Benel D. Lagua
As a practitioner dealing with small to medium (SME) enterprises with great business models or ideas for their ventures, it is very clear that the business proposition alone is not sufficient to spell success. Even with a good product or service and a well defined customer base, the small business will still flounder if it does not pay close attention to good governance practices. Poor governance practices are often identified as the main reasons leading to business performance, fraud and unanticipated failures. The landscape is littered with stories of well developed business models and propositions failing because of conflict of interest, inadequate controls and absence of checks and balances.
Corporate governance is defined as the structure and processes by which companies are managed, directed and controlled. It refers to the existence of clear reporting lines and clarity about how decisions are made and risks controlled. It includes the relationship between board members, the company’s shareholders, officers and staff, customers and other stakeholders. A good corporate governance framework also deals with internal controls and process that lead to discipline, accountability and transparency.
The corporate governance framework includes elements that will ensure decisions made by accountable individuals are fair and transparent. There should be clear reporting lines and clarity about how decisions are made and how risks are controlled. The responsibility lines and limits of authority of the accountable officers are defined and well-balanced. Appropriate internal controls are established and linked to key risks. Boards have good visibility of management actions and decision makings.
Governance can provide the set of tools that SME’s can use to support their survival and growth. Among the many issues considered would include: (a) the roles played by family members in the business; (b) the necessity of developing a clear governance structure, especially in family businesses and cooperatives/associations; (c) the role, structure and composition of the board of directors (including the role of independent directors); and (d) the impact of senior managers, the incentive and penalty structures, the performance monitoring and the importance of developing succession plans.
Although SME’s are not regulated in the same way as big, listed companies and therefore there is no real compunction to adopt strict good governance practices, putting such a framework to help the organization achieve success and create value will ensure long-term sustainability. It is a journey SMEs should embark on for their growth and stability. It is an investment to prevent pitfalls as it prepares the organization for growth and innovation. Building clear reporting lines and defining decision making processes will provide checks on power and balance on responsibilities. The failures we have seen in both big businesses and SMEs alike find their root in undefined and unclear corporate governance systems, where decisions are made outside of authorities and there is absence of alert mechanisms when things go wrong. Transparency and visibility of critical decisions is opaque when the governance structures are not firmly in place.
The benefits of corporate governance for SMEs are plenty. Several articles have expounded on these and the following is just a sample of why governance matters. A proper governance system improves a company’s ability to obtain external funding and improve its ability to grow. It leads to more effective management with clearly delineated roles and responsibilities and easily understood business processes. Governance improves the management of risk and can lead to appropriate innovations as it embarks on entrepreneurial initiatives more confidently. Good governance in an SME can be a major selling point and improves company reputation, especially in an era where failures abound due to poor governance systems. The long-term value of the company is enhanced and risks are properly identified, monitored and mitigated.
Benel D. Lagua is Executive Vice-President at the Development Bank of the Philippines. He is an active FINEX member and a long time advocate of risk-based lending for SMEs.