Monumental misunderstandings about what is the best governance model for Startups/Scaleups/GrowthCos – indeed the whole unlisted company pathway to Trade Sale or IPO – are common.

The first as we have covered (eg Guide to the Core Essence of the Entrepreneurial Board) is to not design your Board but let it be something that “just happens” or is imposed upon you. Good luck with that.

The second is to misunderstand what type of Governance is best for Unlisted Companies. In a nutshell this is roughly the exact opposite of the “Corporate Governance” model of the US/UK et al in recent decades. To open the nutshell and cover what has been proven to work across time and space in many different countries and is most likely to work for you the Founder, in more detail I quote below an extract from Realpolitik Chapter 1 “Eight Essential Aspects Of Small Company Boards” …

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ESSENCE 4 – CONCENTRATED CONTROL COMPANIES, NOT LISTEDCOS, ARE THE GOVERNANCE MODEL FOR SMALLCOS

The governance challenge of SmallCos is entirely different from BigCos. However there is a governance model – CCCs which are near ubiquitous, from family firms to Tech giants such as Amazon, Google, Facebook to vast State-owned concerns.

SmallCos are representative of most companies around the world throughout history which were and still are “Concentrated Control Companies” (CCCs).

In the UK/US the predominant governance challenge of BigCo is a widely distributed ownership base far removed from knowledge or control over what the management are up to.

SmallCos are generally CCCs which have the opposite governance problem – namely that, generally, majority owners are in the Boardroom and hence there is no “remote owners with neither knowledge nor control” concern.

Rather the governance challenge of CCCs is the “tyranny of the majority” – the majority are capable of disadvantaging the small shareholder which happens all too often.

Screwing the small investor is much harder to do, at least on price, in ListedCos where stockmarket investors all own the same share type and receive the same price on any sale and so forth. Larger investors will get preferential visits from the Chairman/senior team which privilege Joe Sixpack never enjoys. Besides Joe has many investments and has neither the time nor inclination to research his negligible votes on the few issues that the Board deign to put before him. Dispersed shareholders know little about the businesses they invest in and care about little other than their share price performance. Andrew Carnegie recognised this and as he went from being dirt poor to America’s richest man and a huge philanthropist he might know a thing or two:

“Where stock is held by a great number, what is anybody’s business is nobody’s business.”

A misunderstanding of the very different, near opposing, governance challenges between BigCo’s remote investors and CCCs/SmallCos in the Boardroom investors is a third reason why applying Corporate Governance approaches to SmallCo is such a bad idea.

Apply “Corporate Governance” to SmallCo and you are taking the medicine for a completely different disease!! Not only that but there is zero evidence that the medicine works even for the condition for which it is prescribed and furthermore it has side-effects introducing a very bureaucratic mentality into the Boardroom.

CCCs have always been, are, and will forever be, superior to the zillion rules & regs approach as a form of Governance. It is in effect a form of structural regulation (the best kind and the most common approach throughout history).

There is no better incentive for companies to be governed well than Boardrooms full of people who really care and have serious money at stake (which is the case in SmallCo Boardrooms). It is ironic in this context that once you list on the London Stock Exchange you have to change how you remunerate your NEDs (which presumably was working if you got as far as the listing stage):

“Remuneration for all non-executive directors should not include share options or other performance-related elements.” [1]

In the UK Bob Tricker wrote the first book on “Corporate Governance” (appropriately perhaps in 1984) and has been called the “father of Corporate Governance” by Cadbury himself. Writing more recently he talks about how concentrated control changes the whole game:

“…the Anglo-Saxon system is not the only governance model and some are questioning whether it is necessarily the best. Corporate governance is concerned with the way power is exercised over corporate entities. In other parts of the world, alternative insider-relationship systems exercise power through corporate groups in chains, pyramids or power networks, by dominant families, or by states.” [2]

There are many types of CCC – the SmallCo, family businesses, founder-centric businesses, industrial groupings, and State-owned businesses. CCCs are by far the most common types of business in the world.

We don’t need to concern ourselves about industrial groupings (German Konzern, Japanese Keiretsu, Korean Chaebol et al) or State-owned businesses other than to notice some of the largest industrial enterprises in the world are also CCCs.

Let’s look briefly at the importance of family and founder-centric businesses. SmallCos (at least for quite some time after founding) are a type of “first-generation family firm” and founder-centric businesses.

To my surprise when researching Concentrated Control Companies around the world family businesses were and are the predominant business model:

“In most societies, at most times, it has been the great family which by its wealth, power, prestige, and presumption of permanence has been the outstanding institution in private economic enterprise.” [3]

In the National Bureau of Economic Research’s 700pp “A History of Corporate Governance around the World: Family Business Groups to Professional Managers”, the editor summarises the global state of play:

“In much of the rest of the world [outside the US], capitalism is a system where a handful of immensely wealthy families control almost all of a country’s great corporations… Wealthy family domination of great corporations is not restricted to poor countries but also characterizes relatively rich economies like Israel, Hong Kong, and Sweden.”

