and internal
Actions for My Company
and external audits.

At the end of this section, you will be better able to do the D Disclosure and Transparency covers both
following: financial and nonfinancial disclosure to
investors and other key stakeholders.
XX See how cumulative governance recommendations
address enterprise risks at each stage. E Ownership addresses the policies and
mechanisms that support the rights and
XX Understand the big picture of how governance evolves responsibilities of shareholders. It includes
together with the company. the rights of founders and family members,
organization of the annual general meeting,
The SME Governance Matrix is a comprehensive and shareholder dispute resolution.
framework that aims to address typical risks for the
enterprise and its investors at each stage of SME The five topics covered in the SME Matrix draw on the
development. The idea is to help a company develop IFC Corporate Governance Framework, which has
smoothly and gradually, always focusing on what is been adopted by more than 30 development finance
appropriate at its given evolutionary stage. The Matrix institutions worldwide. The IFC Corporate Governance
summarizes key mitigating actions along the following Framework, in turn, is based on the OECD8 Corporate
five key governance topics: Governance Principles (OECD 2015). Therefore, SMEs
working with the IFC SME Governance Framework will be
A Culture and Commitment to Good able to naturally graduate into “corporate” governance as
Governance covers owners’ awareness, they become large companies.
demonstrated commitment, and values, such
as having an organizational structure and key It is important to keep in mind the following points:
policies and processes in place.
XX Table 2.2 is an abbreviated version of the Matrix,

B Decision Making and Strategic Oversight providing a general overview (details provided in
demonstrates how decision making Chapter 3).
needs to evolve from a one-man show to
become collaborative and institutional. It XX The recommendations for each topic are cumulative—
introduces the instruments for organizing the they build on the actions of the previous stages.
management team—and later the advisory
board and the board of directors. Human XX The contents of the five governance topics for each
resources and succession planning also need stage are designed to be interdependent and mutually
to be addressed here, because SMEs typically reinforcing. A company should move through the
have few decision makers, which presents a Matrix column by column. It is important for the five
high key-person risk for the company. topics in each given stage be addressed before the
company embarks on the next stage, to ensure that
C Risk Governance and Internal Controls the associated risks are addressed.
starts with the big picture—the overall control
environments as indicated by the company’s
culture and values—and considers specific 8 OECD = Organisation for Economic Co-operation and Development.

22 Chapter 2: SME Governance Framework

Table 2.2:

SME Governance Matrix

Key Governance Stage 1 Stage 2 Stage 3 Stage 4
Topics START-UP ACTIVE ORGANIZATIONAL BUSINESS
BUSINESS GROWTH DEVELOPMENT EXPANSION

XX Core functions identified XX Core positions filled XX Governance champion XX Governance action plan

A XX Articles of association
adopted
XX Organization chart, key
policies, and statement of
XX TORs for key positions XX Company secretary function
XX Core processes documented XX Governance provisions
Culture and basic business principles XX A calendar of corporate incorporated in the articles
Commitment to events of association and bylaws
Good Governance

XX Informal external advisers XX External advisers formally XX Continuous and structured XX A board of directors

B involved*
XX Founder(s) make decisions XX
engaged
Key decisions are made XX
outside advice is engaged
Enterprisewide discussions
XX Board procedures ensure
effective meetings and input
in consultations with in collaboration with on strategy, financing, from all directors
Decision Making
individual executives executives as a group staffing XX Succession-planning policy
and Strategic
XX Authority limits of key XX Limited delegation of XX Executive/management has been approved by the
Oversight personnel have been signing authority formalized (or similar) committee board
communicated XX Staffing priorities identified formalized
XX Business continuity plan for XX HR policies to attract,
CEO and key persons retain, and motivate staff
XX Succession planning
framework for key persons

XX Basic bookkeeping, cash XX Basic principles of business XX Detailed code of ethics and XX Effective internal controls

C flow management, and tax

functions
conduct
XX Basic business risks— XX
business conduct
Objectives, strategic
systems (e.g., based on
COSO)
XX Cash sources, bank accounts including key-person risks— planning, budget, KPIs, and XX Independent external
Risk
are separate from those of identified clear accountabilities auditors
Governance
the founder(s) XX Processes in place for tax XX A professional CFO XX Timely and secure recording
and Internal
XX Basic understanding of payments, records, and XX A basic internal audit and reporting for sales and
Controls
regulatory requirements and filing function accounts
compliance XX Controls on cash XX Policies and procedures
management to monitor and mitigate

SME Governance Framework

strategic and operational risks
XX Business units have clear
authority, reporting lines,
and guidelines

XX Basic financial accounts XX Monthly bank account XX Financial statements in XX Financial reporting for SMEs

D prepared
XX The same financial
reconciliation disclosed to
all founders
accordance with national
accounting standards
is in accordance with the
IFRS or U.S. GAAP (if having/
information and data are XX Founder(s), shareholders, XX Point person for information seeking foreign investors)
Disclosure and
used for all purposes and directors periodically sharing identified XX Financial statements are
Transparency
receive consistent XX Key decisions are formally audited by a recognized
financial and nonfinancial communicated to all staff auditing firm
information XX Basic performance reports XX Quarterly financial reports
XX The public profile of the are presented to external and comprehensive
enterprise has been advisers performance reports are

2
developed XX Key nonfinancial provided to investors
information is disclosed to XX An annual report (or
the public equivalent) is produced.
Shareholders are provided
with information on request

XX The role and responsibilities XX The difference between non- XX Clear distinction between XX Policies and mechanisms to

E of the founder(s) clearly

established
family and family issues is
acknowledged
the roles of the founder(s),
family members, and
regulate family members’
ownership, employment,
XX Basic understanding of XX Awareness of family managers and other benefits
Ownership
roles of all founding family succession planning XX Clear career paths for non- XX All shareholders are
members XX Annual shareholders’ family executives regularly updated on
XX Shareholder dispute meetings XX Family succession plan company policy, strategy,
resolution mechanism XX Annual shareholders’ and results
meetings include XX Mechanism for resolving
discussions of key decisions governance-related disputes
made, dividends, and plans

* Some jurisdictions require a board of directors at the time of company registration. Such boards are often just a formality. This Matrix does
not assume the board to be effectively functional until Stage 4.

SME Governance Guidebook 23

 XX The table is generalized for all markets and types For this governance topic, a Stage 3 SME would
of companies. Its relevance for specific companies consider the following leading practices for Stage
may vary. Use your judgment and/or professional 3 (building on the two previous stages): articles of
advisory services to identify recommendations association adopted; core functions identified; core
relevant for your company. positions filled; organization chart, key policies,
and statement of basic business principles adopted;
XX The Matrix acknowledges that the family of the governance champion identified; TORs (terms of
founders is an important factor to be addressed, reference) for key positions developed; core processes
regardless whether the SME considers itself a documented; and a calendar of corporate events
family business. adopted.

XX Some of the issues addressed in the Matrix, Also, given that the governance topics are
especially at Stages 1–3, relate more to interdependent, these practices for improved Culture
management than to what is traditionally and Commitment to Good Governance must be
understood as “governance.” This is intentional. accompanied by the related practices for the other
Certain management issues need to be addressed four governance topics. For example, a company in
before governance can start to be effectively Stage 3 will see increased delegation (B. Decision
implemented. These might be called “pre- Making and Strategic Oversight), which must be
governance” issues. supported by improved internal controls (C. Risk
Governance and Internal Controls) for effective
To illustrate the cumulative nature of the accountability.
recommended practices, let’s look at the key
governance topic A. Culture and Commitment to
Good Governance.

NEXT: Chapter 3 “expands” the SME Governance Matrix. It

provides a detailed explanation of each governance topic and
discusses related recommended actions in more detail.

24 Chapter 2: SME Governance Framework

 Chapter 3
Key Governance Topics
and Leading Practices

SME Governance Guidebook 25

 3. Key Governance Topics and
Leading Practices

At the end of this chapter, you will be better able to do the following:

XX Understand key governance topics and related concepts.

XX Learn about stage-appropriate governance practices for your company.

THIS CHAPTER looks into select governance concepts and practices

presented in the IFC SME Governance Matrix (shown in Table 2.2
on page 23). These leading practices lay the groundwork for action
planning. SME owners will be able to see what elements are missing
or lagging and can plan the actions necessary for building a more
resilient SME from the perspective of good governance.

NOTE: The Appendix of this Guidebook provides worksheets to support this process.

26 Chapter 3: Key Governance Topics and Leading Practices

 A
Culture and Commitment to Good Governance

“Good corporate governance is about ‘intellectual honesty’ and not just sticking to rules and
regulations, capital flows towards companies that practice this type of good governance.”

—  Mervyn King, Chair, King Report

Stage 1 Stage 2 Stage 3 Stage 4

Culture and Commitment to Good Governance

START-UP ACTIVE ORGANIZATIONAL BUSINESS
BUSINESS GROWTH DEVELOPMENT EXPANSION

XX Core functions identified XX Core positions filled XX Governance champion XX Governance action plan
XX Articles of association XX Organization chart, key XX TORs for key positions XX Company secretary function
adopted policies, and statement of XX Core processes documented XX Governance provisions
basic business principles incorporated in the articles
XX A calendar of corporate
events of association and bylaws

The SME owner needs to demonstrate that corporate Similarly, organizational structure can be very informal
governance is important and integral to the company’s at the Start-Up stage and then evolves into a formalized
sustainable development. This should be done through structure with authorities and responsibilities defined by
addressing the following topics: appropriate policies and processes.

A
XX Owner’s Awareness and Commitment to good
governance Owners’ Awareness and

3
Commitment
XX Appropriate Organizational Structure

XX Key Policies and Processes The ultimate success or failure of the business is highly
dependent on how the owner develops needed skills and
Owners’ awareness and commitment starts with the adjusts his or her priorities as the business grows. Here
owners’ demonstration that they are ready to play by are some contributing factors (Churchill and Lewis 1983):
the rules through basic formalization of business in
Stage 1. As the company becomes more complex, there XX Owner’s goals shift from a personal focus to
is increased emphasis on formalization of processes and sustainability and profitability.
on setting the right vision and culture for the company.

SME Governance Guidebook 27

XX Owner’s operational abilities shift from directly (discussed in Decision Making and Strategic Oversight
managing all operational matters to overseeing and starting on page 34), and to support professionalization
supervising operational matters. of the business through developing its organizational
structure as well as appropriate policies and processes.
XX Owner’s managerial ability shifts from command and
control to leadership.
Organizational Structure
XX Owner’s vision shifts from the short term to the
ability to reconcile long-term strategies with
implementation constraints. Organizational structures vary considerably, depending
on the industry, the sector, and multiple other factors.
As a business moves from one stage to the next, the changing The following are two overarching organizational
nature of these managerial challenges becomes apparent. circumstances that support successful SME evolution:

Typically in a Stage 1 SME, the owner is the business. The XX Companies evolve from fluid and highly centralized
founder is both a visionary entrepreneur and a “jack of all organizational structures to well-defined and
trades,” operating with few or no formal procedures and decentralized firms, with clearly defined roles,
with the support of family, friends, and a few dedicated responsibilities, reporting lines, and authorities.
employees. Start-ups are built on the owner’s dreams and
talents: the ability to sell, produce, invent, innovate, or XX Processes change from supporting multitasking
create. The owner’s ability to delegate is not a priority. teams to supporting defined, specialized functions
and collaboration among them.
If the vision of the owner and the conditions are right,
then the business will experience growth. As the business In recent years, the field of research in organizational
continues to grow, so will the level of complexity, structures has evolved and has developed several
resulting in the need for the owner to increase the level innovative propositions to help companies improve
of skills and competencies of the staff. Soon enough, the their performance. As our focus here is on corporate
skills and competencies of the staff will match or even governance, we emphasize one factor: the need for
surpass those of the owner. a dedicated governance champion to establish and
manage the policies and systems for good governance.
During this growth, the owner has to make the transition
from “doing work” to providing entrepreneurial strategic In the early days of an SME, the owner/CEO should
leadership and “getting work done” through others. The have the role of champion, especially when it comes to
owner must realize that the business has grown beyond him communicating the importance of good governance to
or her and must learn to delegate to specialists and other staff and articulating key principles of business conduct.
managers, accept advice from outsiders, and move the As companies approach Stage 3, however, this role will
decision process from individual to more collegial. In fact, increasingly require specialized expertise and good
the inability of many owners to let go of doing and to begin administrative skills. That’s when it makes sense to
managing and delegating is a major reason for the failure or appoint a dedicated executive or the company’s lawyer
stagnation of many businesses before they reach Stage 3. to perform this function. As the company matures into
Stage 4, a fulltime position for a governance champion
This evolution of the role of the business owner from might be warranted; this position is typically called the
operational management to strategic leadership company secretary (also known as corporate secretary,
requires the owner to create and empower the governance professional, or corporate officer in some
appropriate management and governance bodies markets).

28 Chapter 3: Key Governance Topics and Leading Practices

The company secretary’s duties are wide-ranging and XX Shareholder and other stakeholder
typically include the following: relationships: The company secretary plays a
pivotal role in ensuring proper communication and
XX Scribe: taking minutes during board meetings. education, especially in relation to annual general
meetings. The company secretary may also be
XX Compliance officer: (optional) being responsible for responsible for other stakeholder relationships,
ensuring that the business complies with all its legal including those with key regulators.
and regulatory requirements.

XX Adviser and confidante to the board in general Key Policies and Processes
and to each individual director, including the
chair, on all matters of governance. The company
secretary should provide advice on many issues, Most governance-related recommendations on policies
including, among others, conduct of meetings, board and processes9 deal with specific topics, such as human
succession, appointment and removal of directors, resources, internal controls, decision making, and so on,
conflicts of interest, and trends in governance. and will be discussed in relevant dedicated sections of
this chapter. In the context of key policies and processes,

Culture and Commitment to Good Governance

XX Educator and governance leader: taking the lead the practices described below focus on the following:
on issues related to governance, such as ensuring the
adequacy of the governance frameworks. Together XX Raising awareness on the commitment to good
with the chair, the company secretary should ensure governance throughout the company, to staff,
that new directors are properly inducted into the shareholders, and other stakeholders, through key
organization and that there is an adequate and company documents, such as articles of association,
meaningful ongoing professional education program and internal documents;
for directors.
XX Ensuring high ethical standards of doing business,
XX Liaison between board and management: by setting the tone at the top and disseminating a
The company secretary is in a unique position to culture of ethics throughout the company; and
facilitate information flows between the board and
management. For example, the company secretary XX Supporting an increasingly decentralized business
coaches management on meeting the board’s structure by ensuring that there are proper
expectations regarding information and on behaving communication mechanisms and processes for

A
appropriately within a board setting. The company sharing information between units and departments.
secretary also plays a key role in communicating

3
information from the board to management.

9 ACCA has developed a useful and free online tool to help companies
align policies and processes with the organizational vision and
strategy. ACCA Culture-Governance Tool is available at https://bit.
ly/2CHBtcB.

SME Governance Guidebook 29

 A LP
Leading Practices:
Culture and Commitment to Good Governance

Below, we present leading common practices for each SME’s evolutionary stage, using the categories discussed above:

XX Owners’ Awareness and Commitment

XX Organizational Structure

XX Key Policies and Processes

Note that these practices are cumulative: practices for later stages build on the practices of earlier stages. Some
recommendations may be implemented more effectively in different stages, depending on circumstances, or may be
implemented as the company is transitioning from one stage to the next. Use your judgment to determine the best
timing for your company.

Stage 1: START UP BUSINESS

Owners’ Awareness and Commitment

Officially register the business with proper authorities (as a company or sole entrepreneurship) to
ensure separation of the business from the person.

Organizational Structure

Identify core business functions needed, and distribute them among your multitasking team.
At this initial stage, the company is too small for separate departments and divisions, but it is
important to identify the core business functions that need to be managed, such as finance, HR,
marketing, and administration. Assigning responsibility for these functions to team members
increases accountability and facilitates clear communication.

Key Policies and Processes

Adopt the articles of association and any other relevant policy deemed necessary to provide a
minimum structure to regulate the distribution of tasks.

30 Chapter 3: Key Governance Topics and Leading Practices

 Stage 2: ACTIVE GROWTH

Owners’ Awareness and Commitment

Develop a basic statement on vision, mission, and core values and communicate it to staff. Engage
your staff in developing this document, so they feel a genuine sense of ownership in the company
and its future. This statement will also be important in motivating your staff, especially senior
management (see Maximizing motivating factors on page 46), and establishing an effective

Leading Practices: Culture and Commitment to Good Governance

system of internal controls (see Elements of Internal Controls on page 53).

Organizational Structure

Ensure that the core functions needed for the company to grow have been filled through direct
hiring or outsourcing.

Develop clear job descriptions. Remember to include management/reporting responsibilities—

identify whether this position has direct reports and where it fits on the company organizational
chart, and be sure the description is clear regarding accountability (deliverables/results).

Define, document, and communicate to all staff the organizational structure, with lines of
authority and reporting. Share this information with staff as part of the onboarding process for
new employees. Changes that significantly affect individual employees should be shared on an
individual basis.

Key Policies and Processes

Develop or further enhance basic policies, where applicable, to regulate the authority/function.
These policies are key elements of an effective system of internal controls (see Elements of Internal

LP
Controls, page 53). Regarding policies and processes, managers should have ongoing responsibility
for monitoring the practices of the staff under their direct supervision. Develop a process of periodic
discussions with managers to assess the efficiency of the monitoring process and gauge the practices

A
of employees. If needed, take corrective actions to improve either policies and processes or practices.

