Panelists Discuss Board Engagement at PEI UK Conference

Stanton Chase Managing Partner Çağrı Alkaya Moderates Talk

How can companies generate intense value creation? The best way is through Board engagement, according to a panel of experts who spoke at the PEI UK (Private Equity Insights) Conference on September 12 at the Grosvenor House JW Marriott, London.

Panelists Richard McDougall, a Partner at Cabot Square Capital; Owen Li, a Principal at Investcorp; and Werner Schnorf, a Managing Director at Patrimonium answered questions and offered insights about the strategic and operational role that Boards have within a company.

During the panel discussion, titled “Board Engagement: Generating Superior Returns through Board Engagement,” the three participants focused on the importance of selecting the right Board members — strategic thinkers with the necessary experience, expertise, and vision to successfully guide a company in today’s fast-paced market. Çağrı Alkaya, a Managing Partner at Stanton Chase, moderated the panel.

The participants discussed the critical role Boards have in making executive management appointments, actively engaging with the C-Suite, aligning with the management team, and spotting potential issues ahead of time. They also spoke about the importance of diversity in improving a Board’s performance, while noting that the candidate pool can sometimes be limited.

Following is a transcript [1] of the PEI UK Conference panel discussion.

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Where does putting a Board in place stand when you first undertake plans, and what’s the approach to the Board’s contribution?

Richard: We take a relatively long genesis for measurements for investments in the first place, which is typically because the types of businesses we are investing in are going through or intend to go through significant business model changes, infrastructural developments, and so on. So, we spend a lot of time prior to the actual execution to analyze the needs and issues to understand and work out the business plan. Because of that, we tend to spend quite a lot of time understanding the core capabilities within the existing management team as well as understanding where the gaps exist within the organization. We normally know quite quickly pre-transaction which members of the existing team will sit on the Board and the needed expertise to complement their core capabilities.

Owen: The PE market is increasingly competitive. Therefore, we normally do some market work before the start of a sale process of an asset we like. We try to gain an understanding of the size of the market and the business’ current market positioning early on. For example, looking at the digital marketing industry, we have to bring in a domain expert with us going into a deal in the space. Such an expert would likely be an ex CEO of a business in the space. We get to know the expert, the expert gets to know us, and he/she gets to know the management throughout the DD process. Because these people already know a lot about the space and have valuable expertise, they are candidates as Board members post acquisitions. We actually tell these advisors that if they do well for us, they will help us on the Board. As they familiarize themselves with the business, and they can help us create the investment thesis, help us identify the shortcomings of such a business and how to transform it. Moreover, we are in a people business. The fact that they know us and the management team already enables everyone working better together. When needed, we will also bring in additional experts to be on the board as non-executive directors.

Werner: The core of the Board is in place when the transaction is finalized, along with the PE members. During the transaction period, we would headhunt them from outside, and these candidates will have a chance to meet the management, get some exposure, and ensure that they can work together. Secondly, we would discuss their vision because we have to have an alignment of interest. We would also ask them to invest private money in the company at the same as we do if they are going to be a Board member. We would like for them to provide a written explanation detailing what they can contribute to the Board and why they would excel as a Board member.

In the competition we described, how do you ensure diversity of opinions? How do you ensure you have people with an independent perspective who would say no to certain thoughts and decisions coming from the PE to ensure an independent view of the business?

Werner: We, as the majority owner, have the responsibility of the company toward the investors. So we are not independent. Our duty is to ensure and make the company work. One way we ensure good Board members is by navigating through any problems and networking. We always have one or two soft, independent Board members — we headhunt them, and they don’t know us. These are people who are not from our larger network.

Richard: Fundamentally, we want to ensure impactful decision-making. Rather than having an independent view, you need to have a good decision-making process. In order to have that, we make sure that potential Board members have the right mix of functional skills and background. They also need to have experience sitting on a Board in that decision-making capacity to make sure we provide the necessary challenges. We approach things slightly differently. Typically, we don’t use non-executive directors. Most of the time, the Boards are made up of the executive management team in the company and probably two members from the PE. Because we are so sector-specific, we like to think we are deeply specialized in the sector, and we quite often build our own line of the business if it’s about revenue. We try to make sure that the decision-making is impactful and quick. We think making decisions in a board meeting is almost too late — it’s important to make decisions earlier because you are in constant dialogue. Members of the executive committee should have functional expertise and particular capabilities, and the skills of non-executives should not be used as a substitution.

There is a distinction with strategy-level decisions, which often take a period of seven months. The way we structure the organization is to have two members of the PE work full time with the company. Therefore, Board meetings will be for verifying the decisions.

