The unique nature of small-company boards.

• Author: THURMAN, RANDY

Small companies need to be creative and resourceful in recruiting new directors. Here is a realistic assessment of the challenges of small-company board service, and some strategies for enticing qualified individuals to serve.

OVER THE YEARS I have had the opportunity (and in most cases the privilege) of serving on the boards of large, multinational corporations, academic and volunteer organizations, as well as early-stage, emerging companies in both the service and technology sectors. At this stage of my career I have focused much of my time on working with early-stage companies. It has become apparent that not only do the boards of these smaller companies have unique challenges but the importance of the director's role may be greater than in the larger, more traditional companies.

It is no surprise that finding qualified directors for even large, well-known companies can be a challenge in and of itself. Just taking the combined number of public companies (NYSE, Nasdaq, and AMEX-listed), which is over 8,000, and assuming that each has on average seven directors, that results in 56,000 director positions. Assuming further that a director sits on the average of three boards, the end result is that the approximate demand is for some 18,000 qualified individuals to serve on these public-company boards. Even if every one of the top five executives of the 1,000 largest corporations was willing to serve as a director, that only accounts for less than one-third of the demand. In addition, universities, volunteer and private organizations seek the same high-caliber individuals to serve on their boards.

For the small, emerging company, the challenges of recruiting qualified directors are far greater. In most cases these smaller companies will not have the stature to attract the most qualified directors. Most director candidates will have a choice of boards, with the larger, well-capitalized companies having more to offer in the way of director compensation and probably demanding less of a director's time.

The need for hands-on contributions by directors is greater in the emerging company simply because the company does not have the internal resources of the larger company. Directors are expected to get involved in everything from recruiting to raising capital to assessing new technology investments. And, these demands can be on an ongoing basis. Many potential director candidates will not want to assume the time commitment of these smaller companies.

These early-stage companies are in most cases cash-constrained. Director compensation is largely in the form of stock options and minimal cash. This of course can be an attraction for potential directors if they assume the company's stock will perform. Imagine being a director of one of the dot-com companies founded in the last few years that subsequently went public at an infinite multiple of earnings, Of course, just the opposite can happen: these stocks can plummet and the director's options are underwater for a long, long time. It happens all the time in these early-stage public companies.

On the other hand, larger companies can offer substantial cash along with stock options. While the large company's stock can also go either way, the long-term growth is generally more assured and, of course, the director is receiving significant cash payments as well.

The smaller company must find the director candidate who has a special interest in the business strategy, is willing to contribute significant time, and expects to be compensated largely in stock options with the payout many years down the road, if at all.

Booming competition for directors

While I will use my own industry, health care, as the example of what is compounding this challenge of finding qualified directors for small, emerging companies, I suspect this challenge is the same for other growing industries such as information technology or high tech.

The health care industry is literally going through a revolution. Ten years ago it was fairly straightforward to categorize companies in health care: pharmaceuticals, insurance, and services. Today several dynamics have redefined the industry, all of which make for greater challenges for directors.

First of all, the technology has been revolutionized. Today's health care industry has been redefined by biotechnology, medical informatics, genetics, managed care, drug delivery, outsourcing, e-health, etc. Each of these new technologies has spawned new public companies requiring directors. New directors are expected to understand and bring value to these new technologies, and the small, emerging companies are desperate to find qualified directors from industries with these skills. The chairman and CEO of a three-year-old genetics research company where I am on the board wants to find director candidates from companies such as Oracle or Sun Microsystems to bring expertise to the relatively new field of gene informatics.

Compounding the challenge is the consolidation among the large players within the health care industry, which is creating fewer executive positions from which to recruit directors. Just during the last five years there has been tremendous merger activity among the pharmaceutical, insurance, and service sectors of health care.

Yet another challenge stretching everyone is the explosion of new companies and IPOs in the many new health care sectors. All of these companies are forming boards (an obvious requirement of the IPO), and they all want the same type of directors: general management, research background, international experience, joint venture experience, finance and investment banking, prior start-up experience, etc.

When you combine the shrinking population of executives at fewer large companies (which have traditionally been the suppliers to the director recruiting market) with the explosion of new, small companies being created, the result is a great demand for directors with a shrinking supply of industry-qualified executives.

Director's compensation

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