3
Stage 3: ORGANIZATIONAL DEVELOPMENT

Owners’ Awareness and Commitment

Signal the intent to develop effective governance by discussing its importance with managers
and staff. For a business to practice good governance, everyone has to be on board. It is also key
that the right tone is set at the top, through policies, actions, and communication. In meetings,

SME Governance Guidebook 31

 take the time to talk about good governance and its benefits—to increase awareness and
commitment to implement leading practices.

Articulate and regularly communicate the long-term vision for the company. It will inform
management decisions, guide strategic planning, and serve as a motivational factor for staff.

Organizational Structure

Appoint someone to be responsible for improving governance practices and compliance. This
could be a fulltime position (company secretary) or part-time function for one of the executives
or a lawyer.

Conduct periodic reviews to evaluate the company’s organizational structure and reporting
lines. The organic growth of SMEs may call for these reviews to be more frequent. Include these
reviews as part of the strategic review process, and ensure that any changes are communicated
to staff in a timely fashion.

Key Policies and Processes

Document and regularly review the efficiency of core processes (accounting, procurement,
and so on). Consider whether it makes sense to appoint a person to formally monitor, at the
level of the whole company, adherence to policies and processes. Establish a formal process
of communication between the person in charge of monitoring and the rest of the company,
namely managers, executives, and the owners.

Start producing a simple calendar of company events (team meetings, participation of company
representatives in conferences and public forums, and so on).

Stage 4: BUSINESS EXPANSION

Owners’ Awareness and Commitment

Establish the company secretary function to ensure effective work of the board, to help the board
improve governance practices and compliance, and to organize annual shareholder meetings.

Organizational Structure

Establish the board of directors to perform the key functions of strategic advice and oversight.
(See Board of Directors, page 37.)

32 Chapter 3: Key Governance Topics and Leading Practices

 Key Policies and Processes
Develop an action plan that includes explicit actions, timing, and responsibility to
improve governance.

Formalize governance provisions, with participation of all shareholders and key stakeholders. Include
these provisions in the articles of association, shareholder agreement, and employee handbook.
(Sometimes also known as a staff manual, the employee handbook is given by a company to all
employees and typically includes information about company culture, policies, and procedures.)

Leading Practices: Culture and Commitment to Good Governance

LP
A
3

SME Governance Guidebook 33

 B
Decision Making and Strategic Oversight

“It doesn't make sense to hire smart people and tell them what to do; we hire smart people so
they can tell us what to do.”
—  Steve Jobs

Stage 1 Stage 2 Stage 3 Stage 4

START-UP ACTIVE ORGANIZATIONAL BUSINESS
BUSINESS GROWTH DEVELOPMENT EXPANSION

XX Informal external advisers XX External advisers formally XX Continuous and structured XX A board of directors
involved* engaged outside advice is engaged XX Board procedures ensure
XX Founder(s) make decisions in XX Key decisions are made XX Enterprisewide discussions effective meetings and input
consultations with individual in collaboration with on strategy, financing, from all directors
executives executives as a group staffing XX Succession-planning policy
XX Authority limits of key XX Limited delegation of signing XX Executive/management has been approved by the
personnel have been authority formalized (or similar) committee board
communicated XX Staffing priorities identified formalized
XX Business continuity plan for XX HR policies to attract, retain,
CEO and key persons and motivate staff
XX Succession-planning
framework for key persons

* Some jurisdictions require a board of directors at the time of company registration. Such boards are often just a formality. This
Matrix does not assume the board to be effectively functional until Stage 4.

This section addresses the strategic stewardship of the SMEs need to gradually transition decision making
company and the role of decision making in determining from highly centralized (the owner) in Stage 1 to more
its future: distributed and collaborative, relying on a professional
executive team and trusted external advisers (or advisory
XX Management Decision Making board). Later, select advisers may be invited to serve
on the board of directors, formed at Stage 4, to provide
XX Advisers/Advisory Board guidance to and oversight of the executive team.

XX Board of Directors At the same time, owners have to ensure that the
business has the “depth” of expertise required to take
XX Succession Planning it into the future. This can be achieved through the
development of appropriate human resources policies,
XX Human Resource Planning including succession plans. These policies evolve from

34 Chapter 3: Key Governance Topics and Leading Practices

a focus on addressing immediate business needs and The decision-making style needs to evolve with the
ensuring business continuity (at the early stages) to company. Successful leaders not only empower talented
comprehensive approaches to human resources to managers to excel in their areas of direct responsibility but
support the strategic development of the company also encourage them to work collaboratively as a team.
(starting with Stage 3).
Delegation: As businesses start to grow, effective
delegation becomes increasingly important. Research
Management Decision Making shows that a founder’s inability to delegate is one of the
most common barriers to the growth of an SME into a
larger business.
It is common practice in the start-up stage for an SME
founder/CEO to be the sole decision maker—or with only A 2014 Gallup survey of the business performance of 143
one or two key trusted insiders or outsiders consulted CEOs of the sample of 500 fastest-growing companies
occasionally. This concentrated decision-making process in the United States found that CEOs with a high level
might be justified at the start-up stage, when the of delegation talent posted an average three-year
founder is establishing the company vision. However, growth rate 112 percent higher than CEOs with low
it brings with it a high probability of less-than-optimal talent for delegation (Bharadwaj-Badal and Ott 2015).
decisions, largely due to various personal biases as well as (For Gallup’s guidance on effective delegating, see

Decision Making and Strategic Oversight

narrow perspective and expertise. Box 3.1.)

Box 3.1: Qualities of Good Delegators

The following are qualities of leaders with strong delegatory talent:

XX Willing to relinquish control and hand tasks to others. This frees up their time to focus on
activities that can yield the highest returns for the company.

XX Develop team capacity, using a strengths-based approach. They take the time to understand what
their people naturally do best, and then position them to take on tasks at which they are most
likely to excel.

B
XX Ensure that employees have everything they need to do their jobs. They provide employees with tools,

3
resources, training, and learning opportunities; they genuinely care about each employee's growth.

XX Focus on outcomes, not processes. They set clear expectations about everything from timing to
budget to deliverables, and then monitor progress.

XX Encourage new ideas and approaches to accomplishing goals. They foster psychological ownership
and engagement among employees by giving them autonomy to achieve their goals.

XX Communicate frequently with employees. They provide feedback about what works and what doesn't.

Source: Condensed from Bharadwaj-Badal and Ott (2015).

SME Governance Guidebook 35

Collaborative decision making: As the business becomes This progression allows the company to evolve its
more professional and acquires a cadre of competent approach to strategy from pursuing the broad vision of
management, which usually happens late in Stage 2, it is the founder in Stage 1, to chasing opportunistic strategies
time to start developing a more collaborative approach in Stage 2, to deliberate and institutionalized strategic
to decision making. thinking in Stages 3–4.

Some of the benefits of a collaborative decision-making The decision-making style of the executive committee
style are related to the positive effects of synergy. varies widely between companies—and even from
Combining the talents and experience of a number of decision to decision within the same company. The CEO
people—with a variety of perspectives on an issue—can remains the chief decision maker but might choose to
lead to alternative solutions that might never occur to one consult colleagues on some decisions. For decisions
person working alone. As a bonus, when a team tackles an involving areas where others have better expertise or
issue and arrives at a solution together, the result is better where everybody’s full commitment is important, the
comprehension and acceptance of the final decision. CEO might choose to make decisions by consensus or
majority vote. With time, good executive committees
The collaborative approach also fosters a sense of develop formal decision-making rules for different types
common purpose and commitment to the organization, of business areas, to clarify expectations, authority,
because all management team members have a say in the and responsibilities.
future direction of the company.
TIP: Normally, weekly management
A good mechanism for implementing such decision making meetings are consumed by urgent
in the company is an executive committee (also known operational issues, and people have
as ExCom or management committee). Key participants
little time to focus on topics of
usually include the CEO/founder, finance manager/CFO,
strategic importance—too many moving parts to
product/service manager, marketing and sales managers,
attend to, too many fires to put out. Therefore,
and administration/HR manager. Occasional invitees, when
special arrangements need to be made for strategy
needed, may include key technical specialists, functions
meetings. Some companies have special executive
related to internal controls, external advisers and experts,
and key managers’ assistants or temporary replacements committee meetings, dedicated exclusively to
(for succession planning). strategic issues, every 3 to 6 months. They may
even alter the setting for such meetings (place,
The executive committee typically evolves through time) to change the routine. For example, these
the stages of SME development: At Stage 2, a group of may be called strategic retreats and held outside the
executives forms and meets periodically to discuss current company premises.
operational matters. (Strategic issues may be addressed
from time to time, but such discussions are typically
unstructured and unplanned.) This takes the form of Advisers/Advisory Board
operational briefings and typically happens every week or
so. Most companies have some form of such meetings.
At Stage 3, the executive committee is formalized as a External advisers (trusted fellow entrepreneurs,
management body with an agenda, procedures, authority, mentors) can be highly beneficial in the early stages of
and so on. In the absence of a board, the committee takes SME development. They can provide expertise that the
on both strategic and operational decision making. By Stage company may lack in certain areas, unbiased advice, and
4, a formal board of directors assumes the role of strategic external perspectives free of conflicts of interest—as well
oversight, with input from the executive committee. as new business connections.

36 Chapter 3: Key Governance Topics and Leading Practices

When the law or investors require companies to create remuneration, as it will attract better candidates, and it
formal boards of directors, entrepreneurs in the early also will provide better incentives to actively contribute.
stages tend to create closely controlled boards. Such The payment can be provided on a fixed annual
boards fail to provide the desired independent advice and retainer plus an additional stipend for each meeting
oversight. This often leads to the formation of an advisory attended, which allows for consultation on issues
group (to fill the void), which then coexists with the between meetings.
ineffective board.

Even though individual advisers provide more flexibility TIP: How do you differentiate between
and require fewer resources, there are advantages to a the need for hiring a consultant
more formalized advisory board in the middle stages of company and having an advisory board?
development (Stages 2–3): Consulting is typically considered
a process to help a company uncover a specific
XX It is easier to attract high-level specialists: “member
problem, arrive at a solution, and (often) implement
of the advisory board” sounds more prestigious than
that solution. The input provided may not always
“an adviser.”
be fully unbiased, as it can affect the fees the
consultants receive. A typical example: A consulting
XX A group setting brings structure and discipline to the
company advises a company to undertake a

Decision Making and Strategic Oversight

process and harnesses the power of synergy.
particular M&A (merger and acquisition) and then
XX An advisory board is a very flexible solution: it may be gets hired again to help implement that same
a temporary or long-term institution. M&A. By contrast, advisers help uncover problems
and may provide general recommendations, but
XX The advisory board provides a safe way to test the then they direct their clients where to go for
waters for setting up a proper board of directors. more detailed help. Plus, advising is usually a
longer-term relationship and not so affected by
The most practical size for an advisory board is three to conflicts of interest. The bottom line: advising and
five members. People with conflicts of interests should
consulting are not mutually exclusive but rather
not be part of this board. These may include suppliers
are complementary.
or vendors to the company, family or friends with no
relevant expertise to offer, and providers of services to the
company, such as bankers, lawyers, external auditors,

B
and consultants. Board of Directors

3
In most jurisdictions, members of an advisory board
do not assume legal responsibility for operations, A formal board of directors is the definitive means for
as shareholders retain full control of what type and engaging external expertise, setting strategy, and
amount of company information to share and how strengthening the management control function. It is
to use the advice given by the advisory board. The also an important vehicle for SME owners who plan to
advisory board should establish effective meeting relinquish their role in active management—for further
processes, similar to those outlined for the board of professionalizing the business or passing it to the next
directors below. generation. By becoming chair of the board of directors,
the founder can have strategic input and retain control
Advisory board members may provide their services of the business without having to be constrained by the
free of charge. However, the company should consider day-to-day operations.

SME Governance Guidebook 37

Function of the Board: Boards perform two major facilitate strong leadership and efficient decision
functions (Monks and Minow 2014): making. On the downside, presence of management
on the board makes it less independent, especially in
XX Oversight and control, including, among other duties: its core function of oversight.
−− Reviewing and approving the company’s financial
standards, policies, and plans; XX Two-tier or dual boards provide distinct supervisory
and management bodies. The former is commonly
−− Electing and dismissing senior management,
referred to as the supervisory board, the latter as
especially the CEO;
the management board. Under this system, the
−− Ensuring proper management succession; company’s day-to-day management is given by law
−− Reviewing results (comparing them with to the management board, which is then overseen
the overall company philosophy, goals, and by a supervisory board that focuses on the company’s
competition); long-term strategy (elected by, and held accountable
−− Appraising senior management; to, the shareholder assembly). These supervisory
and management boards have distinct authorities;
−− Ensuring that the company has adequate systems
their composition cannot be mixed. For example,
of internal controls, risk management, and
the management board’s members cannot sit on the
compliance.
supervisory board and vice versa. The advantage of
XX Strategic guidance and advice, including, among other the two-tier system is a clear separation of roles and
responsibilities: responsibilities, but it has been criticized for slow,
−− Approving and reviewing the company strategy on inefficient decision making.
an annual basis;
In many countries, the board structure is defined by law
−− Reviewing and approving the company’s long-term
or regulations. Other countries allow certain types of
goals;
businesses to choose. When agency costs and conflicts of
−− Assuring that the status of organizational interests are high, shareholders may choose the two-tier
strength and manpower planning is equal to the system. When shareholders and managers trust each
requirements of the long-term goals; other (or when shareholders are managers) and the
−− Reviewing and approving the company’s capital company needs better decision-making efficiency, the
allocations. owners may choose the one-tier system.

Empirical evidence suggests that, for most SMEs,

strategic guidance and advice has more importance when TIP: In countries with two-tier boards, the
the business is relatively small, because the owner is executive committee can naturally evolve
very engaged in operations and thus may feel that no into the management board, and the
external help with oversight and control is needed. As advisory board into supervisory board.
the company grows, the oversight and control function
becomes more important.

Board Structure: There are two common board types: Board composition: The composition and size of the board
of directors depend on the size and complexity of the
XX One-tier or unitary boards mix non-executive directors company’s operations. A board of five to seven members
with some members of the management team, most works for most SMEs, and even three can be fine to start
typically CEO, COO, and CFO, who are then called with. (See Box 3.2 for investor perspective.) A typical
executive directors. This governance structure may board has three types of directors:

38 Chapter 3: Key Governance Topics and Leading Practices

XX Outsiders—people who otherwise do not work When considering candidates for board membership,
for the company. Outsiders provide a more an SME owner should start with the mix of skills,
unbiased perspective. backgrounds, and experiences necessary to meet
the business’s strategic needs. The mix evolves over
XX Independent—outsiders who do not have material time as the company goes through the stages. At any
ties to the company’s management, shareholders, or given moment, the company needs to evaluate the
other directors. Independent directors are essential skills already represented on the board and identify
for performing oversight functions and providing gaps. The following are among the factors that should
unbiased advice. be considered:

XX Insiders/executive directors—people who wear two XX Experience in key areas (industry, geographical, market,
hats, as company employees (typically executives) and so on) that will contribute to the company’s
and as directors. Insiders bring intimate knowledge of strategy and growth;
company operations.

Box 3.2: Investor Perspective

Decision Making and Strategic Oversight

Famed American businessman and venture capitalist Fred Wilson wrote on his blog:

I am a fan of a three-person board early on in a company's life. I generally recommend that a founder put himself or
herself on the board along with two other people he or she trusts and respects.
This situation changes a bit when investors get involved. If the founder retains control, then the situation
does not have to change. Founders can still nominate and elect the directors they want on the board. However,
investors can and will negotiate for a board seat in some situations. This is less common for angel investors and
more common for venture capital investors.
Adding an investor director does not mean that the founder loses control of the board. It can remain a three-
person board with one investor director and two founder directors. Or the board can be expanded to five, and
the investors can take one or two seats and the founder can control the rest. These two situations are common
scenarios when the founders control the company.
As a company moves from founder control to investor control, the notion of an independent director crops up. An

B
independent director is one who does not represent either the founder or the investors. I am a big fan of independent
directors and like to see them on the boards I am on. Boards that are full of vested interests are not good boards. The

3
more independent minded the board becomes, the better it usually is.
When the founder loses control of the company (usually by selling a majority of the stock to investors), it does not
mean the investors should control the board. In fact, I would argue that an investor-controlled board is the worst
possible situation. Investors usually have a narrow set of interests that involve how much money they are going to
make (or lose) on their investment. It is the rare investor who takes a broader and more holistic view of the company.
So while investor directors are a necessary evil in many companies, they should not dominate or control the board.
The founder should control the board in a company he or she controls, and independent directors should control a
board where the founder does not control the company.
Source: Condensed from Wilson (2012).

SME Governance Guidebook 39

XX Subject-matter and technical expertise needed in such the best candidates and yet not pay them so much that it
fields as finance, legal, IT, and so on; hinders their ability to remain effectively independent.

