Portfolio company boards: Gurus wanted

Given PAG Asia Capital closed its third pan-regional fund at $6 billion last year, it seems odd to suggest that the firm’s recent investment in Australian restaurant operator Craveable Brands might risk spreading limited resources too thin. Still, the acquisition, said to be worth up to $350 million, could end up doing just that. 

Lincoln Pan, a partner at PAG who sits on six portfolio company boards in five countries, is keen to take on his seventh such position with Craveable. The move would play nicely against his directorship at Sydney-based cake retailer The Cheesecake Shop. But it also highlights a growing problem in private equity around how to get the best people onto boards when talent is finite and portfolios are getting larger and more international. According to a recent survey by the Global Network of Director Institutes, 47% of respondents currently fill three or more directorships or governance roles. 

“Being a good board member isn’t just showing up and reacting – there’s significant prep work for meetings, and the real work usually gets done via intensive engagement with management in between meetings,” says Pan. “When there is a large M&A, refinancing, restructuring or exit, the board work becomes nearly a full-time job. There is a limit though on how many boards senior GP executives can be on, so more and more, we look at former colleagues or executives of portfolio companies to represent us on boards. But it’s a delicate process – these individuals need to have a certain DNA and humility.” 

For PAG, this means a focus on bench building and engaging outside technical people with high EQ who can motivate management without trying to take the credit of the company’s success. But with so many variables at play, no GP has quite cracked the formula for this process. The most glaring missing ingredient on a board is often sector-relevant skills and networks. However, even if an expert is brought in with specific and much-needed expertise in an area such as supply chain management, the knowhow is not necessarily transferable to a new situation in a new company. 

Jack of all trades

Part of the issue is also the diversity in expectations around board members. In addition to bringing technical knowledge and decision-making support, they are by turns required as connections to parallel industries, watchdogs for minority shareholders, confidants to founders, cheerleaders for fundraising, arbiters of in-house disputes, mentors to junior board members, and socially tactful company ambassadors. At the same time, GP-nominated board members serve the interests of both the fund manager and the CEO, adjusting their priorities appropriately at each stage of a company’s lifecycle.

“The board member role is the key to success in portfolio companies,” says Alain Deniau, a Singapore-based partner at Heidrick & Struggles who specializes in helping fund managers make middle-market board appointments. “It’s extremely important to choose one or even two people who can be a bridge between the private equity side and the family or management side. Finding people who can really understand the deal and the operation of the company is difficult, and a lot will be on their shoulders, but it’s the most efficient way to avoid friction.” 

GPs typically rely on recruitment consultants to fill management positions, leaning on tools such as psychometric tests. But filling board seats is a more nuanced game and therefore usually handled in-house. If a GP has a large database of contacts, this can be done fairly quickly and indeed is often a prerequisite for any formal investment proposals. If there is no one waiting to take the post, a selection process can take months, if done properly. 

Best practice here includes an initial contact by phone to confirm basic relevance, experience and interest, with an informal in-person follow-up, perhaps lunch or dinner, sometime later. Another more formal face-to-face should come next as a way of checking if the candidate has done any homework on the company – a key test of motivation. Three such meetings in three days will not work. Time is needed to digest personalities and confirm the fit. 

Culturally, the balancing act is between the relatively short timeframes of private equity and the less bounded vision of ground-level business players. Board members must be able to create alignment when entrepreneurs need money for plans that would be logical and fruitful down the track but irrelevant within the GP’s horizon. From either party’s perspective, the main risk is that the CEO will get frustrated or demotivated, jeopardizing the outlook of the company. And as board selection becomes more difficult, alignment will be a deeper issue for stakeholders beyond the GP-CEO axis. 

“We always want individuals who are able to provide value, but in minority situations, expertise is not enough. You have to be able to influence and persuade the majority shareholder on the board,” says Wen Tan, co-head of Asian private equity at Aberdeen Standard Investments. “As an LP and co-investor, we do try to advise GPs to get this mix of skillsets on the board because, even in a situation where you have control, gravitas on the board is needed to make sure management is paying sufficient attention to the advice being given.”

High-profile board members that fit this description are especially desirable when fundraising is a priority or when it is difficult to attract the favor of a company being courted by several competing investors. But there is a school of thought that board member star-power has its drawbacks. If reputations are not on the line, there may be little incentive to add value, as well as a tendency to veer toward second-guessing or micromanaging the CEO. Few scenarios are more damaging to the morale and productivity of a quorum. 

Money matters

Risk factors around motivation are further aggravated by the question of remuneration. The rule of thumb for paying for advice and guidance is that the compensation should be balanced, rather than weighted too heavily toward long-term upside. If a GP puts in an external director, the incentive program should be the same as it is for management. When board appointments are made from within the GP, best practice is harder to define. PAG handles this by not providing payments to members of the GP when the serve on boards beyond their normal compensation. 

Other pitfalls include the possibility that a CEO does not demand strong autonomy and readily takes advice whether it’s good or bad, as well as conflicts of interest among board members, perhaps related to separate business activities. Many of these issues are likely to be amplified in developing Asia due to the prevalence of minority stakes and smaller, less experienced boards, which puts pressure on making the right choice for representation. To make talent scarcity issues worse, Heidrick’s Deniau says that the time requirements of Asian mid-market PE mean the best appointees are already out of the game.  

