Corporate Governance in Small and Medium Enterprises (For SMEs)

We often don’t talk about corporate governance in small and medium enterprises (SMEs) because we often relate the term to larger companies. But should an SME even think about corporate governance? Might it be too early for SMEs to implement corporate governance? Is the sky too high for a small and medium enterprise to reach? 

Well, corporate governance is all about effective and efficient leadership, and SMEs need proper leadership structure to rise above their challenges. Good corporate governance helps SMEs in aspects like strategic planning, top-level decision-making, accountability, transparency, and regulatory compliance, among others that I’ll share. 

With the correct corporate governance structure, small and medium enterprises can adopt the right business culture, making them more credible, reliable, and competitive. With 50% of small businesses failing within the first five years due to poor leadership, corporate governance for SMEs is a no-brainer. SMEs need it for their sustainability and market survival. 

This guide shall walk you through everything you should know about corporate governance for SMEs, including its benefits, structure, principles, and best practices. Let’s dive in!

What's Corporate Governance

Key Takeaway:

  • Corporate governance encompasses rules and guidelines that dictate how an organization is run and directed.
  • SMEs need corporate governance for various reasons, including strategic planning, improved decision-making, enhanced accountability, financial transparency, regulatory compliance, balance of power, improved capital flow, better stakeholders’ relations, risk management, board efficiency, talent attraction, staff retention, and enhanced business reputation. 
  • Most SMEs don’t have a typical corporate governance structure consisting of key players like the shareholders, board of directors, and management. Instead, the same individual assumes multiple roles.
  • SMEs with an established board of directors need support structures around them, including different board committees, such as the audit, nomination, and risk management committees.
  • Five fundamental principles or pillars govern SMEs’ corporate governance structure: transparency, fairness, awareness (of possible risks), accountability, and responsibility. 
  • Some of the best corporate governance practices for SMEs include delegation, defined roles, leadership, checks and balances, ethical compliance, regular communication, incentives, long-term sustainability, technology utilization, effective recruitment, and board assessment and training. 

What’s Corporate Governance?

Corporate governance refers to the structure and process by which an organization or business is run and directed. It enables an organization to operate more efficiently with clear guidelines, improve capital access, and manage potential risks. Furthermore, it safeguards the business against mismanagement and holds everyone involved in decision-making accountable for their actions. 

Do SMEs Really Need Corporate Governance?

Although corporate governance is historically associated with larger enterprises and established companies, it’s increasingly becoming critical for SMEs. Some of the advantages that small and medium enterprises stand to gain from corporate governance include the following:

  • Strategic planning: Corporate governance provides a framework for defining the organization’s objectives, setting clear priorities, and focusing resources and energy on what matters most, enabling SMEs to attain their strategic business plans. 
  • Improved decision-making: Corporate governance outlines clear roles and responsibilities for shareholders, directors, and managers, streamlining the decision-making process. Everyone understands their roles and who to report to and consult with, except for shareholders who own the business. 
  • Enhanced accountability: When things aren’t working correctly in an SME, questions will arise from stakeholders, and you’ll have to provide the answers. Corporate governance ensures there’s always someone accountable for every action, which means providing the needed answers when things aren’t functioning. 
  • Financial transparency: Corporate governance dictates that businesses be transparent when reporting about their finances, especially to stakeholders, to allow them to make more informed decisions. It enables investors to know what they are dealing with before putting their money into it. 
  • Regulatory compliance: Corporate governance requires that an SME comply with existing regulatory authorities. Such compliance improves the SME’s credibility and reputation and keeps it on the right side of the law. 
  • Balance of power: Corporate governance promotes a system of checks and balances where every stakeholder feels involved in the running of an SME. Call it modern democracy, where no one has absolute power and control, resulting in better accountability and transparency.  
  • Improved capital flow: Corporate governance boosts investors’ confidence, allowing them to pump money into the business, which enhances its capital flow. Lenders also become more confident in extending credit, which an SME can use to grow its inventory or expand. 
  • Better stakeholders’ relations: Sound corporate governance calls for consideration of all stakeholders’ concerns, interests, and contributions, which helps improve their relations. 
  • Risk management: Corporate governance ensures that an SME’s leadership implements proper measures for identifying and mitigating risks. These risks are often common threats to SMEs’ financial performance and operation efficiency, and corporate governance ensures the SME takes a proactive approach to manage them.
  • Board efficiency: The board is the primary driving force in corporate governance. The board becomes efficient in carrying out its mandate, which includes corporate appointments, policy-making, and risk management. 
  • Talent attraction: Corporate governance makes an SME more attractive not only to investors but also to a talented workforce. More of them will likely want to join your SME when you employ a sound corporate governance structure. 
  • Staff retention: Good corporate governance allows the staff to enjoy a better and more stable work environment, which motivates them to continue working. It also demonstrates to them that the SME cares about their well-being. 
  • Enhanced reputation: Improved aspects like transparency, fairness, and accountability are critical to improving the business’ image. Stakeholders become more confident in the SME. 
Do SMEs Really Need Corporate Governance

What’s the Structure of Corporate Governance for SMEs?

