Corporate governance in SMEs

Corporate governance principles have always been associated with large, listed and well-established entities. With the phrase “corporate governance” referring to structures and processes for the direction and control of companies, mainly focusing on the relationships among the major role players like the management, board of directors, controlling shareholders, minority shareholders and other stakeholders.

The distinction, however, between these major players is not as evident in most small and medium enterprises (SMEs), which are usually unlisted. However, with the introduction of King III, South Africa’s recognised code of corporate governance and its recommendations, SMEs depending on whether owner-managed or non-owner-managed should also aspire to follow sound governance practices and principles to reap the long-term benefits, such as business sustainability and stakeholder confidence, which will ultimately assist with the growth of the SME into a larger, well-established organisation.

Therefore, it is encouraged that SMEs consider the application of sound corporate governance to their business operations from the very onset and not only when they have grown into larger organisations or apply for listing. The discussion to follow will focus of some of the recommended principles in King III that SMEs should apply. These principles include, among others, ethical leadership and corporate citizenship of the SMEs, strategies taken by the SMEs, structures of the SMEs and responsibilities within the SMEs.

Ethical leadership and corporate citizenship

Governance within an organisation rests on effective leadership based on an ethical foundation. This is evident through leadership adopting the four ethical principles, which are responsibility, accountability, fairness and transparency, in their decisions.

These fundamental principles and ethical values apply to all SMEs irrespective of nature and size. The ultimate accountability therefore rests with the owner or the board. Natural citizenship entails the state being vested with rights, privileges and duties. Therefore being a corporate citizen implies that the board or, in case of owner-managed SMEs the owner, is not only responsible for the organisation’s financial bottom line, but also its impact on society and the environment in which it operates, since stakeholders are not only shareholders but also include other groups affected by or affecting the organisation’s operations such as, inter alia, employees, suppliers, creditors and the community in which the organisation operates.

Strategies

Strategic thinking relates to what the organisation wants to be and/or do or achieve, and strategic planning relates to how the organisation is going to achieve the strategic vision. This would include considering and preparing the required business plan/action plan, structures and processes required. However, this is not the case in most owner-managed SMEs, where the visions and strategies of the organisation are entrenched only in the mind of the owner and, in most cases, are not shared with other members of the organisation to evaluate. On the same note, if the business plan or action plan is not properly followed, this can lead to impulsive decision-making, which can result in negative consequences for the organisation and its corporate citizenship. Therefore, strategy development processes should address the continuous changing business environment and market conditions in which the organisation operates.

Structures

The structures of an organisation ensure its prosperity, as there will be checks and balances in place to safeguard that not only the stakeholders of the organisation perform effectively. King III recommends that the board should consist of a majority of non-executive directors and individuals with the appropriate skills, experience and knowledge to contribute to board decisions. Owner-managed SMEs will very often not have the financial muscle to appoint non-executive directors. It is suggested that, when considering a major decision, the owner invites or obtains outside objective inputs from knowledgeable people who are not involved in the day-to-day management of the business.

Furthermore, King III recommends that that board of an organisation should also have its own support structures, such as an audit committee, a company secretary and an remuneration committee. The benefit of these board committees is that they reduce the workload of the board. SMEs, whether owner-managed or non-owner-managed, due to their size and nature may be able to handle the load of performing all functions without having to form separate committees.

King III further stipulates that smaller companies need not establish formal committees to perform separate oversight functions but should ensure that these functions are appropriately addressed by the board. It should be kept in mind that some of the board committees are required by law to be setup within an entity. Some entities are exempted for setting up such committees, even though they can opt voluntarily to have such committees as they grow.

Responsibilities within SMEs

In most SMEs the same individual will fulfil multiple roles within the organisation. The individual, tasked with these difficult responsibilities, must ensure that he considers decisions and acts from the perspective of a specific role player at different times to avoid conflicts of interests and ensure independence, which may prove to be difficult as the lines between different roles can become blurry. Hence the best method to differentiate between the different roles is to have a document setting out the roles, responsibilities and duties of each. For example, the Companies Act lists the duties of directors in section 76, therefore the same rules and duties should also apply to SMEs, especially the general principles to act in the best interest of the organisation.

Owner-managed SMEs need to balance their own interests versus organisational interests as in most times there is a lack of opposition, and decisions taken by such an organisation will turn out not to be objective or rational. Among the responsibilities within an organisation is risk governance. Like any other organisation, all SMEs need to identify the risks that the organisation could face and ensure that these are mitigated, and early warning systems are in place should the risk occur or in the event that it is about to occur.

In SMEs, the owners or the board should do everything necessary to be satisfied that the organisational risks are identified, monitored and addressed.

In conclusion

The challenges that SMEs face are that the same individuals play both the directors’ and management role, which may create some conflicting scenarios within the organisation. However, considering the recommendations in King III, SMEs have the assistance to implement sound corporate governance at a principle level without attracting significant additional costs, eliminating the longstanding perception that application of corporate governance in SMEs is costly.

All the underlying principles found in King III are applicable to SMEs. However, to what degree the practices are implemented will depend on the size and complexity of the business. Every organisation needs a strategy, a business plan, performance management and risk governance for it to prosper.

Co-authored by Kelvin Simango