Does Your Small Business Need a Board of Directors?

For companies structured in certain ways, having a board of directors is required. Maintaining a board of directors and holding meetings may seem like formalities, but they’re important to observe to maintain your liability protection.

Board Requirements

C corporations and S corporations have no choice but to elect a board of directors. Exact rules and regulations for boards vary by state. All states require that corporations form a board of directors elected by shareholders, hold at least one annual meeting, and maintain meeting minutes that document topics discussed and actions taken. Sole proprietorships and LLCs are not required to have a board of directors, but can choose to elect one if they choose.

State law determines how many directors you must appoint to the board. Joe Hadzima [PDF], chairman of MIT’s Enterprise Forum, notes that corporations in Delaware and Massachusetts can have as few as one director, but most require more. The U.S. Small Business Administration notes that typical titles include president, secretary, and treasurer.

Legal Consequences

Observing corporate rules is an important part of maintaining limited liability for company shareholders. If the company is sued and you don’t have evidence that you’ve followed the required board formalities, the court can “pierce the corporate veil” and hold owners personally liable for company debts. The Digital Media Law Project warns that neglecting to elect directors, hold director meetings, or prepare meeting minutes are all viable reasons for a court to pierce the veil.

A Director’s Role

The board of directors, elected by shareholders, is responsible for overseeing the company and setting corporate policy. Directors authorize stock issuance, declare stock dividends, and set executive salaries. They also make significant financial decisions around big ticket items like business loans and real estate purchases. The day-to-day operational decisions are taken care of by the officers, whom the directors elect.

In lieu of regular meetings, some states allow directors to sign a consent resolution for important matters. Some states require directors to meet in person but most allow directors to hold meetings over the phone.

Who Can Be a Director?

At a small company, corporate directors and officers are often the same people. The company CEO is often also the chairman of the board and other top executives, such as the CFO and COO, may also serve. If you have a major shareholder who isn’t an employee — for example, an angel investor — that person may insist on being a board member or sending a representative to sit on the board.

Sarbanes-Oxley requires public companies to have a certain number of outside directors — individuals who aren’t affiliated with the company — on the board. The law also requires certain directors to have specific financial knowledge and that you assemble a designated audit committee.

As a private company, you’re not obligated to have outside directors. It is, however, a good idea to appoint a few. Hadzima points out that outsiders have a better ability to spot problems in the company and can provide some expertise that your management may not have.