WholesaleInvestor

31 May 2010

Sound corporate governance for small cap companies

The concept of corporate governance is simple, well run companies produce better results. Although managing corporate governance can at times be like walking a tightrope, falling off the tightrope can have serious repercussions. This is especially true for small cap companies.

In essence good corporate governance is based on the relationship between managing risk, lessening risk as well as the objectives and success of an organisation. Effective corporate governance policies will ensure the business is employing the best market practices and that the business is adhering to the applicable laws, rules and regulations.

Regardless of size, all companies listed on a stock exchange need to:

• Put in place a board of directors independent from the company’s management with the expertise to oversee the company and ensure the board makes decisions in the best interests of the shareholders
• Adhere to numerous laws, rules and regulations
• Employ good communications with shareholders regarding company information.

However, these obligations can be harder for smaller companies to carry out because even though their corporate governance policies may not be as complex as a larger corporate, they don’t always have the resources to adequately handle the necessities involved and don’t often know where to

find the right people or advice.

There is no simple universal formula for good corporate governance. Companies vary greatly in size, complexity, industry, ownership structure and other characteristics. Proven structures and processes help to improve governance, particularly for small cap companies, they can play an important part in building shareholder confidence in the soundness of their investment and thus a company’s ability to attract capital moving forward.

The key issue for directors is to grow the company while maintaining good corporate governance and minimising the personal risk of running a public company. If a director mismanages a company there are potential civil and criminal charges that can be brought against a director under the

Corporations Act

.

The cost of corporate governance is material for a small cap. They would rather allocate the expense to fund the business’ growth and expansion, so they need to consider ways to manage the costs while still maintaining corporate governance responsibilities.

A common way of doing this is to outsource the role of corporate secretary. Most large companies employ an internal company secretary to look after their corporate governance. Smaller companies although having similar corporate governance requirements, may not be able to afford to employ someone full time to carry out this role. By outsourcing to a professional firm they can ensure their corporate governance matters are addressed without having to outlay the full time salary of an in-house corporate secretary.

A small cap may also consider engaging an outsourced CFO to assist the directors with the company’s financial management. As an outsourced CFO would be on a part-time basis, a small company would save approximately $200,000 p.a. by not having to hire a CFO full time.

The audit management function can also be outsourced to reduce the costs of corporate governance. Outsourcing the audit function also helps to ensure its independence from the board and also the accuracy of the company’s financials.

To reduce the amount of time and money that is spent on corporate governance obligations, small cap companies should implement streamlined procedures to eliminate inefficiencies and reduce costs. This also includes the manner in which information is communicated to shareholders. There are a number of compliance organisations that exist offering online tools concerning policies and procedures that can help small caps remain compliant.

Directors should surround themselves with experts that they trust and understand that corporate governance is the key. To ensure you achieve best practice, the performance of the board and key executives should be reviewed regularly against measurable and qualitative indicators. There should also be a clear link between performance and remuneration, with the company’s remuneration policies reported to the investors.

Limited resources and time constraints make the idea of cutting a few corners more attractive for small caps. However, good corporate governance involves extensive financial reporting and also implementing mechanisms to ensure the company is compliant with the relevant regulations, such as the ASX Listing Rule requirements and should not be avoided. This ensures that truthful and factual information is provided to investors in a timely manner, including its financials, performance, ownership and governance.

Corporate governance for small caps can be difficult to manage. Although by implementing sound controls, outsourcing company secretarial duties, managing risk within the business and partnering with sound advisors and an intelligent board, it may make the difference between the business surviving or getting swallowed up by a labyrinth of governance.

Michael Derin

Managing Director of Azure Group, Michael Derin has over 18 years experience as a professional accountant within the chartered and commercial sectors and he has directly steered many companies to achieve both their financial and business objectives. At a young age, Derin is redefining the role that an accountant has with their clients and has developed sophisticated ways in which SMEs can compete with larger organisations.