XX Networks that bring professional and stakeholder A guideline is that a director’s time is valued as much as
connections to the company; the time of the top executive. Therefore, remuneration
should reflect the time spent to prepare for and attend
XX Reputation that will raise the profile of the company the yearly board sessions, plus coverage of expenses
and/or add market confidence; (travel, accommodations, and meals). It may also include
long-term payment plans, such as share options, to
XX Personal attributes, such as risk tolerance, willingness ensure that board members’ interests are aligned with
to challenge, and other characteristics that will round long-term interests of the company.
out the board and strengthen the interaction of its
members; Board role versus management role: There are many
fundamental differences between the role of a director
XX Diversity of views and perspectives, as well as of age, and that of a manager. It is important that these
gender, background, and so on. distinctions be clearly understood by both—directors
and managers. One of the most useful and important
Finding directors for your board: The two most common ways to promote accountability and transparency, and
ways for companies to find directors are through to demonstrate commitment to good governance, is
contacts and acquaintances or through outside to identify and communicate the core functions in the
independent search options. Most SMEs choose to find business together with lines of authority.
directors through existing connections, because the
use of referrals tends to increase the company’s level A guiding principle for the board-versus-management
of confidence in the candidate as well as its potential concern is that directors should have their “nose in the
control over any confidential information that might business, but their hands out.” In other words, directors
be shared with the newly appointed directors. While should let the management team handle the day-to-day
effective and cost-efficient, this method may limit the operation of the company, while the board maintains
ability of the candidate to effectively provide independent proper vigilance and oversight of their activities.
and unbiased input to the board; coming from the circle
of relationships of the owner, the newcomer might not Role of the chair: During board interactions, the chair
be inclined to contradict the owner. has a key leadership role in ensuring that all the directors
participate in discussions and decisions—that no director
Companies interested in finding the most suitable dominates and no one is left out. With the help of the
candidate outside of the owners’ network can use company secretary, the chair prepares for and conducts
the services use of executive headhunters, directors’ board meetings and coordinates their timing and
databases, or search engines. Directors found through frequency. The chair also ensures that the board’s agenda
this means tend to bring more independent and unbiased is appropriate and that meetings stay focused on the
views to the board. However, for their input to add value, key tasks. In particular, the chair makes sure the board
the owner needs to accept the idea of allowing a “true” monitors the company’s progress—but does not slide into
outsider to take a role on the board of the company, managing the business.
which may take some time.
The chair must monitor the board’s composition and
Director compensation: Remuneration is a complex topic. structure—and initiate remedial activity if necessary. The
The owner needs to strike a balance between the need chair is also responsible for inducting new members onto
to provide remuneration sufficient to attract and retain the board.

40 Chapter 3: Key Governance Topics and Leading Practices

Some business owners have difficulty adjusting to the Succession Planning
role of board chair. As CEOs, they get used to being the
direct superiors of other managers in their team. The We define succession planning as the process of identifying
chair, however, is not “the boss” of other directors on the and developing people within an organization to fill key
board but rather is “the first among equals.” The chair business leadership positions in the future or to replace
conducts the meetings so that all members freely share key persons in the event of sudden absence. This is done to
their views. Moreover, a good chair will always aim for a ensure business sustainability and resilience in crisis.
decision based on consensus, not just on majority vote.
The penalty for failing to get ahead of changes in
Establishing effective board processes: To be of real use leadership or ownership can be significant. According to
to the company, the board of directors must commit to research in Asia by a prominent academic, Joseph Fan, in
effective working practices. Too often, this very basic the five years after the company founder turns over the
issue receives only passing consideration, even though it reins to the next generation, companies decline in value
has a direct, immediate impact on the board’s work and by an average of nearly 60 percent (IFC 2017). More than
effectiveness. The following list sums up some simple half the value gets wiped out!
good practices:
SMEs need to be mindful of three types of succession:
XX Define, formalize, and communicate authority and

Decision Making and Strategic Oversight

rules of interaction between the board, shareholders, XX Ownership succession refers to the person who
and management. will take over as the equity holder of the business.
This form of succession is especially relevant for
XX Set a formal agenda, with input from members: family-owned businesses. (See Governance Topic E.
−− Review both past performance and forward- Ownership, page 71.)
looking issues;
XX Management succession primarily refers to the
−− Ensure time for strategic discussions, and limit the
person who will take over the operations and day-to-
mundane issues;
day activities of the business.
−− Ensure proper follow-up, and review progress on
previous decisions. XX Specialized expertise succession concerns people
XX Prepare briefing papers: with expertise that is crucial to the business and/or is
−− Keep them short and specific as to purpose scarce on the market.
(actionable? just for information? and so on);

B
For most SMEs, the ownership and management
−− Send to the directors at least five days in advance,
succession will be interrelated. Founders need to be
so they have time to absorb the information and

3
clear about their long-term business goals, because they
prepare for the session.
directly affect key succession decisions. For example,
XX Take and approve minutes (discussions, opinions, owners working toward building a business with the
and decisions). hope of eventually cashing out with external investors
may opt to transition to professional management. An
XX Create a board calendar with key issues to be owner that is focused on building an intergenerational
discussed (four to six meetings a year), so important legacy may prefer to develop family management talent.
topics are covered and board members can be
prepared and can free their time accordingly. Once you have some clarity on the long-term goals for
your business (typically sometime during Stage 2), it is
time to start working on the succession plan. It should

SME Governance Guidebook 41

 Case Study: Rockstar Succession
Rami’s son, Sherif, is interested in keeping the business in the family, but he has said, “I cannot see myself
in the future of the company, as I have other interests. I am only here to support my dad during this
period.”

In light of this, Rami asked a consultant to propose a succession-planning process to address key-
person risk within the company. The risks were prioritized as follows:

XX High priority & urgent: designer (specialized succession). Design is what gives Rockstar its
competitive edge, but Rami remains its only designer. An apprentice needs to be hired and properly
trained.

XX Medium term: CEO. The growing company needs a CEO with managerial talent, which the
founder lacks. The founder’s son has no interest in running the company, and there are no obvious
successors within the current company ranks.

XX Medium to long term: ownership. To prepare his son for the role of the business owner, it might be
advisable to invite him to the board and engage him in strategic decision making.

move from “a thought in the back of the owner’s mind” to Ownership succession: The task of deciding who
a clear plan that has been shared with every key person in will take over as the equity holder is fraught with
the business and other stakeholders. psychological and emotional issues. Succession
touches on issues of control, power, and relevance
According to PwC’s survey of family businesses in the that some may deem too sensitive to address. The
United States, just 23 percent of these businesses have a circumstances that warrant ownership succession may
robust, documented succession plan in place (PwC 2017); so also speak to the owners’ retirement or the idea of their
whatever your specific solutions are, if you have “a robust, own mortality, which again may push them to delay
documented succession plan,” you’re already ahead of engaging in the process.
the curve!
Ownership succession planning is nevertheless critical
Companies at early stages (Stages 1–2) need to develop for ensuring the long-term survival of the business—and
emergency interim plans for each key risk position. If the preservation of wealth that has been accumulated.
the person is unexpectedly unavailable to perform his or Here are some questions business owner may want
her duties, how will this job or function be performed in to consider:
the near term? What impact could it have on business
continuity? XX Have you defined your personal goals and a vision
for the transfer of ownership of the company?
In the later stages, companies need to focus on long-term (Ownership passing to the next generation? A
systemic succession policies and plans that identify and management buyout? Private equity sale? Other?)
develop potential succession candidates.

42 Chapter 3: Key Governance Topics and Leading Practices

XX Do you have an identified successor in place? Have Founders (and later, boards) often don’t assess the
your intentions been clearly communicated to the true management potential of their rising stars until
relevant parties? it is too late. Homegrown candidates often can be
the best options, if they’ve been identified early and
XX What implications does your plan have for the developed to maximize their potential. Failure to do so
management of the company? often results in the most talented people leaving the
company, especially family businesses, because they
XX Are there significant ownership or family issues see no career prospects.
that need to be addressed before ownership can
be transferred? 2. Tendency for the current CEO (founder) to try to “clone”
himself or herself—to find a new CEO with the exact
It is essential to remember that ownership succession same skill set. This is particularly ill advised, because
is not limited to the transfer of equity/value. different talents are needed at different stages of
Fundamentally, it is the transfer of authority—and company development.
ultimately, legitimacy to run the business. It will have
direct ramifications for how the company is run; so it is 3. Micromanaging the successor. Even when management
crucial to make arrangements for effective shareholder succession has formally occurred, it can be stymied
decision making. For example, avoid an equal split of the if effective authority is still wielded by an owner who

Decision Making and Strategic Oversight

shares among an even number of siblings, which may is unable or unwilling to let go of control. Even the
result in deadlocked shareholder meetings. founders that officially moved to the board from
management often find it irresistible to interfere in
Management succession: Succession planning for the CEO daily operations. They also may impose a specific
and senior management is probably the most important management style, stifling the new CEO’s creativity
issue that confronts companies. Yet many business owners and proactivity.
do not carry out a managed transition to a successor
leadership team. For example, in family-owned businesses, This failure to transfer the authority severely hampers
only 30 percent survive into the second generation, 12 the ability of the new leadership, undermines its
percent survive into the third, and only about 3 percent reputation in the company, and creates confusion
operate into the fourth generation and beyond (Deloitte among staff. (See Box 3.3 on page 44 for some
2015). The following are some typical issues and mistakes practical advice for entrepreneurs on how to let
that complicate management succession: go of operational management.)

B
1. Waiting too long to start the succession-planning process. 4. Failure to face family issues that directly affect the
Founders often stay in active management as long business. This issue of management succession is even

3
as physically possible. That means that succession more important for family businesses, and it becomes
effectively becomes a near catastrophic event for the particularly thorny as the family grows larger and
company. The founder/CEO dies or becomes ill, and several potential senior management candidates from
the change of ownership and management happen different branches of the family become available.
simultaneously, creating various uncertainties and a
power vacuum within the company. Even in the best- Families in business might ignore the necessity
case scenario, the transition of authority happens so of planning for the succession of their CEO for a
late that the founder cannot properly administer it or multitude of reasons. Every family is unique and must
coach and guide the successor, leaving the successor find its own solutions, but here are some general
to struggle to gain leadership legitimacy. pointers that may prove useful:

SME Governance Guidebook 43

 Box 3.3: The Art of Letting Go for Successful Entrepreneurs
Leslie Dashew is a family business adviser and co-author of The Keys to Family Business Success. In a
conversation with Deloitte Tax LLP partner Tom Plaut, he shared his thoughts and recommendations
for the best ways senior-generation family-business leaders can deal with the challenge of letting go.

“In my experience, somebody who has been a dynamic, engaged leader can’t just let go and leave
without having something to go to. And if they have had an active, engaged life, they can’t just sit at
home and read or watch television or play golf. In my experience they have to have something that’s
compelling that they go to. So the first piece is for leaders to begin to transition their energy long
before they plan to let go of the authority. That may mean beginning to cultivate other interests.
This is terribly difficult for entrepreneurs in particular, because they’re typically consumed by
their businesses.

“One of the most successful transitions I ever saw was a client who had started a construction
business from scratch and built it to a value of $60 million. By the time he finally sold the business and
transitioned it to new leadership, he had started helping a nonprofit build its new building. He was on
its board, but he had that technical expertise and they really wanted that help. So he was able to take
his knowledge, passion, and energy and place it somewhere else.

“The second piece is to have the confidence that the next generation will have the supervision—if you
will, the oversight—to know they’re doing the right thing. So one of the best possible strategies is to
make sure that there is an independent board of directors who will provide the kind of oversight and
guidance that the departing leader can trust.

“When that board is in place, and often the departing leader is on it for a period of time, then there’s a
sense that, ‘Okay, I have my nose in and my fingers out, and I can keep an eye on what’s going on.’”

Source: Deloitte (2015).

• Evidence indicates that family CEOs are more often • For family management succession, it is
focused on preserving the company’s reputation increasingly common practice to require family
and values. Professional managers are more likely members to gain relevant experience outside the
to focus on sales growth. company for several years. Often, they are allowed
to come in only at the level they were able to
• Overall, research shows that “internally grown” achieve outside. This helps them build expertise as
CEOs show better track records than the ones well as credibility within the company.
hired from outside the company. That said, if the
company is in trouble or stagnating, the external • There is a clear trend toward professionalizing
hire might be a better way to go. management as the ownership moves to the next
generation. More families realize that owning

44 Chapter 3: Key Governance Topics and Leading Practices

 a company and running it do not have to be the 2012). Southwest flies the same airplanes as everybody
same thing. In this case, it is absolutely crucial to else; but from the very start of the company, it heavily
set up proper governance structures so the family screened potential employees and created a distinct
can retain effective strategic oversight and control. working culture that proved impossible for competitors
to recreate (Romero 2008).
Specialized-expertise succession: Typically, this type
of succession is much more straightforward than Human resource planning typically comes into focus
the ownership and management types. However, in Stage 2. Companies report challenges in attracting
entrepreneurs need to be alert to one psychological qualified staff, having the capacity to afford high salaries,
factor: If you have specialists that qualify as key persons and motivating and retaining staff—especially with the
in high-risk positions, this gives those people a sense of higher expectations of the younger generation.
security—and leverage. It is natural for them to want to
remain indispensable. Therefore, it is important that the Psychologist Frederick Herzberg introduced a very
terms of references for those positions state clearly that practical framework, known as “two factor theory” to
preparing a potential successor (emergency and long- address these challenges (Herzberg 1968). Companies
term) is a key deliverable they will be evaluated on. It is should focus on two distinct objectives: minimizing staff
also important to test the readiness of the successor—for dissatisfaction and maximizing motivation.
example, by requiring the key-risk person to take a long

Decision Making and Strategic Oversight

vacation or take on another, temporary assignment, thus Minimizing demotivating factors: Herzberg introduced
giving the successor an opportunity to be tested. the concept of “hygiene factors,” which include status,
job security, salary and benefits, quality of supervision,
and other work conditions. Research shows that
Human Resources Planning addressing these factors does not lead to employees
being positively satisfied with the job or more motivated
to perform. However, if these factors are not addressed
Human resources is a vast topic that goes beyond the properly, employees will become actively dissatisfied.
scope of this Guidebook. We will touch only on the broad These are “maintenance factors,” in the sense that staff
outline of policies related to the top managerial and dissatisfaction results from their absence.
technical talent.
Eliminating the reasons for job dissatisfaction is the first
We came across the following analogy, sometimes used step in building a productive workforce. There’s no point
in the private equity world: people can be considered trying to motivate people until these issues are out of

B
the “software” that runs the business, as opposed the way! If your company experiences high employee
to “hardware”—physical assets. Hardware is rapidly turnover or a large number of staff complaints—even

3
becoming a commodity—easy to buy or copy. A true if people find the work itself interesting—it might be
differentiation—true value-added that is much harder to an indication that “hygiene” work conditions are not up
obtain—comes from software. to par.

For example, the U.S. airline industry “has reported Hygiene factors, such as supervisory practices or wages/
negative net income in 23 of 31 years since deregulation” in benefits, are highly culture- and industry-specific. Here
1978 (Phillips 2011). By contrast, during roughly the same are some general pointers for addressing them:
period, Southwest Airlines started as a midsize company
with just three airplanes and turned into the country’s XX Foster teamwork and respectful working
biggest carrier. It “remained solvent and has consecutively relationships.
generated a profit for the past 39 years” (Schlanger

SME Governance Guidebook 45

XX Identify and address poor and obstructive company XX Recognition and rewards for good performance
policies that act as “irritants” to staff or that go against and contribution.
company culture.
Autonomy means that employees have meaningful control
XX Provide supportive and nonintrusive supervision. over various aspects of their work, which promotes
their sense of ownership and responsibility. Learning to
XX Be sure your benefits package is competitive; identify delegate is a crucial skill for the entrepreneur who wants
benefits most valued by employees. to create a sense of autonomy in the employees.

XX Provide for job security. Purpose is the desire to do something meaningful and
worthwhile. It should be integrated with the company’s
values and business objectives. Entrepreneurs rarely start
TIP: The most important step is to give businesses to simply get rich. They have visions, dreams,
your employees a voice in establishing and ideas, and they should not shy away from sharing
the company’s culture, work those with employees. When Herb Kelleher set out to
environment, and policies. create Southwest Airlines, he explicitly hired people
to provide superior customer service with “a sense of
warmth, friendliness, individual pride”—and motivated
Maximizing motivating factors: A 2015 Gallup survey them to do so.
found that only 32 percent of U.S. workers were “engaged”
in their jobs, while 51 percent were “not engaged” and All three categories aim to build intrinsic, internal
17 percent were “actively disengaged” (Adkins 2016). If motivation to perform better. Decades of research
your staff do not leave or complain much, yet also don’t shows that intrinsically motivated people consistently
seem to be particularly interested in work (working for outperform those motivated by money or other external
the paycheck), it might signal that the hygiene factors benefits (Chamorro-Premuzic 2013).
have been addressed, but now you need to move to the
next step—to actively motivate your staff for maximum Monetary rewards and recognition: Focusing on intrinsic
performance. motivation does not mean that you can ignore financial
incentives. There is a strong practical argument for giving
Business writer Daniel Pink summarized the diverse your key staff some “skin in the game” to build a sense of
research on employee motivation into three practical ownership and to reward good performance.
categories: mastery, autonomy, and purpose (Popova
2013). Key performance indicators can be an effective motivation
tool for key management and technical staff, starting
Job mastery, as a motivation, is the desire to gain better in simple form with Stage 2. KPIs for managers can be
skills and knowledge. A business can take several actions established with three main components:
to support it, including the following:
XX Individual—to assess the behavior of the manager
XX Training, coaching, and delegation of important in areas such as teamwork, leadership, ability and
tasks for professional advancement and excellence. eagerness to learn, and so on.
Learning and development are especially valued by the
younger generations entering the workforce. XX Functional—to assess how the manager’s function or
unit has performed relative to the objectives.
XX Job enrichment through adding more important and
interesting tasks.

