UK: Corporate Governance For UK Private And Unlisted Companies

Last Updated: 13 May 2011
Article by Michael Thompson and Mike Fox

The principles of corporate governance are well established for UK public listed companies, and the perceived benefits of good corporate governance for those companies and their shareholders, the wider investment community and indeed the national economy, are well understood. Furthermore, in recent years corporate governance has received increased international attention because of (and has evolved as a consequence of) a number of high-profile scandals involving the abuse of corporate power and, in some cases, alleged criminal activity by corporate officers in relation to public listed companies. But what of corporate governance in the context of private/unlisted companies, which until relatively recently has received little or no attention from governance experts and policy makers?

In November 2010 the Institute of Directors ("IoD") published some guidance on corporate governance for private/unlisted companies in a paper entitled "Corporate Governance Guidance and Principles for Unlisted Companies in the UK" (the "Guidance"), which is based on the March 2010 guidance published by The European Confederation of Directors' Associations ("ecoDa") but which has been appropriately adapted for UK companies. The Guidance sets out 14 principles (see below) that provide appropriate guidance on corporate governance to directors and company secretaries of private/unlisted companies including start-ups, owner managed companies, family-owned companies, private equity owned companies and joint ventures.

It has been widely acknowledged that good corporate governance is relevant for all companies (not just listed companies) and ecoDa's initial guidance was born out of its observation that the global financial crisis in recent years has highlighted the importance of applying good corporate governance practices to businesses and that considerations of corporate governance should not be limited to listed companies alone. Therefore, ecoDa's guidance was issued in order to address the distinct lack of corporate governance principles which apply to private/unlisted companies, which account for the majority of businesses in Europe, and to assist such companies design effective corporate governance frameworks based on practical, pragmatic principles of good governance. Indeed, in a UK context, given that private/unlisted companies make a major contribution to UK economic growth and employment, the significance of corporate governance for such companies should no longer go unrecognised.

The Guidance follows, to a large extent, the UK Corporate Governance Code (the "Code"), which applies mainly to all companies with a premium listing of equity shares on the main market of the London Stock Exchange, and is intended as a practical set of principles that can be applied relatively easily by directors of private/unlisted companies to improve corporate governance. However, the Guidance has been adapted to address the particular requirements of smaller companies and, unlike the Code, there is no legal obligation for private/unlisted companies to conform to it, although it is recommended that they do so.

The ecoDa has noted that good corporate governance for private/unlisted companies is not concerned primarily with the relationship between a company's board of directors and its external shareholders (as with listed companies) – it is more about establishing a framework of company processes and attitudes that will add value to the business, help build its reputation and ensure its long-term continuity and success. Therefore, the principal underlying purpose of the Guidance is to provide practical steps and principles which private/unlisted companies can apply in order to improve how they are run and managed. However, it should be noted that the Guidance is not intended to restrict private/unlimited companies in the way that they are run and managed – instead the aim is for such companies to exercise common sense in their observation and application of the Guidance, which includes applying the principles set out in the Guidance in a proportionate way that is tailored to the specific needs of the company.

The Guidance summarises the duties of company directors, gives guidance on how large company boards should be and the structures that family-owned companies should adopt and provides advice for larger and more diverse and complex companies. The 14 principles under the Guidance (see below) cover a number of different areas but in general terms they are aimed at achieving the following 3 key objectives:

  • Protecting value for shareholders, as there is often no ready market for shares in private/unlisted companies, and shareholders are therefore committed to staying with the company for the medium to long term, which increases their dependence on good governance;
  • Balancing the interests of founder families in family companies with the
    success of the company; and
  • Promoting the long-term success of the company and attracting external

The Guidance is divided into two main parts: Part I provides general advice relating to corporate governance and Part II sets out the 14 principles of good corporate governance, the first 9 of which relate to all private/unlisted companies and the remaining 5 of which apply to larger and more complex private/unlisted companies. It is worthwhile noting these principles, which may be summarised as follows:

1. Shareholders should establish an appropriate constitutional and governance framework for the company.

2. Every company should strive to establish an effective board, which is collectively responsible for the long-term success of the company, including the definition of the company's corporate strategy.

3. The size and composition of the board should reflect the scale and complexity of the company's activities. 

4. The board should meet sufficiently regularly to discharge its duties, and be supplied in a timely manner with appropriate information.

5. Levels of remuneration should be sufficient to attract, retain and motivate executives and non-executives of the quality required to run the company successfully.

6. The board is responsible for risk oversight and should maintain a sound system of internal control to safeguard shareholders' investment and the company's assets.

7. There should be a dialogue between the board and the shareholders based on a mutual understanding of objectives. The board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place and should not forget that all shareholders must be treated equally.

8. All directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge.

9. Family-controlled companies should establish family governance mechanisms that promote coordination and mutual understanding amongst family members, as well as organise the relationship between family governance and corporate governance.

