The Provisional Audit Committe

by Ira Tatelbaum

(This article was originally published by Genus Resources LLC. Tom Davidow was a co-founder of Genus and its President for twenty years before launching Thomas D. Davidow & Associates.)

Introduction

Many of America’s largest and most successful publicly traded enterprises were founded by family entrepreneurs, but the vast majority of family businesses remain private companies whose family managers revel in their business flexibility, more than willing to exchange relatively easy access to capital for the ability to control their own destinies without the scrutiny of outside eyes. Unrelenting public scrutiny, burdensome government regulation, and the prospective loss of control and independence in a publicly traded environment are usually enough to keep things "in the family."

Nonetheless some family enterprises may "go public" with the intention of maintaining the same level of family control as before the public sale of their stock. In these cases it is just a matter of time before the realities of management and public ownership come home to roost. The marketplace that measures success in the maintained value of stock can be a cruel environment for a family whose worth is then determined by traders and market makers rather than on the strength of their collective ability to grow and prosper their businesses in good times or bad.

And yet there is one aspect of managing a business with which publicly traded companies are infinitely more skilled than their private counterparts: Governance. Public companies are expected to structure their management teams and their boards of directors with an eye toward maximizing shareholder return for all investors, not just for family stockholders. Successful family run enterprises do well with their management teams, but, more often than not, their board meetings (if they have them at all) look much more like family get-togethers than a gathering of counselors, advisors, and overseers whose presence is essential to maintain objectivity and insure the financial integrity of the business. A company accrues such benefits most rapidly from a board of directors that includes outsiders who have no professional or other business relationship with the company, individuals who become members of the several committees that assist the board in doing its work. Among these committees none is more important than the Audit Committee.

Role of the Audit Committee

The role of the Audit Committee is to assist the Board of Directors in its oversight of the accounting, auditing, and reporting practices of the company. In the case of a public company the reporting aspect of the work refers to public disclosure of financial records and methods. For the private family business this reporting would be to family/owner/managers and directors and, where necessary, to the company’s lenders. The Audit Committee’s objective is to assess the qualitative aspects of company financial processes as well as their effects on management’s ability to measure business and financial risk. Further the Audit Committee reports to the Board of Directors on company adherence to certain legal, ethical and regulatory requirements.

Membership

The membership of the Audit Committee should consist of three or more individuals familiar with general financial and auditing matters. At least one of the members should have an extensive auditing or accounting background. The members of the Audit Committee are generally classified as "outside directors" or "non-executive," i.e. directors who are not members of management or the family. To be most effective they must be free of relationships with the company that might threaten independent judgment.

Communications/Oversight

The Audit Committee maintains open communication with the company’s accountants and/or auditors as well as with management and internal auditors, particularly with the company’s Chief Financial Officer. It is not a function of the Audit Committee to conduct audits. Rather the Committee oversees the processes of internal and external controls through analysis of financial statements and other material. At regularly scheduled annual meetings, more often if circumstances dictate, the members of the Audit Committee meet with the outside and inside auditors to test the validity, timeliness, and accuracy of the company’s record keeping. The Audit Committee then conveys its findings to the full Board of Directors.

Genus Resources Consultants as the Provisional Audit Committee

Genus Resources business consultants have assisted family businesses with issues of governance in general and with the Audit Committee specifically. Most boards of directors of Genus clients are comprised of family members and/or non-family management executives. Only occasionally do these boards include outside directors. Consequently, few of the companies have Audit Committees to oversee their financial processes and, in cases where the client is experiencing financial difficulties, the presence of an Audit Committee could be the difference between success and failure in reestablishing firm financial footing. In such cases the company may not survive the time it takes to expand and reorganize its board of directors to include an audit committee. Here, the Genus team steps in as the Provisional Audit Committee and without delay begins the oversight process.

Initial work includes complete review of financial statements, interview(s) with the accounting firm’s partner in charge of the company’s account, and detailed discussions with management, particularly with the Chief Financial Officer, regarding the company’s financial position. In short order the Genus team makes recommendations to the board of directors based on its findings. The recommendations stimulate an introspective effort by management to understand the components of the company’s financial position with the goal of taking immediate corrective measures. Such corrections range from seemingly simple and obvious reconciliation of accounts to the replacement of the CFO or even the auditor. During the ongoing process of board building the Genus team facilitates discourse and recommends remedial actions to improve the company’s financial standing. As the company moves toward a reconstituted board of directors the Genus team aids in assessment of outside director candidates and then assists with the transition from the provisional to the board appointed Audit Committee.

For the family enterprise that is not experiencing financial challenge the Provisional Audit Committee as part of a transition to a fully representative board of directors can also be the proverbial prevention rather than the cure. The Provisional Audit Committee, devoid of any prejudicial family or management slant, brings unbiased analysis of the company’s financial needs and aspirations ensuring that fundamentally sound financial practice exists to sustain and support future growth. Once the board of directors is revamped to include outside directors the role of the Provisional Audit Committee is assumed by the "official" board designated Audit Committee.

Conclusion

The words "going public" may be anathema to most family business owners, but there are elements of governance in publicly held companies that can benefit privately owned enterprises. Among the most important are the structure of the board of directors and the Audit Committee of the board that oversees the company’s internal and external audit functions. Whether a company is financially sound or having its difficulties the Provisional Audit Committee can be a valuable tool in maintaining the financial veracity of a family owned enterprise while a more broad based governance structure is instituted. The Provisional Audit Committee as managed by Genus consultants not only quickens the pace and benefits of oversight, but also accustoms the family owners to management of their companies within a governance framework that ensures unbiased evaluation of their financial process and procedure.

Copyright © 2002