Navigating boardroom dynamics
Pay close attention to finding the right fit
Even though they grab most of the headlines, activist shareholders aren’t the only shareholder groups that nominate directors. It’s far more common for public and private company boards to have directors that have been nominated by private equity, venture capital and other external investment organizations. These investor groups often negotiate, coincident with their investment in a company, the right to appoint directors to the board, often in proportion to their investment. These ‘sponsor directors’ or ‘representative directors’ may have different investment timeframes, monetization plans, rate-of-return requirements, and/or strategic interests than those of management and the company’s independent board members. And the convergence of these varied interests can breed complex boardroom dynamics.
Mark Dorman, managing director of private equity firm Endeavour Capital, and Scott Hobbs, who presently serves on the boards of Enable Energy Partners and SunCoke Energy Partners, shared some practical advice with me on how they’ve navigated these potentially intricate boardroom situations.
Hobbs has served both as a representative director and as an independent director, elected by public shareholders. Dorman has served on many private boards and one public one, always representing his firm’s investment in the organization.
Both Hobbs and Dorman agreed that the primary responsibility of any representative director on a board is to do what is right for all shareholders, not just those of the sponsoring investment firm. Nevertheless, questions arise about how directors balance the potentially different timeframes of private equity investors versus those of other shareholders, arguing that some private equity investors are considered “wealth destroyers” since their timelines and their habit of “cutting flesh and not just fat” can often upset the long-term strategy and culture of the company. Neither Dorman nor Hobbs denied that there are examples of short-term thinking by private equity and venture capital investors, but Dorman in particular countered that companies have a wide-range of investors to choose from, each with different cultures, time horizons, growth philosophies and skill sets. For example, Endeavour plots a minimum seven-year hold with the idea of using the first three years building strength and structure with the last four years fueling growth. Selecting the right equity investor, who can complement and enhance management’s strengths, is key.
Both Hobbs and Dorman also argued that external investors and their sponsor directors can bring access to capital markets, sophisticated financings, strategic modeling skills, benchmarking and peer looks, and a variety of other helpful attributes to management. Hobbs noted that these “behind the bench” tools provide benefits not just to company management but to all of its directors as well, since they are a way of providing greater resources to key corporate decisions, often paid for by the private equity or venture capital firm.
In response to questions regarding what Endeavour looks for in selecting directors for companies in which it invests, Dorman responded that his firm seeks out both seasoned firm partners with appropriate industry backgrounds to serve on portfolio company boards but also veteran CEOs who are done growing their own businesses and are able to bring “grandfatherly” maturity to a board – without being overbearing.
Instead of taking board seats, sometimes sponsor investors choose instead to have observation rights. This has the potential to create a non-traditional boardroom dynamic. As an observer for private equity firms on boards, Hobbs’s advice is to pick the spot where your advice will have the most influence and where your observations have the greatest impact in mitigating risk and maximizing opportunity, leaving all other board deliberations to those with votes.
With regard to when and how sponsor directors should recuse themselves from a board vote, both Hobbs and Dorman suggested that these board members should do so not only when there might be a benefit to the sponsor from a decision, but when there is simply a perceived benefit as well. As important as the recusal itself, stated Dorman, is the sponsor director’s willingness to suggest to other board members that there could be a possible conflict of interest.
How involved should directors – including sponsor directors – be in recruiting, promoting and severing management members? Both Hobbs and Dorman were emphatic: boards should be focused on selecting and evaluating the performance of their CEO, and then incenting him or her to choose and lead good talent. Dorman cited several instances when sponsor directors can be resources to the CEO in recruiting management talent, but they should advisors, not instigators, regarding hire and fire decisions beyond the CEO level.
In summary, growing companies looking to develop a relationship with a private equity or venture capital firm should pay close attention to finding the right fit. Their investor-sponsored directors can add great value, and ultimately create win/win outcomes for their businesses, but vigilance regarding a number of unique boardroom issues is imperative for both sponsor director and independent directors.