Importance of Private Equity Governance

Nicholas J Price
5 min read
The dynamics between private equity boards and management, especially in regards to private equity governance, are vastly different than the dynamics between public and private boards and their executive teams. McKinsey studied 70 successful private equity deals and found that the prime source of value creation in the majority of deals was the out-performance of the company. McKinsey attributes this to private equity companies managing certain acts of the business better than public and private companies. McKinsey's research also indicated that outperformance was primarily driven by a more direct and engaged form of corporate governance.

According to Egon Zehnder, an executive search company, private equity boards are more focused, decisive, engaged and results-oriented.

Overall, private equity boards are operating under the same scrutiny as every other board. The direct communication and pace at which private equity boards make decisions demand strict adherence to governance principles and a secure board management software platform for confidential board and management communications and file-sharing.

Private Equity Boards: A More Homogenous Group of Shareholders

The primary thing that sets private equity boards apart from private or public boards is that they represent a more homogenous group of stakeholders. Directors of private equity boards are either owners or representatives of owners, which gives them a stronger sense of personal ownership in their decision-making than public and private boards that represent a more diverse group of shareholders.

Private equity board directors tend to be highly focused and decisive, and their style of private equity governance is reflective of that. They have clear expectations of risk return and on their timelines for investment.

Private and public boards of directors can't rival the powerful alignment of interests that exist in a private equity boardroom, where board directors of private equity companies have personal vested interests and expectations for clear returns.

Focusing on a Few Simple Objectives and Measuring Them

Private equity firms don't waste time muddying the water with the details. Having a more consistent group of shareholders allows time for a greater focus on a few, simple, measurable objectives that shape the board's agenda.

Private equity board directors are noted for their adeptness at holding executives accountable in clear, unmistakable ways. Board directors have no fear about asking the hard questions about performance variables and probing management in great detail. They're not likely to accept vague or unsupported answers. The relationship they have with executives tends to be direct and to the point. In this way, they're able to get concise information quickly, which allows them to act faster.

Private Equity Directors Are Forward-Looking

Private equity board directors are more likely to look forward and unlikely to look backward at all. They won't get themselves bogged down by the company's history or by previous performance data. Private equity board directors are better known for setting bold, new expectations right out of the gate without regard to previous performance.

Boards and managers of private equity companies are results-oriented. They spend their time collaborating on innovative ways to free up capital, increase productivity and promote growth. Some companies are willing to go way outside the box with their thinking and strategizing. The most outrageous ideas are not only considered, they're often implemented.

Communication Is Bold and Direct

Communication between private equity board directors and executives is pretty casual. Their debates are robust, focusing on key metrics. There's usually much disagreement and debate on key points, but board directors are able to agree by the end of the meeting and quickly move forward. It's common for private equity board directors to visit the operations in action and have chats with staff.

The chairman or chairwoman of the board almost always has a close working relationship with the CEO. The closeness of their relationship allows for immediate feedback. Public and private companies usually have a more formal style of communication with respected boundaries.

Independent Board Directors and Private Equity Boards

In all other types of industries, the governance expectation is that boards will be largely composed of independent board directors. To have independent board directors is less common in private equity firm boards.

Recent developments in the private equity market could soon change all that. It's long been believed that independence in the private equity boardroom simply wasn't needed. Investors' requests for independent board directors for private equity companies have largely been ignored.

Under new leadership, the Securities and Exchange Commission (SEC) is taking a stronger stance over governance issues related to private equity firms. The industry has long lacked transparency. The SEC has pursued actions against private equity firms because of not stating their fees and expenses, unlawful shifting of fees and expenses, and conflicts of interest related to fees.

Independent board directors could be the key to ensuring that companies are following good governance principles, that they have the proper procedures in place and that the firm is following them. The appointment of independent board directors in the future could end up being a real asset to managers.

Also, as hedge funds struggle to deliver the strong returns they once did and investors are increasing their allocations to private equity funds, investors may demand the same level of independence to which they've been accustomed.

The governance style of private equity boards may have some lessons to teach boards in other types of industries and vice versa. Private and public companies may benefit from a more focused, results-oriented board philosophy, whereas private equity boards might benefit from a more formal, transparent governance style. Perhaps we'll see some sort of melding of the two governance styles at some point in the future.

In either case, the style of private equity governance and public and private company governance requires the support of a highly secure board management software solution by Diligent Corporation. Diligent Corporation provides all the modern governance solutions to handle the many changes that are occurring in corporate governance. Modern governance requires secure communications and file-sharing. Board directors need the ability to access all documents and board materials any time of day or night and have mobile access to them. Diligent is the modern innovator and the number one solution for modern governance digital board management tools.