46 Chapter 3: Key Governance Topics and Leading Practices

XX Enterprise—based on the performance of the working on creative tasks—where innovative, nonstandard
company as a whole, to encourage managers to work solutions are needed—results showed that, in a large
as a team. percentage of cases, variable pay hurts performance.
Managers may “cook the books,” focus on short-term
These KPIs should form the basis for pay raises, bonuses, results, or emphasize “measurable” factors, such as sales,
and other recognition, including nonfinancial. KPIs are over important but hard-to-measure ones, such as
also an important communication tool to signal the company culture or the quality of customer service.
company’s culture and priorities.
This reinforces the need to focus on building intrinsic,
A profit-sharing plan can be devised for key management internal motivation, as discussed above. Be sure your
team members and other staff seen as essential to the managers’ fixed salary is high enough that they don’t have
company’s success. (Some companies do this for all to “think about money” and can focus on the work itself
staff.) For example, on target fulfillment, a company will instead. The variable component should function as a
distribute 10 percent of the profits to stakeholders in reward and recognition and not be the main motivator or
the plan. source of income.

An employee stock ownership plan makes company Determining the optimal mix of variable and fixed pay is
shares part of remuneration to promote long-term one of the key strategic HR functions that should be fully

Decision Making and Strategic Oversight

commitment. This incentive allows companies to make established by Stage 3.
the overall benefit package more competitive, and it
makes key employees less vulnerable to poaching by
other companies. It is also sometimes used by family TIP: SMEs often cannot compete with larger
businesses to encourage essential staff to stay during companies on pay levels, but they have
the transition of ownership and management from one more flexibility to address their employees’
generation to another. needs for mastery, autonomy, and purpose.

Balancing intrinsic motivation and monetary rewards:

There is a growing body of evidence that variable pay—“pay
for performance”—should be used carefully. Contingent
pay only works for routine tasks. However, for people

B
3

SME Governance Guidebook 47

 B LP
Leading Practices:
Decision Making and Strategic Oversight

Below, we present leading common practices for each SME evolutionary stage, using the categories discussed above:

XX Management Decision Making

XX Advisers/Advisory Board

XX Board of Directors

XX Succession Planning

XX Human Resource Planning

Note that these practices are cumulative: practices for later stages build on the practices of earlier stages. Some
recommendations may be implemented more effectively in different stages, depending on circumstances, or may be
implemented as the company is transitioning from one stage to the next. Use your judgment to decide the best timing
for your particular company.

Stage 1: START UP BUSINESS

Management Decision Making

Conduct individual consultations with key executives before making major decisions.

Define and communicate authority limits for key personnel, such as amounts of purchases
that would require CEO authorization. A core element of internal controls (see page 53) is clearly
defined authority limits to ensure that key staff members remain engaged and motivated to act in
the company’s best interest. These parameters facilitate increased accountability and reduce the
unnecessary dependence on owners for day-to-day decision making.

Advisers/Advisory Board

Involve external trusted advisers (even if informally) to discuss strategic issues.

48 Chapter 3: Key Governance Topics and Leading Practices

 Stage 2: ACTIVE GROWTH

Management Decision Making

Develop an authority matrix that defines key decisions and identifies which business units
or individuals are authorized to make them. This should include decisions for the founder/
shareholders, board (if one exists), CEO, key executives, and technical specialists. List key
decisions and decision makers and, after discussion and consultation where needed, identify

Leading Practices: Decision Making and Strategic Oversight

the people who are to be responsible, accountable, consulted, or informed for each decision. All
involved have to be committed to standing by the agreed authorizations—not doing so can erode
employee trust, confidence, and commitment.

Management should meet regularly as a group to collaboratively review operational issues and
progress against plans, and to identify risks/issues and take decisions. The group is engaged by
the CEO/owners for consultations on strategic issues, as needed.

Advisers/Advisory Board

Articulate areas/topics of needed external expertise (providing input on company strategy,

financing plans, new markets and products, technical issues, company structure, business
relationships, external company profile, coaching of executives, or other). Focusing first on areas
of need drives owners to extend their search beyond the “usual suspects,” which leads to a more
customized and valuable pool of expertise.

Define the role and formalize the involvement of the needed external advisers. Make sure the
advisers understand their role and are engaged effectively to add value to the company.

LP
Succession Planning

Create a contingency/business-continuity plan for the CEO and other key persons. It should

B
describe a course of immediate action in case of sudden departure or unavailability.

3
Human Resource Planning

Develop a simple means of communicating to staff the key decisions, policies, and strategies.

Document HR-function job descriptions to ensure that all key roles are being addressed
(or outsourced).

Develop internal (or outsource) expertise on management reporting and analytics—to help with
cost control and strategic decision making. Accurate and timely data are important for effective
decision making.

SME Governance Guidebook 49

 Stage 3: ORGANIZATIONAL DEVELOPMENT

Management Decision Making

At this point, a formal executive committee (the CEO and key senior-level executives) should be
established; it 1) meets weekly/biweekly on operational issues and 2) has dedicated sessions to
focus exclusively on strategic issues, with a set agenda. Ensure that the committee has clear
terms of reference.

At executive committee meetings (for example, monthly or quarterly), review progress against
the plans, and update plans as necessary.

Advisers/Advisory Board

Consider whether setting up a formal advisory board would add value to the company. If so,
formalize the arrangement and communicate it to all relevant stakeholders.

Succession Planning

Develop a basic succession-planning framework for senior management, to ensure timely

preparation of a talent pool. Owners want to be confident that, when needed, people are ready
and willing to fill the critical roles outlined in the succession plan that will carry the organization
forward. The three key steps toward building a viable talent pool are 1) determine the leadership
demand, 2) evaluate the current talent supply, and 3) mobilize and develop potential leaders.

Human Resource Planning

Make the HR function a strategic partner with (and/or part of) the strategic management team
(for example, helping design effective sourcing and retention strategies, compensation and
benefits programs, professional development programs, and performance management systems).

Expand the job description for each position to form detailed terms of reference that include the
qualities and qualifications required. Review the qualities and qualifications of current staff to
see whether they fit the TORs.

Design an incentives system to attract high-caliber talent and motivate them to perform
(mastery, autonomy, purpose), including clear professional and career-growth opportunities
and performance-based recognition and incentives (bonuses, stock options, profit sharing, and
so on).

Take care of hygiene factors to retain staff, such as attractive work environment, internal company
policies, competitive compensation and benefit package.

50 Chapter 3: Key Governance Topics and Leading Practices

 Stage 4: BUSINESS EXPANSION

Board of Directors

Clearly define the role of the board, especially its relationship to management, and include
directors’ duties and responsibilities to the company and shareholders in the board charter and
the director appointment letter.

Leading Practices: Decision Making and Strategic Oversight

Determine the skills required for the board to fulfill its duties, given the strategic direction of the
company; evaluate the existing board skills and note any gaps.

Ensure that the board has an appropriate mix of directors, considering skill sets, professional
background, personal attributes, diversity (age, gender, and so on), and balance of executive,
non-executive, and independent directors.

Create effective and efficient board procedures:

XX Allow enough time for effective discussion and input from all directors.

XX Provide a focused agenda for each meeting, based on the annual board calendar.

XX Maintain a balance between management presentations and board discussions, and between
reviewing past performance and strategic planning.
XX Distribute action-orientated and concise board briefing papers at least five business days before
board meetings.
XX Take and approve minutes (discussions, opinions, and decisions). Use them to ensure diligent
follow-up.

Succession Planning

LP
Develop strategic succession plans for the CEO, key executives, and technical specialists (to include
immediate, mid-term, and long-term succession).

B
3

SME Governance Guidebook 51

 C
Risk Governance and Internal Controls

“Controls protect weak people from temptation, strong people from opportunity and innocent
people from suspicion.”
—Internal Auditor Magazine, 1977

Stage 1 Stage 2 Stage 3 Stage 4

START-UP ACTIVE ORGANIZATIONAL BUSINESS
BUSINESS GROWTH DEVELOPMENT EXPANSION

XX Basic bookkeeping, cash flow XX Basic principles of business XX Detailed code of ethics and XX Effective internal controls
management, and tax functions conduct business conduct systems (e.g., based on COSO)
XX Cash sources, bank accounts XX Basic business risks—including XX Objectives, strategic planning, XX Independent external auditors
are separate from those of the key-person risks—identified budget, KPIs, and clear XX Timely and secure recording and
founder(s) XX Processes in place for tax accountabilities reporting for sales and accounts
XX Basic understanding of payments, records, and filing XX A professional CFO
regulatory requirements and XX Controls on cash management XX A basic internal audit function
compliance XX Policies and procedures to
monitor and mitigate strategic
and operational risks
XX Business units have clear
authority, reporting lines, and
guidelines

We separate the challenging topic of Risk Governance managing key risks to company success. The Committee
and Internal Controls into common topics that most of Sponsoring Organizations (COSO)—the world’s leading
entrepreneurs are familiar with, at least in general terms: organization focusing on developing common standards
on enterprise risk management, internal controls, and
XX Internal Controls fraud deterrence—defines internal controls as “A process…
designed to provide reasonable assurance regarding
XX Audit (internal and external) the achievement of objectives related to operations,
reporting, and compliance” (COSO 2013). Although the
In the most basic sense, internal controls can be defined COSO standards might prove too complex for many SMEs,
as policies and practices to allow SMEs to detect errors, setting up a more strategy-oriented system of controls is
prevent mistakes, identify fraud, and ensure the reliability key for a company’s success. This shift in focus is crucial
of financial reports. This is the minimum that internal starting with transition to Stage 3, when the company
controls must accomplish at Stages 1–2. starts putting more effort into strategic planning.

However, understanding of internal controls has evolved Internal audit is a function designed to provide management
significantly in recent years. Their role expanded to (and later the board) with reasonable assurance that

52 Chapter 3: Key Governance Topics and Leading Practices

the internal controls are adequate and functioning well.
Elements of Internal Controls
The function appears in Stage 3, to support increased An internal controls system helps the SME answer these
decentralization of decision-making authority. five critical questions:

External audit is an independent examination of the XX What is our overall approach to internal controls?
financial statements prepared by the organization. Unless
mandated by law, this is a function not typically needed XX How do we identify and monitor risks?
until SMEs acquire external shareholders, in Stage 4.
XX What do we do to minimize these risks?

Internal Controls XX How do we get, analyze, and share risk-related

information?

Internal controls, as the name suggests, focus on XX How do we make sure that all systems work
the risks to the company’s operating, reporting, and effectively and as planned?
compliance objectives that can be addressed by better
internal processes, policies, and procedures. Such The internal controls system therefore consists of
risks include, for example, fraud, damage to company five elements: control environment, risk assessment,
property, cost overruns, substandard quality of products, control activities, information and communication,

Risk Governance and Internal Controls

or mistakes in financial reporting. and monitoring. (See Figure 3.1.) These elements work
continuously as an integrated system.
Implementation of the internal controls function is the
responsibly of management, with guidance and oversight 1. Control Environment—the set of standards, processes,
from the board of directors (when formed). and structures that provide the basis for carrying

Figure 3.1: Internal Controls Elements

Control
Environment

C
Monitoring
and Risk

3
correcting Assessment
activities Elements not
considered separately...
they work together as an
integrated system

Information
and Control
Communi- Activities
cation

SME Governance Guidebook 53

 out internal controls across the organization. The as competition and regulations, while internal risks
control environment sets the tone of the organization, are overlooked.
influencing the control consciousness of all its
employees; one example is the often overlooked code
of ethics/conduct. It also includes soft elements, such as Tip: SMEs interested in becoming part of
management’s philosophy and operating style and the the supply chain of larger corporations,
way management assigns authority and responsibility. especially multinationals, need to
proactively address environmental
The tone at the top is crucially important and will
and social sustainability risks. For example, agro-
override other elements if in conflict. For example,
commodity companies require their suppliers to
if the leadership emphasizes achieving targets at all
address issues related to forced or child labor, work
costs, the staff might feel encouraged to bend some
safety, and significant impacts on biodiversity and
rules to do so.
the ecosystem (IFC 2013).

Another crucial element of the control environment

is the company’s strategy and objectives. Often,
even the top executives of SMEs do not have a good
understanding of where the company is going. The 3. Control Activities—are actions, established through
situation is even worse down the chain of command. policies and procedures, to detect and prevent risks
If employees do not understand the company and help ensure that management’s directives to
objectives, it will be very difficult for them to assess mitigate risks are effectively carried out. (See Box 3.4
risks jeopardizing the company’s progress toward for some examples.)
those objectives.
4. Information and Communication—ensure that
2. Risk Assessment—involves an established formal management obtains relevant, timely, and quality
process for identifying and assessing risks in relation information (from internal and external sources)
to the achievement of objectives. Discussion of to support the functioning of other components of
potential risks can be uncomfortable for some people, internal controls. Communication is the continual,
making them reluctant to volunteer their thoughts formal process of providing, sharing, and obtaining
and concerns—especially if, for example, the founder/ necessary information.
CEO presents a new idea he or she is clearly excited
about. Therefore, specialists on risk management A typical problem in many SMEs is that the various IT
recommend that every strategic decision include systems do not “talk” to each other and require manual
a dedicated discussion on risks. The “boss” should reconciliation, which happens episodically and carries
explicitly call for this analysis. Furthermore, an the risk of human error.
enterprise should have a dedicated risk management
meeting at least once a year. 5. Monitoring Activities—are ongoing evaluations to
ascertain whether each of the five components
Successful entrepreneurs perform this analysis of internal controls is adequate and functioning.
routinely, but the focus is often on external risks, such Reconciliation of accounts is one example.

54 Chapter 3: Key Governance Topics and Leading Practices

 Box 3.4: Control Activities Examples
Authorization
XX Clear authorities and their limits for review and approval of various transactions

XX Defined lines of responsibility

Performance reviews
XX Regular checks, review of personnel

XX Ensuring employee knowledge and skills

Information processing
XX Accurate records of key transactions, including approving parties

XX Automated controls limiting inputs into the system, checking dates

XX Sequential numbering of documents

Risk Governance and Internal Controls

XX Batch totaling or reconciliation total added and cross-checked

Physical controls
XX Limited access to equipment, petty cash

XX Cameras

Segregation of duties (each participant’s actions are controlled and/or verified by

another participant)

XX Authorization activities from related recordkeeping (sales, payroll, purchasing, etc.)

XX Custody activities from related recordkeeping and reconciling activities

C
XX Depositing cash from reconciling bank accounts

XX Systems development from systems operations and from database administration

3
Crisis Management Plans:

XX Roles and responsibilities for organizing during crises

XX Scenarios for responding and recovering from potential crises

SME Governance Guidebook 55

 Case Study: Rockstar Internal Controls

Rami Bahgat aims to have about 100 outlets across Egypt in five years. Here is a quick
illustration—focusing on just one specific risk—of how the systematic approach to internal
controls might help him achieve this objective.

None of the Rockstar managers is currently aware of Rami’s vision. So Step 1: Control Environment
would require involving the key managers in designing a strategy for this vision, and empowering
them to meet regularly as a group to analyze the progress and risks.

Step 2: Risk Assessment would quickly bring to the surface the cash flow issue. The chief accountant
has already complained privately, “Our main challenge is cash flow shortages and defaults in
paying due checks, resulting from high inventory that has up to seven months’ worth of stock.”

Therefore, Step 3: Control Activities would have to minimize overproduction. The company orders the
manufacture of too many models that are selling slowly—and possibly orders too few models that
are selling well. There is no IT system to generate timely information on the sales by wholesalers
and Rockstar’s own stores—and to compare them with the existing orders and the remaining
inventory. There are separate applications that track different components of the manufacturing-
sales process, and the interface between them is done manually and sporadically.

Implementation of the comprehensive IT system as a control activity to regularly track sales and
inventory would allow the company to free up cash currently “stuck” in its warehouses, and
increase sales by being more responsive to client demands.

Such an IT system would also be an important element of both Step 4: Information and
Communication and Step 5: Monitoring Activities. It would be supported by other related activities,
such as, for example, physical inventory monitoring.

