Private equity governance


Financier Worldwide Magazine

April 2019 Issue

In today’s tightly regulated economy, good corporate governance may be the best way to create lasting value. A strong sense of corporate governance means the board of directors is likely to meet more regularly, will have clearly defined responsibilities and will find it easier to maintain control over the business. It will also have a better handle on risk management and reduce opportunities for fraud and corruption.

Within the private equity (PE) industry, corporate governance has become more important than ever, for both institutional investors and fund managers.

When a PE firm invests in a company, important questions need to be addressed. Such as, in the interest of creating value for investors, how should the decision-making process be managed across shareholders, the board of directors and management? To what extent should PE be represented on the board?

It is becoming clear that building strong governance and expert boards within portfolio companies is crucial to returning value to investors.

Adding value requires PE firms to dedicate more time, energy and resources to their portfolio companies than ever before. Leveraging outside talent to bolster management teams and help drive growth can be important. Appointing the right independent directors, for example, is key. Such directors help to assess the portfolio company’s value-creation possibilities, as well as the landscape within the industry.

Yet, finding the right independent directors can be challenging. These are crucial appointments. “Independent directors with industry experience can be an excellent source of strategic ideas and guidance for inorganic growth, and often open doors for introductions to companies that might not otherwise be on the market,” says Rita-Anne O’Neill, a partner and co-head of the global private equity group at Sullivan & Cromwell LLP. “In addition, independent directors who have prior public company board experience or are financially literate can help ensure that a portfolio company is governed with discipline and maintains good corporate formalities – which not only helps with current oversight of the portfolio company, but also makes for a smoother exit – whether by sale or IPO.”

Ultimately, those PE firms not thinking about ESG policies and sustainability may easily fall behind the competition.

“Independent directors bring needed perspectives, skillsets and professional networks to these businesses,” explains Doug Baumoel, the founding partner at Continuity Family Business Consulting. “In addition, adding independent directors to a family business board often imbues that board with higher stature within the family. Family employees and owners treat their board with a higher degree of deference and respect. This enables the board to govern better and have more impact on company performance.”

Independent directors alone will not improve governance, however. Regulatory scrutiny of PE firms is increasing and limited partners (LPs) are demanding greater transparency. “This demand for transparency continues to expand beyond fees and performance calculations, including to co-investment opportunities, and governance within those co-investments,” says Ms O’Neill. “LPs are also increasingly focused on non-financial performance metrics such as those on environmental, social and governance (ESG) and diversity. LPs want details beyond polices and initiatives. They want to see actual ESG performance at portfolio companies, and diversity at the investment professional and portfolio board level. Just as we are seeing with investors in public companies, PE investors recognise that companies that focus on ESG considerations can minimise risk and reduce costs over the long term, and are aware of the increasing data that companies that prioritise diversity are starting to outperform their peers.”

Responsible investing is a growing issue. PE firms are increasingly aware of their public image and the need to behave ethically. By integrating ESG considerations into all aspects of the PE process, including target sourcing, due diligence and deal negotiation, board oversight and route to exit, firms can generate value. ESG allows firms to manage and track financial sustainability, as well as compliance with the prevailing regulatory climate. Ultimately, those PE firms not thinking about ESG policies and sustainability may easily fall behind the competition.

Investors’ influence on the PE industry has grown substantially in recent years. Increasing pressure from regulators and shifting investor demands will continue to shape the industry, causing fund governance practices to change. “Alignment regarding owners’ vision is key,” says Mr Baumoel. “Owners working toward different visions will likely not be successful. The right PE investor can bring a compelling vision to a board to forge this alignment. The wrong PE investor can dilute alignment, fracture the board and disrupt corporate performance.” Going forward, the push for transparency will be a defining factor, with fees and performance calculations likely to be an important trend in fund governance.

Strong corporate governance has become an essential tool for managing and growing PE portfolio companies. By improving governance systems, firms can boost returns for investors.

© Financier Worldwide


Richard Summerfield

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