A typical corporate governance structure usually constitutes three levels of power or authority;

  • Shareholders
  • Board of directors
  • Management

Shareholders are essentially owners of the company or business. They have the highest level of authority, and part of their job is to appoint a board of directors

The board of directors oversees the running and governance of the business. Part of their job is to recruit and delegate responsibilities to the management and provide strategic guidance. 

Meanwhile, the management oversees the business’s day-to-day operations per the organization’s vision, values, and business strategy. The management reports to the board of directors. 

How about an SME’s corporate governance structure?

Most SMEs, especially those not incorporated as individual companies, don’t have a typical corporate governance structure with an identifiable board of directors, management, and shareholders.  Instead, one individual may play one or more of these roles. For example, the business owner may be the executive director and manager. 

But even so, it doesn’t mean there shouldn’t be a structure where everyone has an identifiable role. Once an SME embraces corporate governance, the owner may need to set up a board and delegate some responsibilities. The board may have to appoint a few managers to run the day-to-day affairs of the business. 

In the long run, everyone will have a defined role. Note, however, that the board may not work alone when performing its tasks. It may need to set up committees to help it handle specific assignments, the most notable being the audit, nomination, and risk management committees.

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What Are the Principles of Corporate Governance for SMEs?

Corporate governance is built on five essential pillars, famously known as corporate governance principles. An SME that wants to adopt corporate governance will need to develop its structure around these pillars, and they include the following:

1. Transparency

The SME’s leadership must disclose relevant information that stakeholders may want to know about the business’s financial performance and position to make a more informed decision. The SME leadership should also reveal potential risk concerns or conflicts of interest. 

The reporting on these matters, especially financial performance, should be accurate and timely. And suppose there are any regulations the SME needs to comply with. In that case, the leadership should ensure that’s the case to avoid any legal tussles, unnecessary fines, and loss of public confidence due to a lack of transparency. 

2. Fairness

Though families and small groups of people own most SMEs, all stakeholders must be treated fairly, including employees, suppliers, customers, creditors, and the general community. 

SMEs should give fair consideration to the legitimate concerns and interests of stakeholders. The stakeholders should be able to air their issues and count on the leadership to act on them. In the long run, it builds their confidence in the business and the leadership. 

3. Awareness 

A successful SME should be aware of the risks around it and take the correct measures to mitigate the dangers posed by those risks. Corporate governance demands this, and the board spearheads risk management efforts to stop or minimize the risks. 

Corporate governance dictates that the relevant personnel define potential business risks and their control measures and inform all concerned parties about the status of specific risks when they occur and the mitigation efforts to manage them. 

4. Accountability

SME leadership is expected to make tough calls and stick by them. Questions are inevitable when running an SME, and the leadership has to be ready to answer them and provide convincing explanations. That’s accountability!

Accountability dictates that the SME leadership justifies all the actions it takes and the decisions it makes on behalf of the business. They should be able to clearly explain why they make certain decisions and be ready to own up even if things don’t turn out according to plan and the effects are pretty dire. 

5. Responsibility 

In corporate governance, the board is responsible for shepherding the business around its challenges, away from potential risks, and towards its strategic objectives. That also applies to small and medium enterprises embracing corporate governance. 

Though this is often a challenging undertaking, it’s what responsibility is about, and the SME leadership should be willing to accept it. They should always act in the SME’s best interest and not their own, even if they own the entire business. 

Corporate Governance for SMEs

What are the Best Corporate Governance Practices for SMEs?

Corporate governance calls for work, especially from an SME’s leadership perspective. Its success depends on the effort that the SME leadership puts into making it work, and here are some fantastic suggestions: 

1. Delegation

As an SME grows and expands its operations and market scope, it may reach a point where the owner, key shareholder, or executive director finds it challenging to manage multiple roles. At such a point, it may be necessary to establish a board of directors who can report to them. 

The board of directors, in turn, sees it necessary to delegate some of the responsibility to a competent executive or manager (s) who oversee the business’s daily operations. With delegation comes a sense of responsibility, as everyone knows what’s expected of them and owns up to their decisions. 

