The importance of corporate governance for SMEs

However, this view overlooks the significant benefits that a tailored corporate governance framework can deliver for SMEs.

It is therefore important for these businesses to understand the key principles of corporate governance and how they apply in Northern Ireland. In January 2024, the Financial Reporting Council published a revised Corporate Governance Code (the Code), which provides requirements in relation to the behaviour, responsibilities and actions of board members of companies in the UK.

The Code has five broad themes – board leadership and company purpose, division of responsibilities, composition, succession and evaluation, audit, risk and internal control, and remuneration.

The Code is mandatory only for companies listed on the London Stock Exchange, in accordance with the Financial Conduct Authority’s Listing Rules. However, many of the principles can be applied to SMEs to aid their directors in improving the quality of their governance and stewardship, and in doing so, fulfilling their fiduciary duties under the Companies Act 2006.

Company purpose

For a board of directors to be effective in its role, it must have a focus on the sustainable success of the company, thereby generating value for shareholders.

A company’s purpose should have a long-term focus and include strategies and sets of values that align to board objectives..

Setting such strategies allows management to identify all sources from where material benefit and value is gained. These include financial sources, but may also include, for example, appropriately skilled workforces, intellectual property or brand recognition.

Focusing on areas that generate the most value is key for effective management of the business. When major decisions are to be made, such as capital expenditure or amendments to staffing levels, the board can then make assessments based on outcomes that will best deliver this purpose.

Corporate culture

Corporate culture is becoming an increasing area of focus for boards, with stakeholders often expecting a company to have its purpose clearly aligned to a framework of values, ethics and behaviours.

Such a framework is most effective when embedded throughout an organisation and scaled to the size and complexity of its operations and stakeholder expectations. Attributes of a positive culture, best delivered through a top-down approach, include honesty, transparency, respect and an environment of psychological safety.

Ownership of a company’s values will be stronger if a collaborative approach is taken, involving management and the workforce in a two-way process, with the directors setting the ‘tone at the top’.

Board composition and performance

Ideally, boards would have a diverse make-up, with a balance of executive and non-executive directors, bringing a range of skills of value relevant to the risks and opportunities facing the company.

However, for SMEs, board diversity can be a challenge. A skills audit may be beneficial, where an analysis of strengths and weaknesses is performed, to identify areas where additional support may be valuable.

It may be appropriate to appoint one or more non-executive directors, or to engage a third party on an ad-hoc basis to provide consultancy, legal or other advice.

An annual evaluation of the board may also be helpful, to determine whether its members are effectively working together to build resilience and achieve company objectives.

Risk management

Effective risk management is vital for companies of all sizes. Directors should consider their processes for identifying and managing both existing and emerging risks.

Of particular focus should be risks, and indeed opportunities, arising from sustainability and climate-related matters.

Whether it is opportunities arising from new markets, risks around future profitability of products and services, or simply managing the as-yet-uncertain impact of climate change, boards should ensure they have a process for regularly reviewing sustainability-related matters, including the capturing of relevant data and implications of any financial reporting requirements.

The board should consider whether it has the necessary skills and abilities to assess the risks that the company is facing, and will face, and consider filling any skills-gaps to enhance the resilience of the business to an ever-changing risk environment.

Effective internal controls

One of the most important duties of any board of directors is stewardship over the company’s financial resources, including the production of financial statements that present a fair, balanced and understandable assessment of the company’s position and prospects.

In the Code, it is a requirement of boards to make a declaration in relation to the effectiveness of their material controls. The definition of material controls is broad, encompassing financial, operational, compliance and reporting controls.

Although the Code only applies to listed entities, the maintenance of a strong system of internal controls is vital for any business.

In performing their fiduciary duties under company law, directors are stewards of a company’s resources, and must use these for the overall benefit of the company’s members. It is vital that there are systems in place sufficient to safeguard such resources, ensuring, as far as possible, they generate maximum benefit for the owners of the entity.

Given that SMEs contribute approximately three-quarters of all private sector income generated in Northern Ireland, their importance to our regional economy cannot be overstated. By adopting a corporate governance framework that is specific to their unique needs, these businesses can establish a robust foundation for ongoing, sustainable growth.

This approach not only strengthens their performance and resilience but also bolsters their reputation, ensuring they remain vital contributors to our economy for years to come.