TIP: Establish an effective channel Special Issues

for reporting fraud and abuse. The
Association of Certified Fraud Examiners The types of risk that SMEs will need to address will differ
(ACFE) discovered that “tips are widely by industry and other factors, but two that are
consistently and by far the most common detection common to virtually all businesses—working capital and
cash flow management and information technology—can be
method." ACFE analysis shows that organizations
particularly destructive to smaller companies.
with hotlines are much more likely to catch fraud
and experience “frauds that were 41 percent less
Working capital and cash flow management. For
costly, and they detected frauds 50 percent more
a company, working capital is defined as the difference
quickly” (ACFE 2014).
between current assets and current liabilities. Current

56 Chapter 3: Key Governance Topics and Leading Practices

assets are elements such as bank accounts and bank third-party data, such as customer information, there is
placements, securities, inventories, and receivables a need to ensure compliance with applicable laws related
that can be turned into available cash within 12 months. to data protection, and to install protective mechanisms
Current liabilities are the costs and expenses—such as to prevent loss, breach, or unlawful theft of confidential
paying suppliers, rent, utilities, and interests—to be or business-sensitive information—occurrences that
incurred within the same period, namely 12 months. could cause the company to face lawsuits and loss of
reputation and business.
If current assets are higher than current liabilities, then
the working capital is positive and the company can Conduct/Ethics
easily fulfill its current financial obligations. Because
small companies may not have easy access to short-term Although the topic of conduct and ethics is not a
credit options, maintaining a positive working capital separate element of Internal Controls, it deserves its
balance is key. If the owner intends to grow the business own discussion, as it directly affects every one of those
quickly, the need for positive working capital is higher elements. All companies have ethics—the values that
than for a business owner looking to stay small. are lived in the company and the principles that govern
how decisions are made. A company’s ethics create its
Internal controls can help the owner better manage the ebb organizational climate and inform its culture.
and flow of money coming in and moving out—and improve
visibility, predictability, and planning. Internal controls can To provide direction to employees and establish an image

Risk Governance and Internal Controls

also help address inefficiencies, thus increasing the short- of good behavior, companies establish codes of ethics and
term financial management of the company. conduct. The terms “code of ethics” and “code of conduct”
are often used interchangeably (Nieweler 2014). They are,
Cash flow is the net amount of cash moving into and in fact, two distinct documents:
out of a company. For the company to be financially
sustainable, its business must generate a positive cash XX The code of ethics sets the tone by explaining key
flow, namely more money coming in than being spent. organizational values and ethical principles. It specifies
How a company manages cash flow depends on multiple commitments or ethical standards that the company
factors—for example, industry, operational efficiency, adopts in relation to its stakeholder groups (employees,
and ultimately a good strategy. Internal controls can customers, business partners, government and
help a company have a better understanding of and more community, society, environment, and so on).
control over the different processes, hence strengthening
the ability to correct potential inefficiencies and to XX The code of conduct is the translation of the

C
improve both the working capital and the cash flow proclaimed values into actionable practices. It
management of the company. establishes a framework for professional behavior and

3
responsibilities, dealing with ethical issues and conflict
Information technology. To thoroughly cover this topic situations. It lists actions that are required or forbidden.
would take an entire book; this Guidebook touches on
the basic need for businesses to be aware of the benefits SMEs can combine the two documents into a single
of IT and to be alert to its challenges. code of conduct/ethics. It should be approved by senior
management and the board of directors, and it is their
As a bare minimum, owners need to ensure that both responsibility to ensure proper compliance with the
hardware and software are updated to stay current with code. Compliance should be monitored and enforced.
the needs of the business, that they perform efficiently, Businesses experiencing rapid growth should review the
and that the IT equipment and software do not fail or code regularly to ensure that it remains relevant and
fall prey to external attacks. As the company handles effective. (See Box 3.5. on the next page.)

SME Governance Guidebook 57

 Box 3.5: Control versus Trust Continuum
Sound governance aims to lead executives and employees to comply with the rules, behave ethically, and make
decisions in the best long-term interests of the organization. There are two approaches to achieve this goal:
one is centered around controls; the other, on trust. Academics, regulators, and executives have traditionally
prioritized the control-based approach. It is based on the premise that people think only of themselves. As a
result, this view emphasizes the need for organizations to implement a full set of “carrots” and “sticks” in order to
align interests and induce desired behaviors.

This perspective has some merits, and controls related to the identification and monitoring of key business risks
are particularly relevant for most organizations. On the other hand, the emphasis on controls should not be seen
as a panacea. Despite the millions of dollars spent every year on control and compliance programs, frequent
corporate scandals suggest that they have not succeed in significantly reducing the level of unethical (or even
illegal) conduct in the business world. It is also important to note that most companies involved in these high-
profile cases, such as Wells Fargo, HSBC, VW, and Petrobras, used to have control functions in place as well as
many internal policies aligned with recommended practices.

The other alternative is investing in the trust-based approach. It operates on the premise that most people will
voluntarily seek to do the right thing when they are immersed in a culture characterized by solid shared values,
transparency, psychological safety, justice, empathy, responsibility, and sense of purpose beyond profits.

The concept of psychological safety is critical. When an atmosphere of fear is created inside organizations, people
tend to become defensive and afraid to express their points of view, including on ethical issues. To reduce fear,
it is essential to foster an environment where people feel that they will not suffer negative consequences—such
as retaliation, ostracism, or dismissal—if they speak up and point out what is wrong. Research also shows that
working in such environments generates a higher level of productivity and innovation (Baer and Frese 2003).

Strong ethical culture allows entrepreneurs to build what Legal Research Network (LRN), a firm devoted to
these issues, calls “self-governing organizations”: companies in which the regulation of behaviors does not
depend on rules and policies, but instead on workplace peers. In one of its studies, LRN observed that companies
characterized as self-governed exhibited significantly better performance indicators than the others in several
areas, including profitability, revenue growth, and innovation (LRN 2016).

An increasing number of companies—such as Patagonia, Southwest Airlines, FAVI, Buurtzorg, Morning Star, and
others—are excellent examples that it is possible to succeed by focusing on an ethical culture based on trust
(Laloux 2014). Studying these cases in depth can help entrepreneurs create concrete practices that lead to a
high-trust environment at their firms.

Business leaders also need to start measuring and monitoring the degree of ethical culture in their companies.
Ethical Systems, for example, provides a free tool for this (Ethical Systems 2018).

Instead of being dichotomous options, the control and trust approaches to governance must be seen as a sort of
“continuum.” It is up to leaders to increasingly move their companies to the trust side of this continuum to bring
out the best in their people.
Source: Alexandre Di Miceli da Silveira.

58 Chapter 3: Key Governance Topics and Leading Practices

 TIP: Make sure all employees SMEs should develop an explicit policy to guide directors,
read the code and understand management, and staff on the issue of conflict of
their compliance responsibility. interests. This policy should spell out what constitutes
Most importantly, the board/ conflicts of interest and outline how the organization
management needs to abide by the code and will monitor and resolve them. It should also identify
potentially high-risk functions.
lead by example. Failing to do so may derail any
attempt for the company to adopt the desired
The policy should pay particular attention to procurement.
ethical culture and obtain the related behaviors
Staff involved in the procurement process should declare
from its employees.
if they have a beneficial interest, relatives, or close friends
in any entity being considered for selection as a supplier of
Conflicts of interest: In certain situations, key business goods or services to the company.
representatives may experience a potential conflict
between their own personal interest and their duty to Related-party transactions (RPTs) are conflict-of-interest
the company. A conflict of interest is a situation in which situations that deserve special attention. RPTs are
a person has a private or personal interest potentially business deals or arrangements between two parties
sufficient to influence—or appear to influence—the that are joined by a special relationship prior to the deal.
objective exercise of his or her official duties as an
employee or a professional. (See Figure 3.2.)

Risk Governance and Internal Controls

Figure 3.2: Conflict of Interests: Most Common Forms

A person who controls all or part of an organization causes it to enter into a

Related-party
transaction—with a professional or another organization—that will benefit
transactions that person or that person’s family or friends.

Outside
The interests of one job are in conflict with another.

C
employment

3
A spouse, child, or other close relative is employed (or applies for employment),
Family
or the company purchases goods or services from such a relative or a firm
interests controlled by a relative.

Items from friends who also do business with the person receiving the
Gifts gifts, which may include intangible things of value, such as transportation
and lodging.

SME Governance Guidebook 59

For many small businesses, RPTs are not unusual; As part of good governance, a Stage 3 SME should have
transactions with businesses of family members, in place an internal audit function. To be effective,
relatives of directors, substantial shareholders, and the internal audit function should be independent of
key employees are a common occurrence. Under some operations. By Stage 4, it should report functionally to
circumstances such transactions can be beneficial for the board, with administrative reporting to the CEO.
the business. Unfortunately, they are also one of the
main ways to siphon money from the company to enrich Depending on the legal structure and the applicable laws
individual shareholders or managers at the expense of in the country of incorporation, a company might need
others. This could scare away external investors as well as to hire an external auditor. If there is no particular legal
demotivate honest employees. requirement to do otherwise, this function becomes
relevant in transitioning to Stage 4. The external auditor
Each company has to develop an explicit policy for directly serves the interests of shareholders/stakeholders
dealing with related-party transactions, taking into by independently ensuring that the company is practicing
consideration their size, type, frequency, and the parties sound fiduciary control and reporting accurately, fairly,
involved. For example, the policy needs to specify the size and transparently on its financial accounts.
of the deals that would require approval by the board
and/or the shareholder meeting. Best practice for managing external auditors includes the
following actions:
On such transactions, full disclosure to all shareholders
is crucial. SMEs should identify the number and size of XX Restrict the auditor from providing other services that
those transactions as well as the policy or procedure may cause conflicts of interest.
governing the transactions. (For more information,
see Governance Topic D. Disclosure and Transparency, XX Consider rotation of auditor—or at least senior audit
beginning on page 65.) partner—every five years.

XX Disclose fees paid to the auditor for audit, and if the

Audit company still choses to obtain non-audit services,
disclose the amount paid for those as well.

Entrepreneurs often mix up internal controls and Internal and external audits serve different functions.
internal audit. Internal controls is a system, operating Internal auditors examine issues related to company
continuously. Internal audit is a function of internal business practices and risks, and internal audits are
controls, conducted at specific intervals. Internal conducted throughout the year. External auditors
audit aims to provide the board and management examine the financial records and conduct a single
with reasonable assurance that the internal controls annual audit. Starting with Stage 4, the company needs
system (among others) is adequate, robust, and to have both.
functioning well.

60 Chapter 3: Key Governance Topics and Leading Practices

 C LP
Leading Practices:
Risk Governance and Internal Controls

Below, we present leading common practices for each SME evolutionary stage, using the categories discussed above:

XX Internal Controls, with three topics requiring special attention:

−− Conduct/ethics

−− Working capital and cash flow management

−− Information technology management

Risk Governance and Internal Controls

XX Internal Audit

XX External Audit

Note that these practices are cumulative: practices for later stages build on the practices of earlier stages. Some
recommendations may be implemented more effectively in different stages, depending on the circumstances, or may
be implemented as the company is transitioning from one stage to the next. Use your judgment to determine the best
timing for your company.

Stage 1: START UP BUSINESS

C
3
Internal Controls

Ensure that the company complies with main laws and regulations.

Working capital and cash flow management:

XX Separate the cash sources and bank accounts of the company from the personal sources and
accounts of the founders.
XX Routinely monitor and analyze cash flow needs to effectively plan working capital and financing
needs and investment strategies.

Conduct a basic valuation exercise to understand a total net worth of the enterprise. It’s generally
accepted that there are three basic ways to describe the value of a business: fair market value,

SME Governance Guidebook 61

 investment value, and liquidation value. Having an objective appreciation for the investment value
of the business is an important bargaining tool when approaching potential investors. This is the
value the business represents to a specific investor and incorporates specific considerations above
and beyond the fair market value.

Stage 2: ACTIVE GROWTH

Internal Controls
Create a mechanism for reporting fraud and abuses (for example, a whistleblower policy). Such
a policy should provide guidance for staff to confidentially report their concerns, and it should
outline appropriate steps to investigate and address violations (disciplinary or otherwise).

Identify potential business risks, assess their impact, and develop corresponding mitigation
actions (with owners to track progress).

Integrate basic risk-based controls into the business processes (such as approval limits, separation
of authority, verifications, and so on).

Identify critical key-person risk positions, designate backup/deputy staff for key functions/
technical specialists, and ensure that they are building needed skills and expertise.

Ethics/conduct:
XX Develop basic principles of business conduct, covering such issues as workplace ethics, what
constitutes theft and fraud, actions in cases of conflicts of interests, and so on.
XX Communicate these principles and penalties to staff.

Working capital and cash flow management:

XX Define signatory authority over bank accounts and control over cash management, with
thresholds, delegation, and segregation of duties.
XX Ensure that sound bookkeeping is in place, with all investments and loans/credits recorded.

XX Make cash flow reports and forecasts part of planning discussions to determine future financing
needs and drive investment decisions. Ensure that any investments take into account cash flow
needs (riskiness, terms, maturities, liquidity).

Information technology management:

XX Document clear TORs for the IT function, to ensure that all key IT needs are being addressed to
support further growth of the company.
XX Consider which IT functions should be in-house versus outsourced.

Make sure the IT system that is used to generate data and reports is secure; develop formal safeguard
processes for administering security and business continuity/disaster recovery.

62 Chapter 3: Key Governance Topics and Leading Practices

 Stage 3: ORGANIZATIONAL DEVELOPMENT

Internal Controls
Create policies and procedures to monitor and mitigate strategic and operational risks in
accordance with the business vision and plans. The executive committee should have the
key role.

Leading Practices: Risk Governance and Internal Controls

Define authority and limits of business units, their reporting lines, and guidelines on key
processes, to create a path of accountability for every project and activity.

Ethics/conduct:
XX Develop a detailed code of ethics and business conduct, use it in the induction process, and
reinforce it regularly in communication with staff.
XX Establish appropriate remedial actions to violations of the code of conduct, and communicate
throughout the organization the results/consequences of noncompliance. Ensure that penalties
for breaches are clear and effective.

Working capital and cash flow management:

XX Hire a professional CFO (if there are external investors, do so in consultation with them).

Information technology management:

XX Develop a simple IT strategy to anticipate future business needs (functionality needs,
infrastructure needs), and prioritize system initiatives over the short and medium terms to better
plan capital requirements.
XX Conduct an independent IT audit to make sure the systems are secure and can support the
organization’s goals and objectives.

LP
Internal Audit

C
Establish an independent and effective internal audit function, coordinating with compliance

3
and risk functions. It can be in-house, outsourced, or co-sourced (using an external firm to
work with internal staff to train and bolster expertise). The owners should ensure maximum
possible independence of internal audit to assure full transparency of risks/problems that need
to be addressed.

Ensure that internal audit is looking at high-risk areas of the business to give added assurance—and
consider ex post or less intensive monitoring for low-risk areas, to make the best use of time/resources.

SME Governance Guidebook 63

 Stage 4: BUSINESS EXPANSION

Internal Controls

Ensure that management (executive committee) regularly reviews progress against the business
plan and identifies and addresses risks with appropriate internal controls.

The board should regularly ensure that the company has a sound system of internal controls.

Information technology management:

XX Establish IT systems to record and display sales and accounts, and accurately estimate accruals
and revenue at any given time.
XX The system should be robust, to protect against unauthorized use and to flag potentially
problematic transactions.

Internal Audit
Have internal audit report functionally to the board of directors, or a committee of the board of
directors (typically the audit committee), and not to the CEO except for administrative purposes.
Ensure that audit plans are approved by the board.

Ensure that the internal audit coordinates with the external auditor.

External Audit

Appoint a recognized external auditor. Make sure the external auditor reviews and reports on
significant controls deficiencies.

Ensure independence of the external auditor by restricting it from providing other services that
may cause conflicts of interest (for example, consulting, tax services).

Consider rotation of auditor, or at least senior audit partner, on a periodic basis (such as every
three years).

64 Chapter 3: Key Governance Topics and Leading Practices

 D
Disclosure and Transparency

“Disclosure and transparency are the partners of good governance; they demonstrate the

Leading Practices: Risk Governance and Internal Controls

quality and reliability of information—financial and non-financial, provided by management
to lenders, shareholders, and the public.”
—  Saleem et al. 2008

Stage 1 Stage 2 Stage 3 Stage 4

START-UP ACTIVE ORGANIZATIONAL BUSINESS
BUSINESS GROWTH DEVELOPMENT EXPANSION

XX Basic financial accounts prepared XX Monthly bank account XX Financial statements in XX Financial reporting is in
XX The same financial information reconciliation disclosed to all accordance with national accordance with the IFRS for
and data are used for all founders accounting standards SMEs or U.S. GAAP (if having/
purposes XX Founder(s), shareholders, and XX Point person for information seeking foreign investors)
directors periodically receive sharing identified XX Financial statements are audited
consistent financial and XX Key decisions are formally by a recognized auditing firm
nonfinancial information communicated to all staff XX Quarterly financial reports and
XX The public profile of the XX Basic performance reports are comprehensive performance
enterprise has been developed presented to external advisers reports are provided to investors
XX Key nonfinancial information is XX An annual report (or equivalent)
disclosed to the public is produced. Shareholders are
provided with information on
request

LP
C
This section covers the basics of disclosure: and heavily involved in running the business. The
team is small, so the key internal stakeholders are well

3
XX Financial Disclosure—the disclosure of financial and informed about material developments. Therefore,
operating results. focus at this stage is on preparing accurate and timely
financial information to all shareholders. At the later
XX Nonfinancial Disclosure—the disclosure of stages new non-managing shareholders may appear,
nonfinancial company information, including past old shareholders may no longer be directly involved in
performance and potential opportunities and operations, and the business itself becomes larger and
information on the company’s governance practices. more complicated. The importance of nonfinancial
information increases, and its target audience becomes
The need and benefits of transparency and disclosure more diverse—external advisers, directors, company
shift along with changing shareholder composition. staff, shareholders, and clients can be some of the key
In the early stages, the shareholders are typically few groups that the company may need to keep informed.