Werner: Interactions between the Chairman and the CEO is much more important, and also the chemistry between the Board and the Chairman has to work. For smaller companies, you have to be quite hands-on in management — even sometimes in daily work, not just in strategic work. We would still like to sit for a strategic discussion. Also, once every year, we have a six-page questionnaire in which we evaluate how the Board is working, how we think the Board is working together with the management team, how the CEO and CFO are doing, and how the Board is performing as well. And the information from the questionnaire would be discussed with the Chairman. You have to make sure that you work together. It is important to be hands-on and have involved Board members who are there not just to create tactics but also strategy.

Owen: Our board meetings never have a big focus on current trading. We see this as an inefficient use of the board meetings. Rather, we focus board meetings on strategic initiatives and how these initiatives fit into our long term plan. For example: should we expand to other geographies, launch these products, or make an add-on acquisition because of an adjacent opportunity or because of the changes in the market? We find that this is the best use of our time in board meetings. We have a dedicated session, outside of the board, with the CFO on a monthly basis to go through the financials in details.

What about strategic HR decisions? How much of a say does your Board have on the CEO and CFO appointments, and how closely will it mentor and coach them? Also, how closely will Board members work with them outside the Board?

Werner: We have the same rule here, which is that the Board has to approve of the CEO. So the Board is part of the search. And every direct report of the CEO also has to be approved by the Board. We typically delegate two Board members who would evaluate those reports — it is quite intense. It is important that the Board stands behind the appointments because it is a team effort. The Board members have to feel good about and approve of the people they hire.

Richard: It is interesting, and I guess there is a fundamental philosophical difference here about how we think about this process. To some extent, we see that, in certain terms, operational impact and the strategic decision is completely in synch with each other, so they are likely to have a significant overlap. Also, we want to ensure the closeness of the PE with the company, so we often don’t post a Chairman in between. And often a Chairman can create distance (although there are a lot of positive reasons to appoint one as well) and has a negative impact on the relationship between the PE and the company. So when we think about strategic HR decisions, quite often when we go in, we would be backing the existing CEO and working with the team around strengthening the executive team. And quite often, to the extent that we conclude the business is developing in such a way that it can grow two or three times larger than where it is now, we make decisions around what the right constructive executive management and Board would be when it’s time to sell the company to the next investors. It is almost never a conflict-led change. We typically don’t hire external directors — we think it is valuable that the CEO or the management team goes through the journey from the beginning, and that’s why we think about certain situations like how you enable an existing entrepreneurial CEO, how to help that person manage a bigger business, etc. So that is the coaching piece, whether solved by a Chairman or otherwise. It is a question that needs to be addressed with the Board and PE closely working with the management team.

Owen: The Board has to be involved with the C-Suite. They have to get the Board’s approval. Sometimes, for really important functional C-Suite executives who have a special expertise, it is crucial to make sure that everyone is on the same page. In every board meeting, we invite functional C-Suite leaders to come, on a rotation basis, and present their functional departments, see how they are doing, and discuss KPIs and how to improve their departments. This is also a motivational tool for the C-Suite executives as they get exposure to the Board.

How do you make sure that the CEO and the executive team get the right partnership and input from the Board to run their operations effectively?

Werner: It depends on the Board and the C-Level executives. For us, they are one body, strongly influenced by the PE delegates. The execution team is the Board. So when something is wrong, you should ask the Board, not just the CEO. When the Board has a large network, it is much more advantageous and cost-effective to bring in the right advisors when necessary. During the first 100 days when the team is being built, especially when you have a highly experienced CEO, you have to think about how closely involved you should be in decision-making process because, although it is a team effort, the CEO is the leader and is in a critical position.

Richard: Execution can break down when there is a disconnect between the Board and the execution team both at a strategic and tactical level. This can be a big problem when it comes to technology. For example, often very experienced CEOs and CFOs have little understanding of the technological end of a business, and this is where you would bring in a CTO. The way we try to deal with this issue is to have our in-house CTO work with the team. Therefore, we are involved both at the strategic level and the operating level, which lets us bring the whole team together without having a disconnect.

Owen: Like what Wener said, we have a board where most of the strategic discussions take place and action items are decided. There may be additional interactions with the CEO outside of board meetings to bounce ideas on the details.

How does the CEO make use of the Board?

Werner: If the CEO is comfortable, he will approach the Board and the Chairman, and he would also specifically use the Board for network contacts. The key elements are for the CEO to be in constant contact with the Board, and to able to speak up to get help and support from the Board members when needed.

