Board Committees – What Private Companies Should Know

Authored by Laurie Bauer

With special thanks to Courtney Tygesson for her contributions

Our US-based private company clients – particularly later-stage companies – often ask us for guidance on board committees. This article explains what board committees are, key factors in determining whether a private company should establish them and decision points for structuring them.

What is a board committee?

A board committee is a subset of a company’s directors to which the full board has delegated certain functions or responsibilities, e.g., determining the management team’s compensation or overseeing the company’s auditors. Subject to certain very limited exceptions, Delaware law permits the board of a corporation to delegate its powers to committees if desired. Once a company is public and listed on a major exchange, such as the New York Stock Exchange or Nasdaq, it will be required to have certain committees, such as audit and compensation committees, and the members of such committees will be subject to certain independence requirements. Many public companies also have committees for nominating directors and overseeing corporate governance and may form committees for other purposes (such as evaluating major transactions), as the need arises.

Committees will typically have a formal charter, approved by the board, which sets out the committee’s scope of authority and responsibilities, as well as its membership criteria and meeting cadence.

When should a private company form board committees?

While private companies do not need to comply with stock exchange listing requirements, they will sometimes establish a committee structure for a few reasons:

• Preparation for life as a public company. Later-stage private companies with a potential initial public offering in their future may form committees to start getting accustomed to public company governance.
• Contractual requirements. Stockholder agreements, such as an investors’ rights agreement, may require a company to create board committees.
• Efficiency and focus. As companies stay private longer, it is more common for private companies to have large boards and highly complex operations, similar to public companies. For these mature private companies, committees may be a useful tool, regardless of whether they are strictly required. For example, delegating responsibility to a compensation committee can enable the full board to spend less time discussing executive pay and option grants – which can be sensitive and time-consuming topics – and focus more attention on other aspects of the business.

Of course, more structure does not always mean more efficiency. For earlier-stage companies with smaller boards, committees may unnecessarily complicate their corporate governance, create a risk of legal and technical foot-faults if the company fails to comply with its self-imposed rules, and increase the administrative burden for directors and management. For these reasons, companies will generally prefer to keep their governance simple at the outset and wait to form committees until there is a compelling reason to do so.

If you are putting board committees in place, what do you need to think about?

Since private companies are not subject to stock exchange listing requirements, they have flexibility as to how they set up committees. Below are some of the most common decision points for private companies in considering how to structure board committees:

• For all committees, the board will need to decide the committee size, any membership requirements (e.g., limiting certain committees to nonemployee directors or including financial experts on the audit committee), and meeting cadence. As noted above, the company should be careful about creating rules that may be difficult to follow and putting excessive burdens on directors and management.
• For compensation committees, two of the most common decision points are:
  • Will the committee have the authority to make final decisions regarding compensation, or will the full board retain that power, with the committee providing advice and recommendations?
  • Will the committee review compensation for the CEO only or for a broader set of employees?
• For audit committees, in addition to supervising the company’s auditor, the board will need to consider whether the committee will also review related-party transactions and/or have other risk management functions. Many public company audit committees have these functions, but they are not always appropriate or necessary for private companies.

Private companies looking to build out their governance by establishing board committees should discuss with their lawyers when considering if this is the best approach, and, if so, how to design the committees so they best serve the company’s immediate needs and long-term goals.