“You need someone who can have several formal boards per year plus do consulting in between, so we’re talking a few days a month or more,” Deniau says. “Basically, it has to be a retired person who is willing to be on the non-executive side of the business. If you hear somebody is very quickly setting up his or her own consulting firm, that may be a red flag. I think most people are honest when they say they want to be non-executive, spending more time with family and playing golf. But once they’re in the boardroom, they’re unconsciously back on the executive side.” 

Private equity firms will naturally find many more people who reflect the non-executive retiree profile outside the GP than within it. Many of these people will be ex-CEOs, seen as familiar enough with deal dynamics to communicate with financial professionals but also close enough to the factory floor to be respected by entrepreneurs. Sourcing board members from outside the firm will require significant time checking references, however, unless the appointees are former partners and colleagues of the GP, who already understand the firm’s culture and investment objectives. 

Directors sourced from outside, meanwhile, will require a learning period to ensure alignment, and they may face other, growing challenges. As GPs delve increasingly into deep tech investments, they will find it harder to access networks of relevant talent, unless they are sector-focused investors with existing connections in the relevant field. In highly technical areas, generalists will have to make sacrifices around personality when choosing board members in order to access the right industry-level expertise. 

Solutions for this situation vary, but they will all have to recognize that even if the personality fit is realized, transitioning from good executive to good board member is not often smoothly achieved. Expertise in both financial and industrial matters can be developed, however, and investment partners joining a tech board can be partnered with an operating professional who will take over the asset in the longer term. 

“It’s a dangerous proposition to immediately outsource the governance and board responsibilities of a transaction to someone who was not involved in the deal because the CEO or founder usually expects the deal lead to stay involved.” says PAG’s Pan. “It’s a core responsibility of the GP to build the CEO or founder relationship. Some GPs hire experienced [multinational corporation] executives to lead governance, but the success of this model is hit-or-miss. These external executives must be totally aligned with the GP’s exit strategy and time horizons and have the emotional intelligence to coach executives and not boss them around.”

People power

All this recalls the industry chestnut that PE is a people business. The nuanced work of board member selection is therefore widely expected to be the last aspect of the industry to be automated. But that is not the perspective of Partners Group, which has brought a distinct technological edge to its hands-on board construction process, internally called “entrepreneurial governance.” The firm is now using a data-driven tool that is said to provide qualitative and quantitative assessments of board effectiveness by digitally isolating personal strengths, weaknesses, and misalignments over the course of an investment. 

“The right board set-up in the first year might not be the right set-up 4-5 years down the line,” says Christian Unger, a co-leader of Partners Group’s operating directors and entrepreneurial governance unit, who currently sits on four portfolio company boards. “The tool gives us a unique opportunity to apply a disciplined and rigorous approach to board evaluation in order to identify gaps and facilitate knowledge exchange among board members with the ultimate objective of maximizing the value they can add to our portfolio companies.”   

 

SIDEBAR: VC – Observers only? 

Many of the generalizations that can be made about GP board appointments in private equity extend into venture as well, but only to a point. Indeed, many early-stage companies have ceased to even consider offering VCs board seats and there’s little protest on the issue. Also, early-stage investors are more likely to have portfolios in excess of 20 assets, which can stretch resources beyond reason. 

Jack McQuire, a partner at Icehouse Ventures who has sat on four portfolio boards in the past two years, says his firm still sources most of its appointments from the high net worth individuals in its LP base. But as Icehouse has institutionalized out of its angel network roots, a community-driven style based on unpaid board support from local businesspeople is starting to gel in interesting ways with the more professional and premediated approach of a bona fide VC.  

“One thing we’ve been exploring recently is getting new founders to be observers for our later-stage companies, so they can see what a good board operates like and have a reference point,” says McQuire. “In an ideal world, we would want the more experienced directors on boards, but we’re pragmatists, and you have to give people a shot. So, it’s not just top-down, it’s bottom-up.” 

Closer to the seed stage, board influence becomes a rather unique affair, sometimes calculated by proxy representation via directors who happen to have the same class of shares as the VC. Observer seats are often preferred because they are considered less legally exposed than directorships and therefore more suited to higher-risk assets.

If things really get litigious, however, this safety net could easily break down. Vishal Harnal, a partner at 500 Startups who rarely joins boards, jokes that he can be more helpful to start-ups with a “WhatsApp board seat” that makes relations less official but perhaps more impactful.

“Ninety-five percent of observers on boards are silent on the sidelines, but they can throw out opinions and that’s a powerful thing because it precipitates discussion in certain areas,” says Harnal. “I take observer seats to understand new investors coming into the region and onto the cap table, their behavior and how they align themselves. Also, if you don’t sit on the board in a formal way, you get a much more honest assessment and appraisal from the founder about how the company’s doing. It totally changes the dynamic of how founders interact with you.” 

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• Topics
• GPs
• Advisory
• Asia
• PAG
• Aberdeen Standard Investments
• Partners Group
• 500 Startups
• Appointments