Owen: This is about the core effectiveness of the Board. If the CEO is not reaching out freely, I would question the Board’s ability to communicate effectively. It is your responsibility to bridge that gap.

Richard: I agree with what Owen said.

How do you assess and monitor the Board’s performance — such as, when the time to make an impact is too short and when you don’t have enough time to observe the changes you made?

Richard: What is paramount is monitoring the performance constantly and qualitatively. You must constantly evaluate how the business is performing against the plan and forecast and if the Board understands when there is underperformance in certain areas. It is important for us to be deeply involved in understanding those issues. Because of the quick decision-making needed, leading through panic is very important, and it is important to understand and analyze any problems correctly — where they are coming from and what the leadership thinks about changing the CEO, etc. Qualitative monitoring is more about thinking through and understanding the delivery of the operation and its limitations — this is more subjective and on a case-by-case basis. But ultimately you need to rely on the rest of the Board and executive team to be somewhat aligned. If there is a necessity to replace a member of the Board or executive team, typically the need comes from the team members themselves, and they would point out the deficit. That’s where our position as PE would be to provide assistance and control that aspect of the business.

Werner: We do a once-a-year assessment of the Board to allow the Board to access itself. Those assessments are quite clear and transparent as they have to be provided in writing. Of course, when the performance is not good, you have to change a Board member. But changing a Board member is difficult and you would not want to do it. This assessment also helps the Board to get better and better. We try to measure and get a handle on how the Board works as a team — as a supportive unit. Everyone should be comfortable. As we have quite diverse Board members who could give different views, it is important that members are able to voice their opinions. It is the same process when we judge the CEO — there is no difference.

Owen: I find it difficult to assess quantitative measures against a board member’s individual performance because there are not any effective KPIs like the number of ideas generated by one particular board member, unlike the performance of the management team. But we have let Board members go in the past. Usually, that was because of poor attendance record or they participated but did not say much. The best Board members pro-actively find you if they have something to say. And often you can see the level of engagement and value of each Board member by speaking with the CEO or the other members. The consensus does not lie. Some people will just collect ideas, and unfortunately, that is just not enough.

Diversity has been a driving force of excellent teams. Is that something you value?

Werner: Yes, by nature, of course, the Board has to be diverse. We don’t try to stress it in particular, but my experience is that the more diverse the Board members are, the better the Board will be. But it is quite difficult because it is mostly a male-dominated economic environment.

Owen: Unfortunately, the diversity of the candidate pool is limited. There are limited female candidates. However, I expect that to improve over time. Nevertheless, diversity also comes from a candidate’s background in terms of expertise and experience, so we tend to focus on that as well to see what is needed to turbocharge the business. PE has a big responsibility toward providing the capital, but it is also important for PE owned companies to be diverse.

Richard: It would also depend on the industry of the portfolio company. Although in three of the Boards I sit in, the majority of operational industry positions are led by women. The key thing is that you are now ending up proactively countering diversity, and you have to make sure you approach the situation with non-prejudice. Also, there is a lot of positive movement coming down from LPs, who are looking at GPs and asking questions about diversity. These are considerations that we have to think about.

What is the optimum size of a Board?

Werner: The size of a Board is important to consider and it has to be relevant. We think three is the minimum and six is maximum. The best scenario would be four or five members.

Richard: Probably four is the average size of a Board, and the maximum is six. If you have more than six members, they become focused on presentations, not conversation or engagement. You don’t want a Board to be too small because it would not give enough exposure to strategy.

Owen: Depends on the size of the company and complexity. If I look at our boards, 5 is good size. Having an odd number means that there is always a majority in every decision. In some countries like the Nordic ones, you have to include employee representatives, which means you have bigger boards than in other countries but that is ok for us. However, bigger does not necessarily mean better, if some members hide behind the seat and do not contribute.

How do you incentivize the Board members and the Chairman?

Werner: The Chairman gets double and usually receives an exit bonus. Everybody has to invest money, and they make money in exit. The Chairman usually has extra work in exit and is crucial in motivating the management team, so he gets a certain extra bonus, which could be $100,000 to $400,000.

Richard: We pay with a return on investment. What we want to achieve is the best possible transparent alignment — with fair payment to all executives.

Owen: Our boards consist of our PE firm colleagues, management and one or two industry experts. Only the industry experts are paid a small salary. Everyone is encouraged to invest in our businesses so they are incentivized this way.

[1] Note: This transcript has been edited for clarity and does not reflect verbatim speech.