GPs and non-execs: Partners through thick and thin

The logic behind private equity houses appointing non-executive directors (NED) and chairpeople is relatively straightforward: introducing directly accountable professionals who can provide strategic or industry expertise and act as a bridge between investors and senior management.

A 2015/16 report published by the European Bank for Reconstruction and Development studied the distribution of power in private-equity-backed company boards. The report found that around 40% of board agendas were determined by chairpeople, with around 12% set by NEDs and the remaining 48% determined by senior management. It stands to reason that the role of such board members is essential to implementing a GP's growth strategy in collaboration with management.

Mark Turner, Livingbridge

"For us, the relationship between the non-executive chair, the chief executive and the private equity house is very much a triangular one," says Livingbridge partner Mark Turner. "We don't work through a chairperson, we work alongside a chairperson and a CEO. It's very much a collaborative process."

Yet in 2016, UK think tank Tomorrow's Company published a report questioning the value of the non-executive director, arguing that the increasing prominence of the role can stifle growth. In particular, the report concludes that focus on governance reforms has grown in recent decades, placing greater emphasis on non-executive directors to protect businesses against excessive risk. The result, it is argued, is that the position often becomes more about value protection than value creation and reduces companies' willingness to take risks that could deliver stronger growth.

However, the introduction of non-executive directors has traditionally been seen as a value creator by private equity investors, especially at formerly family-owned firms requiring structural development in order to scale up. Furthermore, it can be argued that, while value creation is ultimately the name of the game, NEDs with a keen eye for risk mitigation often have an important role to play in an environment where environmental and social governance is becoming increasingly important to LPs.

Identifying risks
Reputational and operational risks can be particularly damaging to private equity investments, given that typical holding periods of four-to-six years do not allow much time for investors to respond when investments turn sour. GPs have certainly borne the brunt of controversies unearthed at portfolio companies throughout the years, in many cases through no fault of their own. The collapse of BC Partners-backed mobile phones retailer Phones4u in September 2014 called into question the management of the business, specifically its overreliance on a handful of partnerships and failure to respond to market trends. It can be argued that similar cases call for the involvement of board members who are removed from day-to-day operations and are able to identify potential operational risks.

If I was an MD of my own business I would certainly seek out a non-exec or two. Just having to report to a board monthly forces you to account for your actions and set out plans for each month ahead" – James Livingston, Foresight Group

Similarly, many would argue that directly accountable board members can be instrumental in turning around private-equity-backed businesses following unsavoury revelations. In the case of former August Equity portfolio company Funeral Services Partnership (FSP), the manner in which the board and private equity owners responded to media outrage surrounding practices at one of its subsidiaries went a long way to restoring faith in the group. Indeed, FSP's board, which included August-appointed members, worked closely with the GP in undertaking an extensive review and overhaul of operations, recruitment and training.

Despite concerns surrounding excessive risk aversion highlighted in the Tomorrow's Company research, another report by corporate finance house McKinsey & Company argues the private equity model is well suited to having NEDs on the boards of portfolio companies. In particular, the report argues, with slightly lower levels of governance than might be found at listed companies, it enables NEDs and non-executive chairpeople to take a more hands-on approach.

James Livingston, Foresight Group

Checks on power
Beyond the risk mitigation argument for appointing NEDs there are other benefits to doing so. "If I was an MD of my own business I would certainly seek out a non-exec or two," says Foresight Group partner James Livingston. "Just having to report to a board monthly forces you to account for your actions and set out plans for each month ahead. NEDs ensure a robust challenge when planning launches into new markets or acquisitions, recruiting senior staff, pursuing product development – they ensure you have really thought about your actions."

Indeed, the introduction of an NED or chairperson often extends beyond the function of providing a bridge between senior management and private equity owners. Often it can be crucial in providing experience and guidance to management teams looking to scale up their operations or the size of their teams.

"We're typically backing founder-led situations," says Livingbridge's Turner, "where you've got very interesting businesses with strong growth potential, but where the company needs to build out its operation platform and value proposition in order to take advantage of that potential." Turner says Livingbridge typically studies individual situations at prospective portfolio companies before identifying chairpeople with know-how and experience of "building great businesses" in similar situations. "It is a case of helping the company and the executive team, acting as a guiding light along the road ahead, someone who can say: 'I've been there, I've done that'."

Another quality NEDs and chairpeople can bring is an extensive track record within a particular sector, which enables a business to expand its network of suppliers and potential customers. Furthermore, such an introduction might often bolster a company's ability to expand internationally, a popular growth strategy for private equity investors.

Says Foresight's Livingston: "You can have industry experts as chairpeople and non-execs who have been in respective industries for 30 or 40 years, so-called black-book non-execs who can open doors to suppliers, customers and acquirers of businesses. Clive Jones CBE, who we introduced at [portfolio company] ProCam ran Carlton television, was a non-exec at GMTV and has been in the television industry for around 30 years. ProCam supplies cameras and crew for the TV industry across the UK and the US. He knows the market intimately and has helped with introductions to customers, as well as identifying acquisitions. More importantly he's helped in terms of developing the culture at the company."

While Livingbridge is more focused on appointing NEDs with situational experience, the firm also recognises the benefit of introducing sectoral expertise where appropriate, says Turner. "If we've got a great situational chairperson and there's something very specific about a situation that requires deep sector knowledge then we would be very comfortable having an additional non-exec. You can play sector and situation in different ways, either all in a chair or with a combination of chair and non-exec, depending on the requirements."

There is no one-size-fits-all method open to private equity houses when appointing NEDs and chairs to portfolio companies. But identifying the person best-suited to a given situation – and marrying that expertise with a strong management team – is a tool GPs will continue to use as a key element of growth strategies.

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