Being asked to join the board of a portfolio company may initially seem an honor, but PE investment professionals and operating partners need to go into the role with their eyes open. Regulatory scrutiny of PE-backed firms is increasing at the same time as LPs are demanding greater transparency on non-financial matters as well as more participation in governance matters at the portfolio level.
In this note, we get the perspectives of Charlie Chipchase, Head of Petra's Private Equity ESG Advisory Services Group, Nate Lankford, Head of Miller & Chevalier's Business & Human Rights Practice, and Sandra Hanna, Head of Miller & Chevalier's Securities Enforcement Practice, who set out what they see as some of the key practical pointers PE executives should keep in mind as they take up board positions on their firm's portfolio companies.
- Know your duties. Understand and fulfill your
legal and fiduciary duties. This includes making decisions based on
careful analysis and considering long-term value creation. The
approach may differ depending on geography, and whether your
company is public or private, but any new board member should see
this as an absolute must. Also, appreciate that laws and
regulations change, and what may have been the norm the last time
you sat on a board may no longer be valid. Read the company's
by-laws and any other relevant document (e.g., shareholder
agreement) and appreciate how they work in practice. Get a lawyer
or current board member to walk you through key points of the legal
plumbing so you understand, for example, what constitutes a
shareholder or board decision and where conflicts of interest are
likely to arise (more on conflicts below).
- Understand the macro...but dominate the micro.
Be attuned to the macro/market risks and opportunities your company
faces but look to take ownership (often by committee participation
or otherwise) on a certain governance aspect and work with the
management team to ensure you know what they know. For example, you
should have a 360° understanding of the company's financial
health, tax strategy, and management's roles/compensation, be
apprised of upcoming governmental/regulator interactions, debt
capacity, and threatened or actual litigation. Don't blame your
lack of understanding in some of these areas on your other
responsibilities at GP level. Make the time.
- Turn up and engage. Turn up to each board
meeting on time and be prepared. Spend time with management and key
employees. Don't take on more board portfolio seats than you
can realistically handle. Don't be the silent board member
– challenge where necessary. An effective board will have
open and respectful conversations to get the best results. The
boards that develop a culture of healthy challenge among board
members and the senior management team make much better decisions
as they test assumptions and the information presented to
them.
- Prudent conflict management. As a board member
your PE firm has nominated, your role is critical in providing
oversight, strategic guidance, and risk management and contributing
to the success of the company and, hopefully, better returns for
LPs. It can, however, be difficult to compartmentalize your role as
a representative of your firm (acting as a steward for your
LP's capital) and your role as a board director (who may owe
duties to more than just the company's ultimate shareholders).
Issues start to arise when the interests of the fund and portfolio
company diverge (e.g., on material M&A, insolvencies, or
litigation). Risks are mitigated here not simply by calling the
lawyer but also by a board member understanding how and when
conflicts may arise and putting in place systems or personnel to
address them early (e.g., independent board members, special
committees to evaluate potential transactions, independent
valuations, etc.).
- Risk management and compliance. In
understanding your duties, it is most important from an ESG
perspective to recognize that you are personally responsible for
ensuring that the company has an effective compliance program to
address applicable laws, regulations, and industry standards. In
practical terms, this means you must understand your company's
risk profile – for example, whether you face significant
risks of bribery, money laundering, or adverse impacts on human
rights – and the key "hallmarks" of an effective
compliance program, such as an appropriate management
culture/'tone from the top', written policies and
procedures, periodic assessment of risks, training, among other
tried and true best practices. To achieve this understanding, you
should require company management to regularly report on processes
to address key risks and related metrics, and 'pressure
test' management's implementation of the compliance
program. For example, you may ask how root causes of specific
issues are being addressed, how the effectiveness of program
components is measured, and whether resources are sufficient to
support compliance program components. You may also test crisis
management systems – for example, how would the company deal
with an environmental issue or a cyber/data leak? Most importantly,
however, make sure that you challenge management on its ESG
assertions, and that you have a reasonable basis to believe that
disclosures to stakeholders about ESG matters are as accurate as
the financial statements.
- Understand and communicate with key
stakeholders. Pay careful attention to the "S"
in "ESG." Make sure management is committed to a culture
of integrity and responds promptly and appropriately to violations
of the code of conduct. Consider requesting time with HR
professionals and learning more about the trends they are seeing in
worker morale and the kinds of complaints they are receiving to
better understand 'the buzz' at all levels of the
organization.
- Don't neglect the power of ESG as a potential value
creation tool. Consider and ensure ESG considerations are
integrated into the company's strategy, risk management, and
decision-making processes. Depending on your company's
industry, strategy, fund, location and size, orient yourself of the
ESG risks and opportunities, appreciate what's material to the
company, and ensure the company's policies and initiatives are
in step with your firm's ESG objectives/KPIs. Look for those
"quick [ESG] wins" that can be achieved in the first 100
days of ownership as well as the more medium/long-term goals.
Ensure that external reporting is handled diligently and is
defensible and accurate.
- Board reviews. Well managed boards carry out a
self-assessment at least annually and have it externally
facilitated every three years. It's a great way of reminding
everyone of their roles, reflecting on what's going well and
what's not, and agreeing on the actions needed for further
board improvement.
- Be proactive on succession. Having fixed terms
of office and regular board turnover aids better decision-making,
avoids groupthink, and introduces fresh thinking and new opinions.
Include deal team VPs and associates (and GCs/CCOs when necessary)
in all board meetings so they are ready to step up as they make
their way through the firm.
- Personal liability. Finally, understand your personal liabilities and when the board may need a separate legal advisor (e.g., in a restructuring scenario or for investigations involving senior management) and, as obvious as this may sound, lock in D&O cover from day one with appropriate run-off cover.
Regulatory bodies, industry initiatives, and investor pressure have played a significant role in driving the adoption of strong governance practices within ESG frameworks. Laws requiring due diligence and public reporting on ESG topics are proliferating globally, and many stock exchanges and financial institutions have also introduced ESG reporting requirements and guidelines to encourage companies to disclose relevant information and improve governance standards.
Overall, governance in ESG focuses on ensuring responsible, ethical, and sustainable practices within organizations, integrating environmental and social considerations into decision-making processes, and fostering transparency and accountability to stakeholders through accurate disclosures.
You will find no statues of boards in any city, but on the premise that effective boards are often greater than the sum of their parts, some basic tenets can help you be a very effective board member and help drive better decisions and ultimately better risk-adjusted returns.
Originally Published by PETRA FUNDS GROUP INSIGHTS
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
