Problems with boards of small companies: based on real experience, here is a litany of dysfunctional behavior on small-company boards and what can be done about it.

• Author: Edelson, Harry

Help is what small companies with revenues of zero to $50 million need from their directors. Monitoring and oversight are not enough. Neophyte CEOs, even those with prior executive experience, often do not understand the efficacy of structuring a sound board. Even if they do, it is an uphill battle. Investors often require board seats as a precondition, and competence is not a requirement.

For this and other reasons, diversity of talent is difficult to achieve. For one thing, there is little money to attract talented independent directors. Another problem in small companies is that boards are heavily stocked with founding management personnel, and removing one of them, even after he or she is no longer important to the success of the company, is often traumatic. Founders do not easily perceive that the infusion of outside capital requires a change in thinking about corporate governance. No longer can the company be managed solely for the benefit of founding management. It is no small leap of thinking for management to switch allegiances and respect the rights of outside shareowners before the rights of coworkers.

Edelson Technology Partners is a venture capital firm. As such, my partners and I have served on dozens of boards involving intimate contact with scores of CEOs. My rating of the CEOs of small companies, based on a sample of about 60 companies, is as follows:

Crooked 10% Incompetent 15% Stay past their time 25% Good 25% Excellent 25% In reality, my ratings are almost surely positively biased, since we are professional investors, do extensive due diligence, and often invest alongside other professional investors. It may seem startling to suggest that 10% of the CEOs of small companies are crooked, but I wouldn't be surprised if the IRS agreed with me.

The typical crooked CEO may not have started out that way. Larcenous activity may have begun by taking liberties with cash before outside investors were attracted--something like stealing your own money. But then, all those years of hardships and suffering and all that money from fat-cat investors often leads to a philosophy of "I deserve a Persian rug, or a home gym, or a Mercedes, or even cash." In our portfolio of investments, approximately 6% of CEOs have been removed for unethical conduct--in other words, stealing. I figure that we haven't caught the other 4% yet.

Replacement of a CEO is always an unpleasant task and is most difficult in a small company, where in all likelihood the management team founded the company and is intensely loyal to the CEO. Key people may threaten to walk if the CEO is axed. If unethical conduct is involved, more than just the CEO might be involved.

To compound the problem, the CEO and early investors (possibly management and relatives) may own a majority of the stock. In that case, the only recourse may be lengthy legal proceedings. Sometimes the CEO holds vital information and, to protect his job, will be unwilling to share it with a new CEO from the outside. This is particularly disturbing when...