Independent Directors and SME’s

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An independent director can be loosely defined as a director who does not fall within the management or operational structures of the Company and who does not hold a direct or indirect material interest in the Company outside of the position of a director.  The Companies Act does not set out what would be considered an independent director nor, for that matter, does it distinguish between executive and non-executive directors. While this omission may well serve to ensure that the powers of all directors are indistinguishable under the Act, in practice it is important to differentiate between director types.

Under South African company law all directors hold a fiduciary duty to avoid any conflicts of interest, and to act in the best interests of the Company. This fiduciary duty is however not always upheld in the strictest sense, especially in SME’s where management, ownership, and directorship are generally one and the same. It is well documented that the performance and growth of a company will be hindered where it becomes difficult to separate the best interests of the Company from the best interests of the Board. It is no surprise then that international best practice and King IV propose that the majority of a Board’s members be independent, something which is not always achievable or practical in SME’s.

King IV defines independence in the context of directors as “the absence of an interest, position, association or relationship which, when judged from the perspective of a reasonable and informed third party, is likely to influence unduly or cause bias in decision making.” Independence, along with knowledge, skills, experience and diversity, are considered by King IV as key elements to the composition of an effective Board under Principle 7. When looking closely at these key elements of Principle 7, one is able to see the true benefit of an independent director to a company. The appointment of an independent director allows one to bring into a business resources that may otherwise not be available to it. An effective independent directorship appointment would therefore be one that complies with all the considerations of Principle 7, by adding to the knowledge, skills, experience, diversity, and independence of the Board.

Independent directors are able to play a central role in conflict resolution within the business as they can look at issues objectively; this objectivity aids in limiting the effect of emotional influences on decision making at Board level. Independent directors can also broaden the network of a company and provide insight into other industries and markets.

Ultimately the main consideration around the appointment of independent directors in SME’s is cost, and the ability of a company to bear that cost relative to the benefits which are derived. The onus to ensure Board independence therefore rests on shareholders and investors, as they are the ones who stand to realise the benefit of the effective operation of the Board.

An independent director can be many things to a company; they can be a mentor, a mediator, an advisor, or a champion of good corporate governance, and should not simply be seen as a person appointed to meet “governance requirements”. The careful appointment of an independent director can thus ensure a balance of power at Board level; promote effective decision making; protect the interests of the Company and its stakeholders and foster good governance practices.

Contact the team at Resolve for assistance required with Corporate Governance.

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