For senior executives who sit on privately held or public company Board of Directors, the prospect of serving the needs of private equity firms is an enticing one. The differences between Board roles, however, are vast, and for those interested in serving these roles, there are several “rules of the road” that will allow for more effective contributions to a PE firm portfolio company Board.
“PE FIRMS ARE FROM MARS, MANAGEMENT TEAMS ARE FROM VENUS”
In the book “Men Are From Mars, Women Are From Venus”, the author focuses on ways for men and women to communicate better by understanding the differences between them. In an analogous way, independent Board members need to convey the “language” of PE to non-PE centric management teams. For reasons that are related to the deeply analytical ways the industry invests, PE teams often struggle with management on language related to analyses, pacing of initiatives, and related growth programs. Into this void an independent Board member should readily step to bridge gaps. In a recent investment, a management team had the view six months after an investment that the PE firm was making the operating decisions – which was not the case! Every time a key decision needed to be made, the management team believed that the PE firm was responsible for making it. No PE wants to make operating decisions and, to the extent that they must, trouble must already be occurring with the investment. In this situation, the “gap” between the role of the PE firm and what the management team believed was enormous. It took a period of 2-3 months, but the accountability and decision making gap was clarified and put into the right context for future management of the enterprise.
UNDERSTAND INVESTMENT “VALUE CREATION” THESIS
There are several value creation strategies with a private equity investment, including improving margins, organic revenue growth, growth through acquisitions, or some combination of a series of strategies. Each PE investment has its own “investment thesis” and independent Board members will be most effective if they understand the various components of that firm’s strategy and the time line for the investment thesis to unfold. Understanding the core value creation thesis, or collection of theses, is critical for Board members so that they are aligned with the operating strategies of the enterprise.
PREACH AND TEACH THE PE MINDSET
Many management teams have never worked with private equity ownership and are unfamiliar with the analytical, strategic, and growth mindset that PE brings to bear. The transition to PE ownership is rarely easy, at times strained, and often takes a longer period than desired. As a member of the Board, directors need to facilitate that growth by working with management to help change the culture to one of professionalization and innovation. Working with management to help them understand the new paradigm in which they are operating can add significant value on the part of an independent Board of Director.
GET TO KNOW MANAGEMENT
Independent Board members need to spend quality face time with not only the CEO of the company but other members of the senior management team. This type of time allows a Board member to understand the way the team members think – what is important to them, how they evaluate problems, how they look at the business paradigm. This type of insight is invaluable in evaluating decisions that are under the purview of the Board of Directors and is valuable for potential succession planning.
TAG TEAM WITH OTHER BOARD MEMBERS
Board members bring different skills to the table and the best PE firms compose a Board based on different skill sets. An IT expert, an industry expert, and maybe an M&A expert. It is essential that Board members understand the functional value that they bring, and then “tag team” with other Board members to complete a mosaic of skills that contribute to the performance of a PE enterprise. With one of the companies whose Board I sat on, we “designated” responsibility for functional areas to each Board member. The Board member with marketing expertise interfaced regularly with our head of Marketing and Sales. The same held true between our CFO and a Board member with finance expertise. This created a deeper understanding at the Board level of the challenges and strategy in each functional area. Of more importance, the functional expertise of the Board members provided critical guidance to the management team in each of these areas.
NUMBERS ALWAYS TELL A STORY
A PE investment is just that – an investment – and numbers drive the day. Understanding the economic/financial profile of an enterprise is critical. The economic profile relates to revenue and cash flow drivers. The financial profile is an extension of the same, requiring in-depth understanding of the P&L, cash flows, and balance sheet. It is not possible to be an effective Board member without understanding the story that the numbers tell.
KNOW WHO YOU WORK FOR
Ownership is the PE firm – not management - and Board members need to reflect that in their thinking. The urgency of initiatives and timing of an exit are the domain of the PE firm, not the Board. In this respect, a PE backed Board is fundamentally different from a public Board. Board members need to be fully cognizant of the interests of the PE owners from start to finish.
UNDERSTAND RISK ASSESSMENT
Risk assessment comes in many flavors – name a risk and a Board member needs to understand the implications of said risk on an investment. It is incumbent upon the Board to mandate that management understand and assess risk, and that the Board evaluate said risk independently. The Board has a fiduciary responsibility to evaluate all levels of risk inherent in a business enterprise. A recent example of risk assessment was where an important client required a higher level of security than what the company had been accustomed to due to issues unrelated to our company but related to the vendor. Our Board’s understanding of this risk allowed for more effective decision making. Capital was expended to alleviate concerns on the part of the vendor, saving a sizable revenue relationship. A potentially troubled situation was avoided.
DEBT DEFINES BOUNDARIES
With many privately held middle market enterprises generally averse to taking on outside debt, private equity firms will almost always utilize debt to reduce the overall cost of capital and improve rates of return. The debt level is dependent upon the nature of the business and the appetite for debt risk on the part of the PE firm. It is important for Board members, even those without depth of financial acumen, to understand the operating and expansion “rules” associated with the debt structure. Recognizing this, Board members need to understand that lenders have as much say on key decisions as equity holders
IF YOU DON’T KNOW … ASK
There is no excuse on the part of a Board member for not understanding the business fundamentals. If there are discussions in areas where a Board member’s expertise is not deep – information technology, for instance – it is not enough to suggest that “we will leave that to the IT experts.” Board members need to deepen their understanding of these areas to properly assess risk and opportunity. If you don’t know the answer, ask for individual time with management or ask for a Board “education session”. As the CEO of an institutional owner, I established education sessions in areas where it was clear that the quarterly Board of Directors presentation was insufficient in terms of outlining the risk parameters associated with various projects. On one critical project, our management team went “deep” on a critical business development initiative with our Board separate from the quarterly Board meeting. This ensured a higher-level understanding of the complexities of the technology centric project and ultimately to our investors ability to expend the level of capital required for the initiative.
Any Board member of a private company, PE backed or not, knows the challenges of developing and distributing the Board package in a timely manner. All of us have received packages at the meeting for the first time, much to our dismay. Best practices in private equity backed companies mandate that Board packages be distributed at least 24 hours if not 48 hours in advance of the meeting. Board members need to review the materials in-depth, be prepared with questions, so that the contributions at the actual Board meeting are effective as possible. Not reading the material is an inexcusable mistake on the part of independent Board members.
The contribution of an independent Board member is directly related to the degree of energy that the individual brings to bear. Private equity boards are different beasts than public boards – more active, more contributory, more operational, more engaging, especially in the middle market. The most important ingredient of Board performance is to be actively engaged in all matters related to the company’s strategy and performance. Engage to be a successful Board member!
ABOUT THE AUTHOR
James Still is an operating executive and Board of Directors member with extensive experience in the middle market. His sector experience includes business services, education, training, health care services, and financial services. Formerly the CEO of five privately held companies, he has a passion for leadership. This is the first in a series of thought leadership articles centered around best practices for Boards of Directors, private equity owners and operating management
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