SME Governance Guidebook 65

General Guidelines document with examples and a contact person who can
clarify the status of information if it is unclear.
The terms transparency and disclosure are often used
interchangeably. They are indeed complementary and
overlapping, but there is an important distinction to
Financial Disclosure
highlight. Disclosure is a legal obligation to provide
certain types of information and content to certain Financial statements provide information for making
parties. Transparency is the emanation of a corporate economic decisions. They cover the financial position,
culture of openness—and one of the best ways to performance, and relevant changes in the financial
showcase that culture to the outside world. position of the business. For SMEs, the key users of
financial statements—and beneficiaries of financial
A company’s practice of disclosure and transparency disclosure—are likely to be owners/investors and creditors.
increases investors’ trust and therefore improves the
company’s access to external capital and lowers its Financial disclosure addresses the following areas:
cost. It also gives the company an opportunity for early balance sheet, income statement, statement of cash
identification of risks and weak points, which lowers the flows, statement of equity, notes to the financial
overall risk of company crises and scandals, and improves statements, and accounting policies used. An SME should
operational performance. explicitly state its commitment to high-quality financial
reporting in its code of conduct
SMEs are often concerned about disclosing information,
for fear that competitors can gain sensitive information In July 2009, the International Accounting Standards Board
on their business and financial condition. In reality, (IASB) issued IFRS for SMEs,10 which we highly recommend
though, sensitive business information is surprisingly for more information on this topic (IASB 2009).
limited and is more likely to involve corporate strategy,
products in research and development, pricing terms,
and so on. As an owner, you need to remember that the Nonfinancial Disclosure
market already knows you and your product/service,
because customers know you, and your competitors
know you, just as you know your competitors. Therefore, The general rule for deciding on nonfinancial disclosure
providing information is not about revealing your secret and its extent is based on whether the disclosure
formula, rather it is about taking the opportunity to is required by law or regulations, or by external
share who you are from your own perspective. constituencies to the company. This will mostly depend on
the business area the company is active in as well as the
Also, most competitive companies gain their advantage development stage of the company.
and barriers to entry from doing something that cannot
be easily replicated, as Southwest airlines did. For those For instance, a licensed business, such as a financial
companies, the advantage is in their way of doing things; institution, may have to legally disclose some nonfinancial
therefore, disclosure of business data will not allow a information to increase market confidence. A company
competitor to simply copy the process. aiming to supply goods through a global supply chain, or
aiming to compete in public tenders, may need to provide
Business owners should develop policies defining what nonfinancial data on its website.
constitutes confidential information (including for whom
confidential material is reserved) and what information
can be provided to stakeholders beyond required
disclosure obligations. This should be a simple one-page 10 IFRS = International Financial Reporting Standards.

66 Chapter 3: Key Governance Topics and Leading Practices

Whatever the reason, companies disclosing nonfinancial reference, meeting attendance, minutes, conflicts of
data need to follow the general principle of materiality. To interest, board performance assessment, and so on.
determine what is material, they should ask three questions:
It is a good idea to use the company website and other
XX What factors—what inputs, processes, and outputs public means to disclose to other stakeholders any
and outcomes—influence our ability to create value? information that is not commercially sensitive.

XX Which stakeholder groups do we depend on in our Relationship with big corporations

process of creating value in the short, medium, or long
term, or whom are we affecting significantly? SMEs that aim to become part of the supply chains
of bigger corporations need to get used to the idea of
XX Which factors are sufficiently likely to (and/or could) environmental, social, and governance (ESG) disclosures.
have a large enough impact on our value creation? Also called sustainability reporting, this includes disclosure
of their environmental-impact hazards, their human
Typical disclosure for investors covers the following health, social, and labor issues and impact on local
broad areas: communities, and their regulatory compliance and
liability. (See Box 3.6.)
XX State of the company: management team, key
personnel, and products and services offered. Some If you are looking to grow through a partnership with
companies may also choose to disclose data on an equity investor, be aware that requirements for
market share, their industry analysis (supply chain, sustainability reporting may become even more detailed
customers, competitors, and so on), and a broad- and specific.

Disclosure and Transparency

brush explanation of their strategy.
Related-party transactions
XX Ownership: structure and voting rights, articles of
association, relevant charters, bylaws, policies, and The RTP policies (as discussed on pages 59 and 60)
recent material events/changes. should include clear guidance on disclosure of such
transactions. Their proper disclosure is an important
XX Governance: such as values and code of conduct/ element of building trust between various investors and
ethics, board size and composition, terms of the management of the company.

D
Box 3.6: Benefits of Sustainability Reporting

3
Sustainability reporting provides the following benefits:

XX Helps communicate risk management information to investors

XX Increases awareness of risks and opportunities
XX Emphasizes the link between financial and nonfinancial performance
XX Benchmarks and assesses sustainability performance relative to laws, norms, codes, performance
standards, and voluntary initiatives
XX Helps manage and communicate environmental, social, and governance performance
XX Improves reputation and brand loyalty

Source: GRI (2013).

SME Governance Guidebook 67

 D LP
LEADING PRACTICES:
Disclosure and Transparency

Below, we present leading common practices for each SME evolutionary stage, using the categories discussed above:

XX Financial Disclosure

XX Nonfinancial Disclosure

Note that these practices are cumulative: practices for later stages build on the practices of earlier stages. Some
recommendations may be implemented more effectively in different stages, depending on the circumstances, or may
be implemented as the company is transitioning from one stage to the next. Use your judgment to determine the best
timing for your company.

Stage 1: START UP BUSINESS

Financial Disclosure

Prepare basic financial accounts and use this information consistently for registration, reporting, and
other purposes. Consistency in maintaining such financial records is important to potential investors
and funding institutions, because it allows them to better evaluate the business’s performance and
future growth potential.

Stage 2: ACTIVE GROWTH

Financial Disclosure

Conduct monthly reconciliation of bank accounts. This simple control activity allows for more
effective cash flow management and helps detect and prevent fraudulent activity. (See Elements
of Internal Controls on page 53.)

68 Chapter 3: Key Governance Topics and Leading Practices

 Ensure timely (monthly or quarterly) dissemination of financial statements to all shareholders.

Nonfinancial Disclosure

Agree with shareholders on key nonfinancial information to be presented to them on a regular

basis. The information should include past performance as well as forward-looking issues (risks,
opportunities, and so on).

Ensure that information is provided equally to all shareholders.

Develop the public profile of the enterprise and use it consistently for marketing, Web presence, and
other business purposes.

Stage 3: ORGANIZATIONAL DEVELOPMENT

Financial Disclosure

Prepare financial statements in accordance with national accounting standards.

Disclosure and Transparency

Nonfinancial Disclosure

Establish the disclosure function, possibly combining it with a compliance officer, CFO, or
company secretary. (See Organizational Structure on page 28.)

Identify information to be included in briefing papers for the regular meetings with external
advisers/advisory board.

Define key nonfinancial information to disclose to the public (for example, performance
summary, forward-looking strategies, governance practices, corporate social responsibility

D
practices) and present through accessible channels, such as the company website.

3
Establish the means to effectively communicate key decisions (strategy, priorities) and other
relevant information to all staff.

Make sure there is regular communication of the code of ethics/business-conduct policy. Find ways to
reinforce the message regularly.

SME Governance Guidebook 69

 Stage 4: BUSINESS EXPANSION

Financial Disclosure

Prepare the company’s financial reporting in accordance with the IFRS for SMEs or U.S. GAAP (if
you currently have or aim to have foreign investors).

Choose the external auditing firm by clearly defined criteria, such as experience, independence,
reputation, cost.

Nonfinancial Disclosure

Regularly present all material information to the board in a predefined format and time frame (at
least quarterly).

Distribute reports with key information (for example, annual report) to shareholders as required
by law and per the shareholder agreement.

Consider what forms of regular voluntary disclosure to stakeholders (beyond those required by
law) would be beneficial for the company.

Make sure the company’s disclosure function provides for orderly handling of shareholder
information requests.

70 Chapter 3: Key Governance Topics and Leading Practices

 E
Ownership

“I don’t know cases of families. . .that had become more united because of money, but I do
know of many cases where families destroyed companies because of money.”
—  Roque Benavides, CEO, Buenaventura

Leading Practices: Disclosure and Transparency

Stage 1 Stage 2 Stage 3 Stage 4
START-UP ACTIVE ORGANIZATIONAL BUSINESS
BUSINESS GROWTH DEVELOPMENT EXPANSION

XX The role and responsibilities XX The difference between non- XX Clear distinction between the XX Policies and mechanisms to
of the founder(s) clearly family and family issues is roles of the founder(s), family regulate family members’
established acknowledged members, and managers ownership, employment, and
XX Basic understanding of roles XX Awareness of family XX Clear career paths for non- other benefits
of all family members succession planning family executives XX All shareholders are regularly
XX Shareholder dispute XX Annual shareholders’ XX Family succession plan updated on company policy,
resolution mechanism meetings XX Annual shareholders’ strategy, and results
meetings include discussions XX Mechanism for resolving
of key decisions made, governance-related disputes
dividends, and plans

SMEs typically start as sole proprietorships or partnerships Shareholder Participation

of two or three people. As the company develops and

LP
shows signs of success, other investors may show Growth in SMEs is often organic and unstructured
interest—first, friends, family members, or managers, and can lead to confusion over roles, responsibilities,
and later, professional investors such as private equity and scope of authority of shareholders. These issues

D
funds. These shareholders often have diverging interests are intensified in family businesses, where authority,
and views on the company development. This section power, and influence are not necessarily related to

3
discusses how to manage shareholder-related issues for formal business roles. Therefore, the key focus for
the benefit of a business’s long-term development. It looks Stage 1–2 SMEs should be on providing basic clarity of
specifically at the following: the shareholders’ roles and responsibilities. In Stages
3–4, the emphasis shifts to regulating growing family
XX Shareholder Participation in determining the future of involvement in the business and balancing the interests
the company; of an increasing number of shareholders for the benefit of
the company’s long-term sustainability.
XX Founder/Family Role in running the company;
Evolving Nature of SME Ownership
XX Shareholder Dispute Resolution to proactively
handle conflicts that can threaten the survival of the At the beginning of the lifecycle of an SME, initial
company. shareholders tend to be connected—as acquaintances,

SME Governance Guidebook 71

family members, or business partners. Most tend to
Types of Investors
be involved in the operational matters of the company, SMEs might be interested in attracting external investors
acting as both owners and managers. Others frequently for reasons beyond access to financing. Investors can
“check in” with the company to see what’s going on. bring important connections, knowledge, and expertise
to enable the company to fully realize its potential for
Many SMEs start as sole proprietorships or partnerships, growth. They typically require representation on the
but some SMEs start as corporate legal entities, which board commensurate with their share of ownership.
means that from the beginning they have to comply with Table 3.1 on the next page describes the common
the legal requirement to have a board of directors. For types of investors that SMEs can investigate.
those SMEs, the board of directors becomes a formality,
without real substance. Early on, this is not a problem— The vast majority of SMEs have friends and family
as long as the number of owners is small, they all run or members as partners, especially at the early stages of
interact with the business, and all have a direct input in development. The shareholder relationship often remains
shaping the future of the company. highly informal and trust-based. Even in this case it is
strongly recommended to clearly spell out some of the
This situation can continue for as long as there is key elements of shareholders’ rights discussed in this
no substantial growth, either of the business or the chapter, such as their role in decision making, claiming
ownership. However, as soon as the business becomes a profit share, role in the company, and so on. This will
more complex, the initial owners who do not run the enhance trust and provide reasonable insurance against
company will gradually start losing the ability to have potential misunderstandings and conflicts in the future.
a full picture and strategic control over the operations.
The situation becomes even more complicated if the
company brings in external investors. Unlike the founding Key Shareholder Rights
owners, the new investors do not have inside information
about the business and may not have the same level All shareholders, regardless of their size, have certain
of trust in the capacity of the founder/CEO as the co- rights, among them:
founding owners may have.
XX The right to obtain relevant, material information
These changes will make it necessary for the company about the business on a timely, regular basis
to formalize the relationship with its investors, with (discussed in the section on Disclosure and
clearly established processes and policies to handle Transparency, above);
communication flows and strategic decision making.
Companies that have boards as a mere formality will have XX The right to have a say in the strategic development of
to enable them to effectively fulfill their roles. the company.

For family-owned SMEs, the change in the structure of An annual general meeting (AGM) provides a vehicle for
ownership may also be a product of family members the sharing of information and the participation of
belonging to different generations and branches of the shareholders by allowing them to take the following
family inheriting the business. As the pool of shareholders actions:
grows larger, most of them will end up with a smaller
percentage of the company’s shares, and issues related XX Review and approve company results and dividends.
to shareholder rights will become more common. These
issues can be mitigated by ensuring clear protection of XX Set company goals on growth, risk, profitability,
minority shareholders in the business charter, bylaws, and liquidity;
and business governance code.

72 Chapter 3: Key Governance Topics and Leading Practices

XX Appoint members of the board of directors; no longer adhere to the vision, strategy, or decision
processes that were associated with the development of
XX Make other key decisions, such as those concerning the company. An exit of one or several initial investors is a
equity structure, company strategy, and large related- frequent occurrence, and without an agreed mechanism
party transactions. for the valuation of shares (typically part of the
shareholder agreement), a company may be faced with
One of the most important issues is minority infighting among investors and paralysis of operations.
shareholders’ representation on the board. For most Be clear about who can sell their shares, how much at a
SMEs, the founder typically remains the dominant time, how often, by what method, and to whom.
shareholder and can effectively control the board
composition. It is a good practice, however, to allow In family businesses, the company may establish a
minority shareholders to appoint a director to represent shares-redemption fund to buy back any shares that
their interests on the board. This position is typically family members would like to liquidate. The aim is
filled by an independent director. Institutional investors to provide liquidity for the shareholders, without

Leading Practices: Disclosure and Transparency

generally make their participation conditional on having undermining the company. The business typically
a nominee director on the board. finances such a fund by contributing a small percentage
of profits to it every year.
As SMEs evolve through the stages of growth, it is
important to note that initial owners or investors may

Table 3.1: Types of Investors

STRATEGIC PARTNERS SMEs can benefit from investment from companies that become strategic partners. An example
is a property management company making a strategic investment in a property maintenance
company—as one will provide service to the other.

ANGEL INVESTORS Angel investors typically are people with high net worth, often business people themselves, who
provide capital to start-ups, usually in exchange for equity or convertible debt. Angel investors,

LP
having taken on considerable risk by investing their personal funds, often offer a great deal of
one-on-one support and personal guidance to owners in a bid to support the company’s successful
growth and development. Hence angle investors typically seek to invest in business fields where

D
they have considerable experience. Angel investors may also work through funds or alliances to help
diversify risks.

3
VENTURE CAPITALISTS Venture capitalists—a well-known form of funding through a professionally managed fund—look for
a high return on investment and have strict procedures to follow. The venture capitalist takes equity,
and if a business does not live up to expectations, the venture capitalist can have the company
sold to recoup its investment. Venture capitalists typically fund enterprises later in the investment
process and, having deeper pockets, invest larger amounts of capital than angel investors.

CROWDFUNDING Rather than asking one person or a single bank for a large sum of money, a business accessing
crowdfunding has the opportunity to ask thousands of people for small amounts of money each.
The investment can be in exchange for future products or services, or equity in the company. A
relatively new source of funding, it has been used successfully by nontraditional start-up businesses.
A strong board can help companies stand out and attract more capital, especially if the boards have
independent directors who will represent interests of retail investors.

SME Governance Guidebook 73

Founder/Family Role11 business, it sometimes leads to a misalignment of
incentives among all family members.
If the business is successful, the role of owners is bound
to evolve along with the evolution of the company. XX Informality. Because most families run their
Owners will move from micro to macro positions, businesses themselves (at least during the first
leaving operational decision making to professional and second generations), they usually show very
managers. little interest in setting clearly articulated business
practices and procedures. As the family and its
Some of these managers might be family members. In business grow larger, this situation can lead to
fact, the vast majority of SMEs are family businesses. many inefficiencies and internal conflicts.
The founders rely heavily on family members’ labor,
funding, and connections to get the business going, XX Nepotism. Favoring family members can destroy
and they plan to pass it to the next generation. SMEs value or diminish value creation.
that are family operated benefit from trust-based
relationships, informality, and streamlined decision These concerns are further compounded by an
making, which can be an asset in the early stages of additional variable: the evolution of ownership as
company growth. These SMEs can be resilient in crisis, the business passes from the founder to successive
given the trust between related parties—and with generations, bringing changes in the number and
generations at stake, the long-term business planning nature of shareholders. Also, there will be more
can lead to superior business performance (as outlined possible combinations of roles that different family
in Liu, Yang, and Zhang 2012). members can play:

However, while many family businesses are thriving, XX Owning shares in the company but not working for
there are also many that fail to be sustainable in the it;
long term. Indeed, about two-thirds to three-quarters
of family businesses either collapse or are sold by the XX Working for the company but not owning shares;
founders during their own tenure. Only 5 percent to 15
percent continue into the third generation in the hands XX Owning shares and working for the company.
of the descendants of the founders (Neubauer and Lank
1998). These factors can seriously complicate both family and
business relationships. To address issues and interests
Many of these companies fall victim to weaknesses of the family as a whole, many family businesses find it
that are specific to the nature of family businesses, useful to develop family governance structures that are
among them: parallel to the business governance structures.