The Economist writing about Italian business points out that many Italian businesses are dominated by family concerns:

“…most of Italy’s medium-large firms [are] still owned and managed by families: the list runs from Alessi (homeware) to Zegna (fashion) via Barilla (pasta), Ferrero (chocolates), Lavazza (coffee), Ferragamo (leather goods) and many more.” [4]

The advantage of the model is clearly to narrow the so-called principal-agent gap between “owners” and “managers” (the prime Corporate Governance concern ever since Berle and Means seminal tome in 1932 [5]) but also:

“For Emma Marcegaglia, president of the national employers’ association, and managing director of her own family’s steel business, such firms succeed because of their owners’ flexibility, quick decisions and willingness to plan and invest for the long term, even in bad times. This also wins loyalty from employees.” [4]

The global stats are amazing for anyone brought up on a diet of US/UK business press:

“Worldwide, family enterprises represent anywhere from 80% of all businesses in developed economies to 98% of all businesses in emerging economies. (They account for about 90% throughout Latin America, depending on the country.) They are responsible for anywhere from 64% of the GDP to 75% of the GDP of individual countries.” [6]

Nor is the US unexposed to significant degrees of “family capitalism”:

“[In the US] family ownership is both prevalent and substantial; families are present in one-third of the S&P 500 and account for 18 percent of outstanding equity.” [7]

The most common device for effecting family control is the pyramidal group which is ubiquitous outside the US/UK. Here the apex shareholder(s) control a single company which has controlling voting blocks in the companies below it which in turn control the companies below them and so on. They can contain hundreds of firms and ensure that small numbers of people can control vast swathes of the economy.

To SmallCos and FamilyCos we must also add another supe-rimportant type of CCC – founder-centric companies – which, along with frequent use of mechanisms such as “super-voting stock”, are actually the predominant Tech/high-growth model. Think Bezos at Amazon, Zuckerberg at Facebook, Jobs at Apple, Gates at Microsoft, Page and Brin at Google, Elon Musk at Tesla, Reed Hastings at Netflix.

The founder-centric model is more widely applied than just in “Tech”, the Murdoch media empire springs to mind (and here founder-centrism starts to mutate into family-business). Another leading example of founder-centrism (and control) is Berkshire Hathaway the phenomenally successful investment vehicle of Warren Buffett.

These phenomenally successful founders did not grow mega-businesses by allowing their control to become diffused. Dispersed ownership and dispersed control might be the “textbook” model of a US firm but the “Tech Titans” don’t fall for that kinda “Business PC” thinking nor submit excessively to Statist/PC dot-to-dot Corporate Governance, full of do-gooders’ rules and regulations written by politicians, bureaucrats or businessmen who never created anything from scratch.

There is no end to this game of “Spot the CCC”. Morck points out that in Germany apparently widely-owned companies are actually narrowly-controlled by banks in the larger companies and families in the smaller companies. Even in the US in 2017 the largest 50 institutional shareholders own 44% of the shares of listed companies [8]. This is hardly “widely-dispersed ownership” and much more akin to the allegedly very different German “bank capitalism” model than generally assumed.

One can also include the 19thC heyday of the exponential rise to predominance of the US economy when it overtook Britain as another prime example of CCCs, where a small number of individuals dominated industry:

“Between 1890 and 1904, huge waves of consolidation left most of the country’s industrial base in the hands of around fifty organizations… The merger era produced some of the most powerful companies of their time, including U.S. Steel, American Cotton, National Biscuit, American Tobacco, General Electric, International Harvester, AT&T, and United Fruit. Two people are synonymous with the trust era: Rockefeller and J. P. Morgan.” [9]

Despite the occasional successful move to break up huge businesses – notably Standard Oil and American Tobacco, both in 1911, concentrated ownership lasted for quite some time until the Great Depression.

Dispersed-ownership Listed BigCos and Corporate Governance are historically and presently hugely anomalous.

Conversely, SmallCos map much more closely onto almost every business that has existed since records began some four thousand years ago – the first recorded businesses (in Old Assyria) were CCCs.

SmallCos map closely onto the predominant global model today – FamilyCos.

They map closely onto the giant Tech firms that have had such phenomenal success in recent decades.

They even map closely onto huge business groups – Konzern, Keiretsu, Chaebol – or onto German bank capitalism or State ownership around the world.

SmallCos are in no sense whatsoever anomalies to be reined in to “grown up/real company” models.

Vice versa they are representative of the most successful model over millennia of successful growth and meaningful control of management by owners.

It is no surprise that the UK/US models have seen the greatest numbers of BigCo failures. Other countries predominantly rely on Boards comprised of people who have serious skin in the game and so really care – personally as well as professionally.

Concentrated Control Companies are not only the dominant model but the model which has been shown in recent decades to surpass all others in terms of ability to turn a concept into a product and scale rapidly without excessive numbers of disasters.

Be proud of your SmallCo! You, and your concentrated-control form of governance, are the rule not the exception! Yet another reason not to copy, ape or mimic current BigCos which, far from being a model of good governance, are unprecedented and continue to drop out of the sky. Some of you might even grow up to be ListedCos yet still retain the CCC/family ethos.

Having said that there is an Achilles heel in CCCs – major shareholders may make merry at the expense of the smaller shareholders – an important topic to which we shall return.

[MB: to avoid waiting before we return to this topic the essence is, to take a simple example, if your Board is solely say “Founder + single VC” then there is no independent representation of minority shareholders can hardly said to be “good governance” . Whilst major shareholders “have the Company’s interest at heart” as they have major stakes, time and time again when push comes to shove some/many/all Investment Directors (which is what they both are in a vote) have their own individual interests as primus inter pares. Having an independent NED who is not a major shareholder is the only way to really look after the smaller, minority investors].

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References

1. FRC UK Corporate Governance Code 2018

2. Tricker, Mallin. “Rethinking the Exercise of Power over Corporate Entities” 2010

3. Lane “Venice and History” 1966

4. Economist “Keeping it in the family – Italian businesses” 10th March 2011

5. “The Modern Corporation and Private Property”. Ironically at that time controlling shareholders were still common. It was not until the 1960s that widely-dispersed ownership became the predominant model.

6. Poza “Family Business” 2009

7. Anderson, Reeb “Founding-Family Ownership and Firm Performance: Evidence from the S&P 500” 2003

8. Bebchuk et al “The Agency Problems of Institutional Investors” 2017

9. Micklethwait, Wooldridge “The Company A Short History of a Revolutionary Idea” 2003