Prof. Chitra Singla
Small and medium enterprises (SMEs) that are not listed on stock exchanges constrain themselves when it comes to growth. Most such firms grow up to a particular size and no further. This is particularly true of SMEs owned by founders and their families.
Outside board members can be particularly effective at coaching and guiding owners to address mental barriers to grow. To understand that, we must first address the question: Why are family owned SMEs not able to grow?
Growth in such firms gets limited because of many reasons; to a list a few: owners’ aversion to external funding and interference by outsiders; fear of losing control over decision-making if they dilute shareholding to some extent; fear of becoming irrelevant in their own firms; inexperience of managing large firms, which adds to fear of growing; limited resource sets; and lack of motivation to grow.
Some of the above-mentioned constraints to growth are due to peculiar characteristics of SMEs. For example, most of the systems and processes in family-owned firms are informal. Decision-making may not be a formal and well-defined process because it is difficult to draw clear boundaries between business, family and owners. There is lack of clarity on reporting lines; consequently, accountability for decisions is diffuse. Moreover, owners often micromanage and get deeply involved in all activities; resultantly, they find it difficult to delegate responsibilities and lose control. In addition to this, a large fraction of the owners’ wealth is tied up in the enterprise, making them risk averse.
Further, firm profits are the primary source for funding growth in SMEs. In industries with scale or scope economies, since SMEs have limited scale and scope, profitability from existing operations is limited. Therefore, external funding is required for further growth. However, external funding, via equity or debt, makes management accountable to outside financers. Therefore, owners do not want to be subjected to scrutiny by external parties.
In interviews with SME owners, I have found that owners have concerns about external funding at multiple levels. One, they do not want to dilute their control on the firm. Second, they do not want outsiders to interfere in decision-making. Third, they worry about their organizational structure and managerial bandwidth and, as a result, do not think they can manage further growth. Fourth, they are concerned about the extent of internal changes in the organization required for growth. Fifth, they worry where the path of external funding will take them—will there be an end to dilution, or, once they are on this path, they will end up losing control?
To summarize, an SME is a reflection of its owner, and therefore, the growth of an SME is largely dependent upon the motivations and goals of its owners. Even if the owners of SMEs want the firm to grow, they find it difficult to come out of existing organizational structure, mindset and the above-mentioned issues. This is where board members, especially outsiders, can help owners by guiding them through the process of growth.
Unlisted firms (family-owned SMEs, in this case) do not have to abide by the stringent norms of corporate governance whereby a firm, if listed on a stock exchange, is supposed to have 50% of the board members as outside directors.
However, family-owned SMEs should voluntarily seek to appoint outside directors on their board. These directors’ role in the firms should be more of guides and counsellors than monitors. Further, these firms should be careful in deciding who should come on the board.
If an SME wants to grow primarily through internal funding but the owners are not clear about the roadmap for growth, then it should consider having board members who can coach them through the various challenges of ensuring growth. Ideally, these board members should have successfully gone through growth experience in their own firms. Such board members can guide owners about professionalization process as well as help owners overcome the fear of becoming irrelevant in the process or being unable to manage large firms.
If an SME is planning growth through external funding , board members with knowledge of processes of raising funds can be brought in. If an SME is facing constraint in terms of resources and capabilities (financial, network, knowledge about industry, etc.), it should bring board members with good network and industry knowledge on board. If the owners of the SME are struggling to delegate responsibilities and organize professionally, then professionals from corporate world who can help in delegation and reorganization process can be brought in as board members.
Thus, SMEs can bank on the knowledge and advice of outside advisers as board members to overcome some of the constraints that limit growth in these firms. However, it requires awareness of the challenge, openness to the idea and a conscious effort on the part of SME owners to bringing in outside directors as coaches and guides to help these firms continue on a positive growth trajectory.
Chitra Singla teaches business policy at IIM Ahmedabad. Her research interests lie at the intersection of international business and corporate governance.
First published in 'View from IIMA' column in Mint.
