Ins and Outs: The Basics of Having an Outside Director

Ins and Outs: The Basics of Having an Outside Director

by Belle Wong, J.D., November 2018

While publicly traded companies are required by both Nasdaq and the New York Stock Exchange to have a certain number of outside directors on their boards, private corporations can also benefit from having such board members. In addition to providing independent opinions on company decisions, outside directors can often bring much-needed expertise to the board table.

Inside Director vs. Outside Director

As the term suggests, an outside, or independent, director is someone who is not part of the company. More broadly, it refers to an individual who is not a company stakeholder—for example, employees or major shareholders—and who therefore does not have any involvement with the company other than sitting on its board.

Most directors on boards of private companies tend to be inside directors, or individuals who are also company stakeholders, such as senior management employees. Founders, CEOs, and other individuals holding high-level management positions frequently act as directors as well.

While the outside directors bring a number of benefits to board decisions and actions, they primarily help your board view your company from a big-picture perspective. Inside directors, on the other hand, are highly experienced in the running of your particular company and have intimate knowledge of the industry's ins and outs. As employees, inside directors are also major stakeholders, meaning the well-being of the company is of the utmost importance to them.

Benefits of Having Outside Board Directors

While there is no requirement for private companies, including family-run companies, to include outside directors on their boards, there are a number of reasons why you should consider including one or more:

  • Objective advice. Because outside directors do not have any ties to the company other than their presence on the board, you can generally look to such individuals to provide unbiased advice.
  • Expertise. Selecting outside directors allows you to pick individuals who can provide a specialty or area of experience that your own inside directors might be lacking. This additional expertise helps add to your board's knowledge base and can prove invaluable.
  • Less conflict of interest. Because they have been selected based on their independence from company matters and activities, outside directors are less likely to face conflict of interest issues when tackling board matters.
  • More credibility for your business. Unlike publicly traded corporations, private corporations are not required to have independent directors on their boards. A small company with an outside director on its board therefore sends a message to the business community that it takes corporate governance seriously, which in turn can lend credibility to your business overall.
  • Access to additional networks. Because most outside directors tend to be experienced in their fields, they can potentially provide access to a large network of people and resources.

Independent Director Requirements

Because private companies aren't required to have independent directors, there are no hard and fast rules as to the criteria to use when selecting one. You should, however, look for someone who is not involved in any relationships with the company, employees, major shareholders, or investors, so that the potential director's independence is maintained. You should also gauge what expertise or skill your board may currently be missing and then look for an outside director who can share this knowledge when the board makes decisions.

Once you've formed your private corporation, consider including outside directors on your board. The value of such individuals for publicly traded companies is both well-known and mandated, but smaller companies also stand to benefit from having the viewpoint of an independent director. In fact, adding an outside director to your board may be one of the best business decisions your company makes.