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Corporate Governance: How Small Cap Companies Can Improve

Having analyzed many small cap companies over the years, I know that it is often the CEO and company executives who are also the board members. Having studied corporate governance both during my MBA and in continued financial industry studies, I know the importance good governance can have. It will help protect a company from potential pitfalls that can arise and also sends a positive message to the investment community.

As a company grows, there are a number of governance practices that are not best practice and should to be addressed. The following is a list of traits that many companies trading over the counter have and how to improve the governance structure:

1) All board members are also officers of the company. It is important to have independent directors. A company should strive for a majority of directors to be independent, but in the interim as it grows, there should be at least one or two independent directors (not family members). Directors should have relevant and complimentary experience to each other.

2) Directors are not compensated. For a company to attract talented independent directors with relevant experience, the company must offer some sort of compensation to independent directors. This compensation should not be excessive, but perhaps $5,000-$10,000 cash and options that vest over a period of time (for example quarterly for three years) that are worth $5,000 to $10,000 annually, depending on the size of the company and number of meetings.

3) There are no board members who are deemed a "financial expert." A company may give the rationale in the 10K that sales were under $X million as to why there are no "financial expert" board members. This is no much of an excuse. As the company continues to grow, it is increasingly important to have at least one board member who is knowledgeable about financial statements and accounting.

4) Executive compensation is 100% base. It is important to set goals for each of the officers to achieve for the year. Depending on the amount and extent of goals achieved, the bonus will determine a significant portion of the total compensation. The hurdle to get a full bonus should not be set so low that it is essentially given automatically. Many large cap companies can learn from this as well.

5) The executives determine their own compensation with unclear criteria. In a perfect world, there would be a compensation committee on the board made up of independent directors. I understand that when a company is still very small it may not be practical to do this. Although even if there are two independent directors, it is still possible. It is a huge conflict of interest for the executives to be determining their own compensation. It is also often unclear from company filings how these amounts are determined.

As an investor, you should communicate the importance of strong corporate governance to company management. Perhaps if your skills are relevant, you could be a valuable board member.

I understand that these governance issues will not get resolved overnight, but it would be great to see companies moving in the right direction toward a strong corporate governance structure as they continue to grow.