Private equity (PE) board members are unique among board members in general due to the fine line of loyalties and responsibilities that they must tread in discharging their duties. Highly valued on the board for the experience and insight that they offer, they thrive on the opportunity to influence companies much more directly than is possible for board members with public companies. Being a successful private equity board member requires strong personal integrity, drive and commitment, as well as the ability to wear different hats to balance the interests of all of the parties they represent. Here we look at how private equity boards vary from their public company counterparts and examine the “Five Cs” (responsibilities) of private equity board members. We’ll also look at how PE board members can safeguard against some of the pitfalls that are inherent in such a finely balanced role.
Katherine Woodthorpe, former CEO of the Australian Private Equity and Venture Capital Association (AVCAL) and private equity governance specialist, notes the results-focused nature of private equity boards: “There is greater focus on strategy and achieving goals in a defined period. The owner (the PE firm) has much higher expectations of the board and can be very demanding. A PE board can involve more work than a listed company board.”
The nature of private equity tends towards taking a shorter-term view of the portfolio company than would be normal for a public company board, as the private equity firm is focused on its ultimate exit strategy. As we’ll see later, this can cause conflicts of interest for private equity directors sitting on portfolio company boards.
Examining the greater success often achieved by private equity boards compared with their public company counterparts, Damien I. O’Brien of board consulting specialists Egon Zehnder notes that the board’s relative homogeneity has a role to play: “There is a powerful alignment of interests around the private equity boardroom table that is quite different to the public company board. Private equity directors have the benefit of representing a relatively homogeneous shareholder group; they have significant personal vested interests and clear risk/return expectations.” In public companies, the stakeholders are a far more diverse group with different attitudes towards risk and return.
“The five Cs” of PE board member responsibilities
In common with all board directors, private equity board members have a fiduciary duty of care and loyalty to the portfolio organisation on whose board they serve. However, in their case, they also have a responsibility to their employer, the private equity company. When serving on the board of a company that is part PE-funded, directors should aim to prioritise loyalty to the portfolio company acting as a representative of all of its shareholders, not just of the private equity company, insofar as this is possible. They must ensure that they stay well informed of the affairs of the portfolio company so that they can adequately and knowledgeably discharge their duties.
As identified earlier, serving on the board of a private equity company typically requires a greater commitment of time and resources than serving on the public company equivalent. To ensure that the duty of care is met beyond criticism, or indeed a legal challenge, it’s essential that directors commit appropriate time to attending meetings, reviewing board materials, researching strategic decisions and communicating with other board members outside standard meetings. It’s also important that there is evidence that the board member has fulfilled their duty effectively. Board communication tools such as portals and secure messaging systems can ease this burden and allow board members to liaise in a more resource-efficient manner.
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3. Conflicts of interest
The private equity board member is required to remain constantly alert to possible conflicts of interest caused by the different hats that they wear. These conflicts of interest can arise for several reasons, one of which is the disparity in favoured time frames and priorities between the portfolio company’s interests and those of the private equity company. As previously mentioned, private equity companies naturally work to shorter and more defined timescales than the portfolio company, which can generate a conflict when the short-term option under debate meets the objectives of the PE company, but not those of the portfolio company.
Further conflicts may arise for a director who sits on more than one private equity board when two companies’ activities converge. It may not be possible for the director to balance fiduciary duties to both parties, and a conflict of interest must be declared. Failure to do so could result in a breach of duty. Conflicts of interest represent a significant risk to PE board directors, and they must be alert and take protective measures to prevent themselves from being held liable for a breach.
To avoid these or other potential issues arising from the special position of a PE board director, it is vital that board packets are provided in good time for full review by the director prior to meetings and that those meetings are attended, as much as possible, in person. It is also essential that board minutes carry sufficient detail to fully document the decision-making process and prove the extent to which decisions were reviewed and discussed. Any conflict of interest must be clearly declared and recorded, and the director should withdraw from any material involvement in decisions where their neutrality may be compromised.
To ensure transparency, all communications between board members should take place on a formal basis and be documented to avoid doubt over the integrity of the process. Where possible conflicts of interest are identified, the board should consider using external consultants to provide third-party, independent counsel on key decisions.
4. Clear communications
PE board directors must ensure that their communications clearly state on whose behalf they are speaking when engaging with third parties. Are they representing the portfolio company or the private equity firm? The distinction between the two organisations must be unambiguous so as to avoid blurring the lines between them and potentially extending the portfolio company’s liability to the private equity firm.
As both board member and member of a PE firm, the director is privy to information that must remain confidential and must not be permitted to flow between the two organisations via an unofficial channel. The most obvious instance of this would be the director disclosing information to the private equity firm in advance of this being shared with other shareholders, resulting in the potential for insider trading.
The key to meeting many of the challenges that PE directors face is a strong separation of employee and director duties and the robust documentation and communication of all activities associated with the portfolio company board. With this separation in place, the PE director can confidently fulfil their roles of adding value and strategic insight to the portfolio company, while also satisfying the requirements of the private equity company that they represent.
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