XX Complexity. Adding family emotions and issues Governance institutions: A family governance
complicates business relations. Also, when family structure could take the form of a family assembly,
members take on different roles within their which has all family members meeting annually to
update each other on how the business is going,
to discuss certain issues, and to benefit from the
viewpoints of those not formally involved in the
11 This subsection is based on the IFC Family Business Governance governance of the business.
Handbook (IFC 2008), which is freely available online and highly
recommended for further study on this topic: http://www.ifc.
org/wps/wcm/connect/topics_ext_content/ifc_external_corporate_
In addition, there may be a family council, which acts
site/ifc+cg/resources/guidelines_reviews+and+case+studies/
ifc+family+business+governance+handbook. as an executive committee of the family assembly. It

74 Chapter 3: Key Governance Topics and Leading Practices

typically is composed of five to nine elected members, Shareholder Dispute Resolution
who represent different branches and age groups in the
family. This includes members who are employed in the It is important for the shareholders and directors to ask,
business as well as those who are not. “Do we have an adequate mechanism in place to prevent
and resolve governance disputes?” James Groton, dispute
Family governance policies: The family constitution resolution consultant and arbitrator, emphasizes the
is the most comprehensive type of family governance importance of this duty.
document. It typically covers the family’s values and
beliefs (mission statement) and family business principles “. . .[T]he parties to a business relationship, at the time
or policies and can include the following: they enter into that relationship, should always address
the subject of how they are going to handle any problems
XX Family shareholding policy—establishes rules for share or disputes that may arise between them. At this point they
ownership and transfer, to ensure that shares are have a unique opportunity to exercise rational control over
kept in the family when desired (an example is a share any disagreements that may arise, by specifying that any
redemption fund); disagreements be processed in ways that are likely to avoid
litigation, preferably by agreeing on a dispute resolution
XX Family employment policy—provides guidelines on ‘system’ that will first seek to prevent problems and
how family members can gain employment with disputes, and next establish a process for resolution of any
the company (for example, it might set criteria for disputes” Groton and Haapio 2007.
educational background and professional experience);
Provisions for how to resolve potential disputes should be
XX Family dividend policy—establishes guiding principles included in the shareholder agreement and other relevant
for family dividend payments, to help resolve differing company documents. Together, these documents should
family cash demands; provide a practical procedural roadmap that makes clear
for all disputants how matters will be resolved.
XX Family director nomination policy—provides guidelines
for electing family members to the company board of The most effective and efficient way to resolve

Ownership
directors; governance disputes is mediation—a voluntary,
confidential process whereby a respected impartial third
XX Conflict resolution policy (and committee)—describes party (mediator) helps the disputing parties work toward
measures to help resolve conflicts between family a negotiated agreement. The parties in mediation craft
members, within a defined scope. the terms of an agreement by consensus, which means

E
they fully control the outcome, unlike outcomes in
Deciding what type of institution to establish and the litigation.

3
content of the policies will depend largely (but not
exclusively) on the size of the business, the family’s stage For detailed guidance on setting effective dispute
of development, the number of family members, and resolution in business, we recommend Boardroom
the degree of involvement of family members in their Disputes: How to Manage the Good, Weather the Bad, and
business. Prevent the Ugly (IFC 2015a).

SME Governance Guidebook 75

 E LP
LEADING PRACTICES:
Ownership

Below, we present leading common practices for each SME evolutionary stage, using the categories discussed above:

XX Shareholder Participation

XX Founder/Family Role

XX Shareholder Dispute Resolution

Note that these practices are cumulative: practices for later stages build on the practices of earlier stages. Some
recommendations may be implemented more effectively in different stages—or, depending on circumstances, as the
company is transitioning from one stage to the next. Use your judgment to determine the best timing for your company.

Stage 1: START UP BUSINESS

Founder/Family Role

Define and communicate to all staff the role of the founder(s) in company operations.

Define the role and rights of other family members—and communicate to them as well as to
company employees. This issue needs to be addressed not only for family members who are
employed in the business but also those not formally involved in running the business. If multiple
family members own or are expected to own shares, adopt a formal process to enable them to exit.
The aim is to provide liquidity for the family shareholders without undermining the company. For
instance, be clear about who can sell their shares, how much at a time, how often, by what method,
and to whom.

Shareholder Dispute Resolution

Incorporate shareholder dispute resolution provisions into the shareholder agreement or articles
of incorporation.

76 Chapter 3: Key Governance Topics and Leading Practices

 Stage 2: ACTIVE GROWTH

Shareholder Participation

Hold annual meetings of shareholders to discuss key decisions made, dividends, and plans.

Founder/Family Role

Clearly define and communicate the difference between business and family issues, and the
proper channels to address them.

Discuss contingency succession issues internally with the family, and identify possible successors, both
in top management and in ownership. (See Succession Planning on page 41.)

Stage 3: ORGANIZATIONAL DEVELOPMENT

Shareholder Participation

Be sure shareholders meetings are well-organized and function effectively to allow for adequate
shareholder participation. In particular:

XX Provide as much advance notice as is practicable.

XX Ensure that documentation is professional and distributed in a timely manner.

Ownership
XX Make the meeting relevant and interesting; listen to shareholders on voting issues.

Founder/Family Role
Discuss the desirability, or lack of thereof, of family members assuming multiple roles and
responsibilities in the business. The decision needs to be clearly communicated inside the

E
business and family.

3
Create clear functional distinctions between 1) owners (shareholders), 2) employees (especially
senior management), and 3) non-employee/non-shareholder family members. Family members
“wearing multiple hats” should understand proper modes of behavior and communication in their
various roles. In discussing and defining family-member roles, be sure to consider these three
dimensions and their points of interaction: 1) the family subsystem, 2) the business subsystem,
and 3) the ownership subsystem.

Identify clear career paths for non-family executives and technical specialists. Review the role of
job mastery as a motivating factor. (See Human Resources Planning on page 45.)

Develop and communicate the family ownership (and management, if applicable) succession plan.
(See Succession Planning on page 41.)

SME Governance Guidebook 77

 Stage 4: BUSINESS EXPANSION

Shareholder Participation

Define effective ways to regularly update all shareholders on company policies, strategy, and
results. Ensure that these means of communication do not create an additional burden for
shareholders (for example, multiple mailings or e-mailings).

Founder/Family Role

Develop and communicate policies, mechanisms, and structures to regulate decisions that
might affect family members’ ownership, employment, dividends, and other benefits. This should
include defining specific training and education needs for current and future employed family
members. Consider establishing a shares-redemption fund.

Shareholder Dispute Resolution

Expand dispute-resolution provisions to include the leading role of the board in governance-
related conflict resolution, and specify approaches to be taken in case of conflicts with different
stakeholders, such as shareholders or managers. Incorporate relevant provisions into company
bylaws.

Appoint someone to oversee the development and implementation of the governance dispute-
resolution strategy and policies. A board member, the chair, a board committee, the CEO, or possibly a
senior executive could assume this responsibility.

78 Chapter 3: Key Governance Topics and Leading Practices

 Chapter 4
Conclusion

SME Governance Guidebook 79

Conclusion
The goal of this Guidebook is to help SMEs gain a better grasp of the challenges they face—and how to tackle them
from a corporate governance perspective. It is built on the innovative concept of tying governance recommendations
to growth stages, which helps entrepreneurs take a pragmatic approach to progressively adopting better governance
policies, practices, and structures as the business evolves. The advice in this Guidebook is intended as a general guidance
and not as a panacea. It needs to be adapted to the specific context of a given company and its business environment.

The Appendix provides an SME governance action planning tool that summarizes the recommendations of this Guidebook.
It presents that information in a workbook format designed to help you develop a tailored governance-improvement plan for
your company. The ultimate goal is for your company to become more competitive and to grow sustainably.

Case Study: We Say Goodbye—Investors Say Hello!

This Guidebook has described a wide range of recommendations that the IFC team provided for Rockstar
Clothing. At the beginning, the company needed massive changes. Our challenge: where to start?

IFC recommended that Rockstar prioritize three actions to address pressing immediate issues as well as
to enable the company to achieve positive changes down the road:

1. Establish an executive management committee, supported by clear authority and reporting

lines. This action requires no additional resources and will help alleviate acute and obvious
management challenges. The management committee should be empowered to start
developing a proper business plan.

2. Hire a recruiting company to find a competent HR manager. The company’s HR policies need to be
reorganized and clearly defined to attract high-caliber staff, especially for the CFO position, and to
address key-persons risks (most notably for the designer and CEO).

3. Hire a consultant to establish basic computer-enabled internal control processes to provide

accurate and timely information on the state of the business. This will enable better
management of available resources and serve as a prerequisite for attracting investment.

The company accepted the recommendations and embarked on an ambitious plan to reinvent itself
with the goal of achieving Rami Bahgat’s vision of opening 100 stores all over Egypt. The last time we
heard from the company, in late 2018, it had managed to raise financing of approximately $10 million
from a private equity firm through a competitive process.

This turnaround has Rockstar Clothing looking good! (The suits that Rami creates look very nice, too.)

80 Conclusion
 Appendix
SME Governance Action Planning Tool

SME Governance Guidebook 81

Appendix
SME Governance Action Planning Tool

This tool summarizes the key recommendations of the SME Guidebook to help you identify high-priority actions
appropriate for your SME’s stage of growth. The diagnostic is organized around five governance topics and their
subtopics. (See Figure A.1.)

Figure A.1: Governance Topics and Subtopics

A B C D E
Topic A: Topic B: Topic C: Topic D: Topic E:
Culture and Decision Making Risk Governance Disclosure and Ownership
Commitment to and Strategic and Internal Controls Transparency
Good Governance Oversight
XX Owners’ Awareness XX Management XX Internal Controls XX Financial Disclosure XX Shareholder
and Commitment Decision Making XX Internal Audit XX Nonfinancial Participation
XX Organizational XX Advisers/Advisory XX External Audit Disclosure XX Founder/Family Role
Structure Board XX Shareholder Dispute
XX Key Policies and XX Board of Directors Resolution
Processes XX Succession Planning
XX Human Resources
Planning

82 Appendix
The tool provides a THREE-STEP PROCESS for developing a priority action plan
for improved governance:

Identify the PRIMARY STAGE OF

DEVELOPMENT of your company.

STEP
1

STEP Identify LEADING PRACTICES/CHANGE

ACTIONS for the development stage and

2 assign a time frame and priority for their

completion.

STEP
3
Create an immediate ACTION PLAN

Appendix
that includes a dedicated table listing the
short-term high-priority changes that you
have identified.
5

SME Governance Guidebook 83

 Step
1
My Company’s
Primary Stage of Development
Use the worksheet on the next page to identify the stage
of development of your company. Circle the component
description that most closely matches your company’s
current state. Then choose the stage that has the
most matches.

Important: If your company is in the process

of moving from one stage to the next, you
should use the earlier stage as the primary stage
of development.

84 Appendix
Worksheet A.1:
Identify the Stage of Development

Defining Factors/ Stage 1 Stage 2 Stage 3 Stage 4

Parameters START-UP ACTIVE ORGANIZATIONAL BUSINESS
GROWTH DEVELOPMENT EXPANSION

Size* Small Small to Medium Medium Medium Growing

(# of employees) (e.g., <50) (e.g., 50–75) (e.g., 76–150) (e.g., 151–250)

Enterprise Focus Developing products, Sales and growth, Optimizing own Further growth,
testing the market increasing variety of structure/processes supported by improved
products, creating client after growth internal organization
base and processes

XX Small multitasking team XX Team is growing— XX Increased XX Continuation of trends

A XX High degree of distinct functions and
organizational structure
professionalization of
functions
started in Stage 3
informality
Culture and Commitment start emerging XX Formalizing
XX Few systems,
to Good Governance established “on the go” XX Simple systems to organizational
enable functions to structure, policies, and
(Policies, processes, and
collaborate procedures
organizational structure)

XX Highly centralized XX Emergence of delegation XX Professional managers XX Separation of strategic

B decision making by the
founder(s)
to management are hired and operational decision
making
XX Consultative leadership XX Decentralization of
Decision Making and XX Autocratic leadership style—largely autocratic authority through XX Institutional decision-
Strategic Oversight style but with input from key division /functional making style, based on
managers and advisers management defined organizational
(Decision-making process structure, roles, and
XX Collaborative
and bodies, leadership procedures
management style
style)

XX Founders are fully XX Introducing internal XX Detailing authorities XX Focus on proactive

C involved in operations—
limited need for checks
controls to support
delegation of authority
and accountability and strategic risk
management
XX Systems are formalized
Risk Governance and and balances and automated
Internal Controls XX Developing practices to
(Internal checks and control main operational
balances) risks

XX Everyone knows XX Silos—good within, but XX Internally: improving XX Internally:

D everything challenging between cross-divisional/ management, board,

Appendix
silos functional information and shareholders
Disclosure and XX Basic external sharing communicate
Transparency information shared on XX Enhanced external XX Externally: targeted
products offered business-related information for different
(Communication with
information stakeholders
internal and external 5
stakeholders)

XX Single owner or couple XX New minority XX New minority XX Common options:

E of individuals shareholders possible
(internal or related)
shareholders possible
(internal or related)
a. Founders, PE, and
XX Founders personally other investors
Ownership control every aspect of XX Founders remain XX New investors informally b. G
 rowing family
business dominant and fully influence strategy but ownership/
(Founders/Shareholders/
engaged are not directly involved generational change
Family)
XX Increasing number of in operations
c. G
 o Public (IPO)
family members getting XX (If a major investor
XX Investors require tools
involved in operations enters—company moves
for control and direction
to Stage 4)
of the company

*May vary by industry, so this guidance is intended to be broadly indicative.

SME Governance Guidebook 85

 Step
2
Governance Leading Practice –
Identify Relevant Practices
Use Worksheets A.2–A.6, on the next page, to identify relevant
governance practices for your company.
Review the Leading Practices/Change Actions. Fill in the check-circle on
the left if the practice has already been satisfactory implemented. If it
has not been implemented or needs further improvement, assign a time
frame and priority to it, as illustrated in Figure A.2.

Figure A.2: Example Worksheet for Leading Practices and Change Actions

Time Frame: ST = <6 mos.; MT =6–12 mos.; LT = > 1 yr.

Priority: H = High; M = Medium; L = Low

SME Time
Stage Leading Practice/Change Actions Frame Priority

Owners’ Awareness and Commitment

A1-1. Officially register the business with proper authorities (as a company or sole entrepreneurship) ST MT LT H M L

to ensure separation of the business from the person

Stage 1
Organizational Structure
A1-2. Identify core business functions needed, and distribute them among your multitasking team. ST MT LT H M L

Key Policies and Processes

A1-3. Adopt the Articles of Association. ST MT LT H M L

It is important to be alert to the following:

XX These practices are cumulative: practices for later stages build on the practices of the earlier stages. So always check to
be sure your company has covered the actions recommended for the earlier stage(s).

XX The staging of actions is indicative. Also, many companies are in the process of moving from one stage to the next.
Therefore, in some circumstances certain practices or actions may be done sooner or later than recommended. Use
your judgment to decide the best timing for your company.

86 Appendix
Worksheet A.2:
Topic A. Culture and Commitment to Good Governance

A Time Frame: ST = <6 mos.; MT =6–12 mos.; LT = > 1 yr.

Priority: H = High; M = Medium; L = Low

SME Time
Stage Leading Practice/Change Actions Frame Priority

Owners’ Awareness and Commitment

A1-1. Officially register the business with proper authorities (as a company or sole entrepreneurship) ST MT LT H M L

to ensure separation of the business from the person.

Stage 1
Organizational Structure
A1-2. Identify core business functions needed, and distribute them among your multitasking team. ST MT LT H M L

Key Policies and Processes

A1-3. Adopt the Articles of Association. ST MT LT H M L

Owners’ Awareness and Commitment

A2-1. Develop a basic statement on vision, mission, and core values, and communicate it to staff. ST MT LT H M L

Organizational Structure
Stage
2 A2-2. Ensure that the core functions needed for the company to grow have been filled through ST MT LT H M L

direct hiring or outsourcing. Develop clear job descriptions.

A2-3. Define, document, and communicate to all staff the organizational structure, with lines of ST MT LT H M L

authority and reporting.

Key Policies and Processes
A2-4. Develop basic policies, where applicable, to regulate the authority/function. ST MT LT H M L

Owners’ Awareness and Commitment

A3-1. Signal the intent to develop effective governance by discussing its importance with managers ST MT LT H M L

and staff.
Stage 3
A3-2. Articulate long-term vision for the company—to be used for staffing, strategic planning, and ST MT LT H M L

other purposes.
Organizational Structure
A3-3. Appoint a person to have responsibility for improving governance practices and compliance. ST MT LT H M L

This could be a fulltime position (company secretary) or part-time function for one of the executives
or a lawyer.
A3-4. Conduct periodic reviews to evaluate the existing organizational structure and reporting lines. ST MT LT H M L

Key Policies and Processes

Appendix
A3-5. Document and periodically review the efficiency of core processes (accounting, procurement, ST MT LT H M L

etc.). Establish basic communication channels to communicate the shortcomings of core processes.
A3-6. Start producing a simple calendar of corporate events (such as team meetings, participation ST MT LT H M L

of company representatives in conferences and public forums, etc.).

5
Owners’ Awareness and Commitment
A4-1. Establish the company secretary function to ensure effective work of the board, help the ST MT LT H M L

board improve governance practices and compliance, and organize annual shareholder meetings.
Stage
Organizational Structure
4
(Board established—see Topic B) ST MT LT H M L

Key Policies and Processes

A4-2. Develop an action plan that includes explicit actions, timing, and responsibility to improve ST MT LT H M L

governance.
A4-3. Formalize governance provisions with participation of all shareholders and key stakeholders. ST MT LT H M L

Include them in the Articles of Association, Shareholder Agreement, and Employee Handbook.