10. There should be a clear division of responsibilities at the head of the company between the running of the board and the running of the company's business. No one person should have unfettered powers of decision-making.

11. All boards should contain directors with a sufficient mix of competencies and experiences. No single person (or small group of individuals) should dominate the board's decision-making.

12. The board should establish appropriate board committees in order to allow a more effective discharge of its duties.

13. The board should undertake a periodic appraisal of its own performance and that of each individual director.

14. The board should present a balanced and understandable assessment of the company's position and prospects for external shareholders, and establish a suitable programme of stakeholder engagement.

It is useful to examine briefly how these principles, as set out in the Guidance, seek to achieve the 3 key objectives mentioned above.

Protecting value

The Guidance suggests that all private/unlisted companies should have an appropriate constitution in place to regulate how the directors and shareholders interact with each other and, ultimately, to protect the value of the company for its shareholders. In effect this means the articles of association of the company (the "articles"), which is a company's principal constitutional document.

A company is usually formed with standard articles and over a number of years these may remain unchanged, whilst the business and composition of the company may change significantly. Appropriately drafted articles may, for example, prevent dilution of shareholdings, ensure that 'bad leaver' employee shareholders are forced to sell their shares upon leaving the company, and also provide for a sensible process to follow in order to remedy shareholder and director disputes, thereby generally preventing a situation where interested parties reach an impasse or deadlock which impairs the effective running and management of the company.

The Guidance also emphasises the importance of having an effective board which is of an appropriate size and composition relative to the size and complexity of the company. Furthermore, the Guidance stipulates that a board should have an appropriate mix of skills and experience without being too large which may render it difficult to manage and therefore less effective. Also, most importantly, the board should have some form of succession planning in place and again, the articles can be drafted so as to assist with providing for the orderly rotation and resignation of directors to constantly refresh the board.

As with the Code, the Guidance also recommends employing non-executive directors where possible in order to provide some objective, independent input to the board.

Family companies

The Guidance differs markedly from the Code in respect of family controlled companies. Various respected research has shown that companies controlled by families rarely survive after three generations and that this is largely due to a persistent failure to distinguish between the interests of the company and the interests of the family, which are not necessarily always aligned. Furthermore, it is common in family controlled companies to see shares being passed down through these generations, which leads to an increase in the number of family shareholders and which in turn often leads to administrative difficulties and conflicts.

The Guidance recognises these shortcomings and seeks to address them by suggesting the formation of a family council and a separate family assembly. The family council is effectively a small body of family members who have been voted to the council by family members in order to represent them by, for example, liaising with the board and making decisions on behalf of the family. The family assembly, however, comprises all family members and the Guidance suggests that it should meet twice yearly to discuss any concerns with a view to pre-empting and preventing any conflicts.

The Guidance suggests that this family council/assembly structure should be formalised by putting in place an appropriate 'family constitution', the aim of which is to balance the interests of the family whilst promoting a strong independent board and the long-term success of the company. This constitution may be a shareholders' agreement or nominee agreement, which should set out:

  • the family's values, mission statement and vision;
  • the role of a family council and a family assembly;
  • the role of the board of directors and its relationship with the family council;
  • policies for important family issues, such as employing family members,
    restricting transfer of shares and succession planning for the chief executive; and
  • nomination of family members to the board.

Long-term success

The main overall purpose of the Guidance is to improve the corporate governance of private/unlimited companies with a view to promoting their long-term growth and success and, to that end, the Guidance emphasises the importance of an independent board and the separation of power between those running the company (the board) and those with a financial interest in the company (the shareholders). Clearly these will often be the same people in smaller companies, but the Guidance makes it clear that no one person should have unfettered control or powers of decision making. It also suggests that larger private/unlisted companies should regularly appraise the performance of the board in order to identify any scope for improvement.

Corporate governance guidance for private/unlisted companies has for some time taken a back seat to the corporate governance codes and related guidance for listed companies, but the Guidance makes it clear that good corporate governance is also very important for private/unlisted companies. It is also clear that the framework and principles set out in the Guidance must be adapted for each company in a way that is both practical and flexible but ultimately, if their application is to be successful in a given company, the company's key decision makers will need to implement and comply with an appropriate governance framework and principles based on the Guidance. It is envisaged that private equity investors will view a commitment by private/unlisted companies to apply the Guidance as a positive factor for making any investments in those companies, even though it is likely that such investors will seek to apply some of their own corporate governance procedures to an investee company, such as appointing their own non-executive director. However, it is reasonable to conclude that a private/unlisted company that has already fostered a strong corporate governance culture will be able to adapt more easily to the requirements of external investors and therefore applying the principles in the Guidance would be a worthwhile exercise for any private/unlisted company to undertake now. In any event, a company's corporate reputation will undoubtedly benefit from the gradually increasing transparency and accountability that application of the Guidance would bring about.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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