2. Defined roles

It’s not just enough to delegate responsibilities when adopting corporate governance in an SME. The duties should be defined. For example, the directors should understand their oversight roles, especially regarding strategic planning, policy development, and corporate governance. They should also recognize their mandate in recruiting, evaluating, and compensating top management.

On the other hand, the top managers should understand their limits and the importance of consulting the board on certain weighty matters before making a decision. The board, in turn, should know when to involve the shareholders.

When there’s a clear chain of command, and everyone understands and does their job, business growth and success are attainable with corporate governance at the helm. 

3. Leadership

Remember, corporate governance is all about effective and efficient leadership. For that reason, the ones calling the shots (shareholders, directors, and top management) should set the right tone in leading the SME to its short-term and long-term objectives. 

Effective leadership means firm-wide consultation with the relevant personnel, critical thinking, and sound decision-making. It also means owning up to one’s decisions despite disappointing outcomes. Moreover, effective leadership is about helping the SME navigate its way out of a crisis and complying with applicable standards and regulations. 

4. Checks and balances

Good corporate governance dictates that no one should have autonomous decision-making power. It’s ‘modern democracy,’ as I mentioned, which means that all shareholders should feel like their input matters and have equal voting rights. 

Even when an individual owns the company, the directors need to experience a balance of power. They should be able to contribute at the board meeting. SMEs need to consider checks and balances when fighting impartiality and embracing fairness, which is a critical pillar of corporate governance. 

5. Ethical compliance

The issue of ethical compliance is non-debatable when it comes to corporate governance. First, SMEs should comply with the necessary regulations, including accurate and timely financial performance reporting. In that case, the SME should observe the essential corporate governance pillar of transparency.

Ethical compliance is also about being morally upright. In this case, the SME shouldn’t intentionally engage in fraud or malpractice, which may result in huge fines or, worse, a lack of stakeholder confidence. Its ethical conduct and drive should be apparent in order to earn public trust.

6. Regular communication

The success of corporate governance at an SME level largely depends on the flow of information across the various ranks and, more importantly, between shareholders. Shareholders should communicate with each other respectfully and more regularly regarding the dealings of the SME.

Constraints in communication could be a reason for dissatisfaction among some shareholders or directors. That, however, doesn’t rule out the directors, if they exist, and managers. They, too, should maintain regular communication with each other and the workforce they manage.

7. Incentives

Incentives are motivating in nature, and everyone wants to be incentivized. From the employees at the bottom of the hierarchy to the directors at the top, they all need some enticement to continue working for the SME and promote its agenda wholeheartedly. It makes them loyal, and every SME needs a loyal workforce and leadership to succeed.

8. Long-term sustainability

It’s not just enough for an SME to address its present challenges but also to focus on conquering those that arise in the future. That shows the SME’s commitment to sustainability and long-term value.

9. Technology utilization

Corporate governance has reached a point where its execution increasingly relies on emerging technologies such as artificial intelligence (AI). For example, nowadays, AI robo-directors attend meetings, make valuable contributions, and propose data-driven solutions to business problems. That means that as long as an SME embraces corporate governance, they must also embrace the available technological solutions. 

10. Effective recruitment

There’s always the need to refresh the working staff with the changing economic climate. This may mean getting fresher graduates, more experienced personnel, or more competent managers. What matters is having the proper recruitment structure and hiring people who can contribute positively to the company’s corporate governance objective.

11. Board assessment and training

SME leadership should stay updated with the latest corporate governance practices and trends. That’s attainable through frequent assessment and training. The evaluation helps to identify weaknesses and areas that need improvement. At the same time, the training focuses on injecting the required energy, expertise, and leadership for successfully running the SME.

Principles of Corporate Governance for SMEs

Wrapping Up!

There’s no denying that SMEs need corporate governance just as much as larger and more established firms. Good corporate governance has advantages such as improved decision-making, enhanced accountability, regulatory compliance, power balance, capital flow, risk management, board efficiency, talent attraction, and staff retention, to name a few. 

However, observing essential governing pillars or principles, which include transparency, fairness, risk awareness, accountability, and responsibility, is critical. More importantly, SMEs shouldn’t forget to refresh their corporate governance structure, which involves regular assessment and training of the board and top management. That’s where we come in. 

As the Center of Corporate Governance, we run a monthly corporate governance mastery course that entrepreneurs, risk managers, board of director members, business owners, and SME leaders can benefit from. We invite you to check out this fantastic program on our website, which can help SMEs and other entities unlock leadership excellence and improve their corporate governance culture. 

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