SME Governance Guidebook 87

Worksheet A.3:
Topic B. Decision Making and Strategic Oversight

B
Time Frame: ST = <6 mos.; MT =6–12 mos.; LT = > 1 yr.
Priority: H = High; M = Medium; L = Low

SME Time
Stage Leading Practice/Change Actions Frame Priority

Management Decision Making

B1-1. Conduct individual consultations with key executives before making major decisions. ST MT LT H M L

Stage 1 B1-2. Define and communicate authority limits for key personnel, such as amounts of expenditures ST MT LT H M L

that require CEO authorization.

Advisers/Advisory Board
B1-3. Involve external trusted advisers (even if informal) to discuss strategic issues. ST MT LT H M L

Management Decision Making

B2-1. Develop an authority matrix that defines key decisions and which business units or individuals ST MT LT H M L

are authorized to make them. This should include decisions for the founder/shareholders, board (if
Stage one exists), CEOs, key executives, and technical specialists.
2
B2-2. Management should meet regularly as a group to collaboratively review operational issues ST MT LT H M L

and progress against plans, to identify risks/issues, and to take decisions. The group is engaged by
CEO/owners for consultations on strategic issues, as needed.
Advisers/Advisory Board
B2-3. Articulate areas/topics of needed external expertise (providing input on company strategy, ST MT LT H M L

financing plans, new markets and products, technical issues, company structure, business
relationships, external company profile, coaching of executives, or other).
B2-4. Define the role and formalize involvement of the needed external advisers. Make sure the ST MT LT H M L

advisers understand their role and are engaged effectively to add value to the company.
Succession Planning
B2-5. Create a contingency/business continuity plan for the CEO and other key persons, which ST MT LT H M L

describes a course of immediate action in case of sudden departure or unavailability.

Human Resources Planning
B2-6. Develop a simple means of communicating to staff the key decisions, policies, and strategies ST MT LT H M L

(e.g., formal e-mail form, circulars).

B2-7. Document HR function and job descriptions to ensure that all key roles are filled (or ST MT LT H M L

outsourced).
B2-8. Develop internal (or outsourced) expertise on management reporting and analytics—to help ST MT LT H M L

with cost control and strategic decision making.

Management Decision Making

B3-1. Set up a formal executive committee (the CEO and key senior-level executives). Ensure that ST MT LT H M L

the committee has clear terms of reference (TORs).

Stage 3
B3-2. The executive committee 1) meets weekly/biweekly on operational issues and 2) has dedicated ST MT LT H M L

sessions to focus exclusively on strategic issues, with a set agenda (strategic retreats, 2–4 times a
year).
B3-3. At executive committee meetings (e.g., monthly or quarterly), review progress against the ST MT LT H M L

plans, and update plans as necessary.

Advisers/Advisory Board
B3-4. Consider whether setting up a formal advisory board would add value to the company. If so, ST MT LT H M L

formalize the arrangement and communicate it to all relevant stakeholders.

88 Appendix
Worksheet A.3:
Topic B. Decision Making and Strategic Oversight (continued)

B
Time Frame: ST = <6 mos.; MT =6–12 mos.; LT = > 1 yr.
Priority: H = High; M = Medium; L = Low

SME Time
Stage Leading Practice/Change Actions Frame Priority

Succession Planning
B3-5. Develop a basic succession-planning framework for senior management, to ensure timely ST MT LT H M L

preparation of a talent pool.

Stage 3
Human Resources Planning
B3-6. Make the HR function a strategic partner (and/or part) of the strategic management team ST MT LT H M L

(e.g., helping design effective sourcing and retention strategies, compensation and benefits
programs, professional development programs, and performance management systems).
B3-7. Expand the job descriptions for every position to form detailed TORs that include the qualities ST MT LT H M L

and qualifications required. Review the current staff for fit with the TORs.
B3-8. Design an incentives system to attract high-caliber talent and motivate them to perform ST MT LT H M L

(mastery, autonomy, purpose), including clear professional and career-growth opportunities,

performance-based recognition, and incentives (bonuses, stock options, profit sharing, etc.).
B3-9. Address personnel retention factors with meaningful engagement from the staff: attractive ST MT LT H M L

work environment, internal company policies, competitive compensation and benefit package.

Board of Directors
B4-1. Clearly define the role of the board, especially in relation to management, and include ST MT LT H M L

directors’ duties and responsibilities to the company and shareholders in the board charter and
Stage director appointment letter.
4
B4-2. Determine the skills required for the board to fulfill its duties, given the strategic direction of ST MT LT H M L

the company, and evaluate the existing board skills and gaps.
B4-3. Ensure that the board has an appropriate mix of directors, considering skill sets, professional ST MT LT H M L

background, personal attributes, diversity (gender, age, etc.), and balance of executive, non-
executive, and independent directors.
B4-4. Create effective and efficient board procedures: ST MT LT H M L

• Allow enough time for effective discussion and input from all directors.
• Provide a focused agenda for each meeting, based on the annual board calendar.
• Maintain a balance between management presentations and board discussions, and between
reviewing past performance and strategic planning.
Distribute action-orientated and concise board briefing papers at least five business days before

Appendix
•
board meetings.
• Take and approve minutes (discussions, opinions, and decisions). Use them to ensure diligent
follow-up.
Succession Planning 5
B4-5. Develop strategic succession plans for the CEO, key executives, and technical specialists (to ST MT LT H M L

include immediate, mid-, and long-term succession).

SME Governance Guidebook 89

Worksheet A.4:
Topic C. Risk Governance and Internal Controls

C Time Frame: ST = <6 mos.; MT =6–12 mos.; LT = > 1 yr.

Priority: H = High; M = Medium; L = Low

SME Time
Stage Leading Practice/Change Actions Frame Priority

Internal Controls
C1-1. Ensure that the company complies with relevant laws and regulations. ST MT LT H M L

Stage 1 C1-2. Separate the cash sources and bank accounts of the company from the personal sources and ST MT LT H M L

accounts of the founders.

C1-3. Routinely monitor and analyze cash flow needs to effectively plan working capital and ST MT LT H M L

financing needs and investment strategies.

C1-4. Conduct a basic valuation exercise to understand the total net worth of the enterprise. ST MT LT H M L

Internal Controls
C2-1. Create a mechanism for reporting fraud and abuses (whistleblower). ST MT LT H M L

C2-2. Identify potential business risks, assess their impact, and develop corresponding mitigation ST MT LT H M L
Stage
actions (with “owners to track progress”).
2
C2-3. Integrate basic risk-based controls into the business processes (e.g., approval limits, ST MT LT H M L

separation of authority, verifications, etc.).

C2-4. Identify critical key-person risk positions, designate backup/deputy staff for key functions/ ST MT LT H M L

technical specialists, and ensure that they are building needed skills and expertise.
C2-5. Articulate key principles of business conduct, covering at a minimum the conflicts of interests ST MT LT H M L

and related-party transactions, and communicate them regularly to staff.

C2-6. Define signatory authority over bank accounts and control over cash management, with ST MT LT H M L

thresholds, delegation, and segregation of duties.

C2-7. Ensure that sound bookkeeping, accounting policies, and reports have been put in place, with ST MT LT H M L

all investments and loans/credits recorded.

C2-8. Make cash flow reports and forecasts part of planning discussions to determine future ST MT LT H M L

financing needs and drive investment decisions. Ensure that any investments take into account
cash flow needs (riskiness, terms, maturities, liquidity).
C2-9. Document clear TORs for the IT function to ensure that all key IT needs are addressed to ST MT LT H M L

support further growth of the company. Consider which IT functions should be in-house versus
outsourced.
C2-10. Make sure the IT system for generating data and reports is secure; develop formal safeguard ST MT LT H M L

processes for administering security and business continuity/disaster recovery.

Internal Controls
C3-1. Create policies and procedures to monitor and mitigate strategic and operational risks in ST MT LT H M L

accordance with the business vision and plans. The executive committee should play the key role.
Stage 3
C3-2. Define authority and limits of business units, their reporting lines, and guidelines on key ST MT LT H M L

processes, to create a path of accountability for every project and activity.

C3-3. Develop a detailed code of ethics and principles of business conduct, use them in the ST MT LT H M L

induction process, and reinforce them regularly in communication with staff.

C3-4. Establish appropriate remedial actions for violations of the code of conduct, and ST MT LT H M L

communicate throughout the organization the results/consequences of noncompliance. Ensure

that penalties for breaches are clear and effective.

90 Appendix
Worksheet A.4:
Topic C. Risk Governance and Internal Controls (continued)

C Time Frame: ST = <6 mos.; MT =6–12 mos.; LT = > 1 yr.

Priority: H = High; M = Medium; L = Low

SME Time
Stage Leading Practice/Change Actions Frame Priority

C3-5. Hire a professional CFO. (If there are external investors, this should be in consultation ST MT LT H M L

with them.)
C3-6. Develop a simple IT strategy to anticipate future business needs (functionality needs, ST MT LT H M L
Stage 3
infrastructure needs), and prioritize system initiatives over the short and medium terms to better
plan capital requirements.
C3-7. Conduct an independent IT audit to make sure the systems are secure and can support the ST MT LT H M L

organization's goals and objectives.

Internal Audit
C3-8. Establish an internal audit function, coordinating with compliance and risk functions. It can ST MT LT H M L

be in-house, outsourced, or co-sourced (use an external firm to work with internal staff to train and
bolster expertise). The owners should ensure maximum possible independence of internal audit to
assure full transparency of risks/problems that need to be addressed.
C3-9. Ensure that Internal audit is looking at high-risk areas of the business to give added ST MT LT H M L

assurance—and consider ex post or less intensive monitoring for low-risk areas to make best use of
audit time/resources.

Internal Controls
C4-1. Management (executive committee) regularly reviews progress against the business plan and ST MT LT H M L

identifies and addresses risks, with appropriate internal controls.

Stage
C4-2. The board regularly ensures that the company has a sound system of internal controls (e.g., ST MT LT H M L
4
based on COSO).
C4-3. Establish IT systems to record and display sales and accounts and accurately estimate ST MT LT H M L

accruals and revenue at any given time. The system should be robust to protect against
unauthorized use and to flag potentially problematic transactions.
Internal Audit
C4-4. Have internal audit report functionally to the board of directors or a committee of the board ST MT LT H M L

of directors (typically the audit committee), and not to the CEO except for administrative purposes.
Ensure that audit plans are approved by the board.
C4-5. Ensure that the internal audit coordinates with the external auditor. ST MT LT H M L

External Audit

Appendix
C4-6. Appoint a recognized external auditor. Make sure the external auditor reviews and reports on ST MT LT H M L

significant control deficiencies.

C4-7. Ensure independence of the external auditor by restricting it from providing other services ST MT LT H M L

that may cause conflicts of interest (e.g., consulting, tax services).

5
C4-8. Consider rotation of the auditor (or at least the senior audit partner) on a periodic basis (e.g., ST MT LT H M L

every three years).

SME Governance Guidebook 91

Worksheet A.5:
Topic D. Disclosure and Transparency

D Time Frame: ST = <6 mos.; MT =6–12 mos.; LT = > 1 yr.

Priority: H = High; M = Medium; L = Low

SME Time
Stage Leading Practice/Change Actions Frame Priority

Financial Disclosure
D1-1. Prepare basic financial accounts. ST MT LT H M L

Stage 1 D1-2. Use the financial information consistently for registration, reporting, and other purposes. ST MT LT H M L

Financial Disclosure
D2-1. Conduct monthly reconciliation of bank accounts, and provide the results to the founders. ST MT LT H M L

Stage D2-2. Ensure timely (monthly or quarterly) dissemination of financial statements to all shareholders. ST MT LT H M L

2 Nonfinancial Disclosure
D2-3. Agree with shareholders on key nonfinancial information to be presented to them on a ST MT LT H M L

regular basis. The information should include past performance as well as forward-looking issues
(risks, opportunities, etc.).
D2-4. Ensure that information is provided equally to all shareholders. ST MT LT H M L

D2-5. Develop the public profile of the enterprise and use it consistently for marketing, Web ST MT LT H M L

presence, and other business purposes.

Financial Disclosure
D3-1. Prepare financial statements in accordance with national accounting standards. ST MT LT H M L

Stage 3 Nonfinancial Disclosure

D3-2. Appoint the person or establish the disclosure function responsible, possibly combining with ST MT LT H M L

a CFO, compliance officer, or company secretary.

D3-3. Identify information to be included in briefing papers for the regular meetings with external ST MT LT H M L

advisers/advisory board.
D3-4. Define key nonfinancial information to disclose to the public (e.g., performance summary, ST MT LT H M L

forward-looking strategies, corporate governance practices, CSR practices), and present through
accessible channels, such as the company website.
D3-5. Establish means to effectively communicate key decisions (strategy, priorities) and other ST MT LT H M L

relevant information to all staff.

D3-6. Make sure to regularly communicate the code of ethics/business conduct policy. Find ways to ST MT LT H M L

reinforce the message regularly.

Financial Disclosure
D4-1. Prepare the company’s financial reporting in accordance with the IFRS for SMEs or U.S. GAAP ST MT LT H M L

(if having/seeking foreign investors).

Stage
4 D4-2. Choose the external auditing firm by clearly defined criteria, such as experience, ST MT LT H M L

independence, reputation, cost.

Nonfinancial Disclosure
D4-3. Regularly present all material information to the board in a predefined format and time frame ST MT LT H M L

(at least quarterly).

D4-4. Distribute reports with key information (for example, annual report) to shareholders as ST MT LT H M L

required by law and per the shareholder agreement.

D4-5. Consider which forms of regular voluntary disclosure to stakeholders (beyond those required ST MT LT H M L

by law) would be beneficial for the company.

D4-6. Make sure the company’s disclosure function provides for orderly handling of shareholder ST MT LT H M L

information requests.

92 Appendix
Worksheet A.6:
Topic E. Ownership

E Time Frame: ST = <6 mos.; MT =6–12 mos.; LT = > 1 yr.

Priority: H = High; M = Medium; L = Low

SME Time
Stage Leading Practice/Change Actions Frame Priority

Founder/Family Role
E1-1. Define and communicate to all staff the role of the founder(s) in company operations. ST MT LT H M L

Stage 1 E1-2. Define the roles and rights of other family members and communicate them to the family ST MT LT H M L

members and company employees.

Shareholder Dispute Resolution
E1-3. Incorporate shareholder dispute resolution provisions into the shareholder agreement or ST MT LT H M L

articles of incorporation.

Shareholder Participation
E2-1. Hold annual meetings of shareholders to discuss key decisions made, dividends, and plans. ST MT LT H M L

Stage Founder/Family Role

2 E2-2. Clearly define and communicate the difference between business and family issues—and the ST MT LT H M L

proper channels to address them.

E2-3. Discuss contingency succession issues internally with the family, and identify possible ST MT LT H M L

successors, both in top management and in ownership.

Shareholder Participation
E3-1. Shareholder meetings should be well-organized and function effectively to allow for adequate ST MT LT H M L

shareholder participation. In particular:

Stage 3
• Provide as much advance notice as is practicable.
• Ensure that documentation is professional and distributed in a timely manner.
• Make the meeting relevant and interesting; listen to shareholders on voting issues.
Founder/Family Role
E3-2. Discuss the desirability, or lack of thereof, of family members assuming multiple roles and ST MT LT H M L

responsibilities in the business. The decision needs to be clearly communicated within the business
and family.
E3-3. Create clear functional distinctions between 1) owners (shareholders), 2) employees ST MT LT H M L

(especially senior management), and 3) non-employee/non-shareholder family members. Family

members “wearing multiple hats” should understand proper modes of behavior and communication
in their various roles.

Appendix
E3-4. Identify clear career paths for non-family executives and technical specialists. ST MT LT H M L

E3-5. Develop and communicate the family ownership (and management, if applicable) succession plan. ST MT LT H M L

Shareholder Participation
E4-1. Define effective ways to regularly update all shareholders on company policies, strategy, and ST MT LT H M L
5
results. Ensure that such ways do not create an additional burden for shareholders.
Stage
4 Founder/Family Role
E4-2. Develop and communicate policies, mechanisms, and structures to regulate decisions that might ST MT LT H M L

affect family members’ ownership, employment, dividends, and other benefits. This should include
defining specific training and education needs for current and future employed family members.
Shareholder Dispute Resolution
E4-3. Expand dispute resolution provisions to include the leading role of the board. ST MT LT H M L

E4-4. Appoint somebody to be in charge of implementing governance dispute resolution strategy ST MT LT H M L

and policies.

SME Governance Guidebook 93

 Step
3
My Company’s
Governance Action Plan
Identify high-priority action items—to be taken in the short
term, based on the recommended actions highlighted in
Step 2. Use Worksheet A.7 to identify, refine, and prioritize
your short-term action items.
First, list at least one item in each category. Then review
the lists, with the objective of grouping the actions into
broader action categories, preferably putting together
actions that will be mutually supportive. We recommend
that your final list include no more than a total of five
action items—to keep the list realistic and manageable.

94 Appendix
Worksheet A.7:
Short-Term High-Priority Action Items

Governance
Topic Action Item Responsible Date

A
Topic A:
Culture and Commitment
to Good Governance

B
Topic B:
Decision Making and
Strategic Oversight

C
Topic C:
Risk Governance

Appendix
and Internal Controls

SME Governance Guidebook 95

Worksheet A.7:
Short-Term High-Priority Action Items (continued)
Governance
Topic Action Item Responsible Date

D
Topic D:
Disclosure and
Transparency

E
Topic E:
Ownership

96 Appendix
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