Board Members & Financial Literacy

Last week I blogged about some ideas around the board member selection process for expansion stage companies. This week, I’d like to share some ideas around criteria for independent board members who can also meet the financial literacy or financial expert criteria for a public company.

You might ask why on earth an expansion stage tech company should care about public company financial expert criteria.You’re probably also thinking that your ideal board should be made up of individuals who can guarantee venture funding…why worry about finance? Well, here are some reasons.

1. As an expansion stage company, you can never begin preparing for an IPO soon enough. Independent directors aren’t always going to be available for recruiting on short notice. Independent directors who also meet the financial expert criteria are even more in demand.

2. The right financial expert will provide companies and their management teams with extremely useful guidance.

3. In today’s environment, the more critical eyes on your company’s financial processes and financial statements (and the sooner), the better. Fast forward to your company’s IPO preparation. It’s highly doubtful that you’ll want cleanup or discovery of an accounting issue to be the gating item.

Now, hopefully I haven’t offended any expansion stage or start-up board members by implying that they aren’t “financially literate” or that they aren’t “financial experts.”  These are actually defined terms.

Financial literacy is defined by AMEX and Nasdaq as being able to read and understand fundamental financial statements, including a balance sheet, income statement and cash flow statement. NYSE has left determination of financial literacy up to the judgment of a company’s board of directors. Since implementation of SOX, I’m pretty sure that most board members of NYSE-traded companies take this financial literacy concept pretty seriously.

Financial expert is a defined term by the SEC. You can read about this in great detail in Item 401(h) of the SEC’s Regulation S-K. The highlights of the attributes of a financial expert are these:

• Understanding of GAAP principles and financial statements
• Ability to assess the application of GAAP in connection with estimates, accruals, reserves, etc.
• Experience preparing, auditing, analyzing or evaluating financial statements (or actively supervising the preparation of financial statements) in sufficient depth and breadth as to be reasonably expected to be comparable to the company’s financial statements.
• Understanding of internal controls and procedures for financial reporting.
• Understanding of audit committee functions.

Further, this experience must have been gained through:

• Education and experience as a principal financial or accounting officer, controller, pubic accountant, auditor or equivalent, or
• Experience actively supervising such an individual, or
• Experience overseeing or assessing the performance of companies or public accountants with respect to preparing, auditing or evaluating financial statements, or
• Other relevant experience.

Pretty serious stuff, and pretty serious responsibility for a board member.  This is why recruiting the financial expert takes time.

If you’re on the board of an expansion stage company, or if you’re the CEO or the CFO, and you believe that an IPO is a viable path for the company, now is the time to assess whether your company has an independent board member who meets the financial literacy and financial expert tests. If not, you’ll probably want to add this to your plan for 2010.

Stay tuned for more from out of the back office…