The boom in private equity and its impact on global investment markets has had much attention. Less considered is the sector’s rising influence on corporate governance.
Dr Katherine Woodthorpe, FAICD, has seen this trend from both sides. As the former CEO of the Australian Private Equity and Venture Capital Association (AVCAL), Woodthorpe was the architect of the AVCAL Code of Private Equity Governance.
Launched in 2011, the Code improved transparency in the sector, encouraged higher governance standards and helped private equity fund managers with their duties to stakeholders. Its goal: to bring Australian private equity governance up to best-practice international standards.
Woodthorpe had built a successful governance career before leading AVCAL (2006–2013) and turning it from a small networking group into a respected industry body. She is regarded as one of Australia’s most influential innovation and commercialisation thinkers.
Woodthorpe now serves on six boards, advises others, and is a member of the NSW Division Council of the Australian Institute of Company Directors. Her portfolio includes a non-executive directorship of Sirtex Medical and several chair roles of not-for-profit enterprises, including the fast-growing Fishburners, a leading provider of co-working space for start-up ventures.
Here is an extract of her interview with the Governance Leadership Centre on the private equity sector’s growing influence on corporate governance.
Governance Leadership Centre: Why is the global private equity sector showing greater interest in corporate governance?
Katherine Woodthorpe: The interest tends to come in waves, depending on public perceptions of private equity. After the GFC the sector realised it could not operate only in the background or have an attitude that its work was nobody else’s business. Private equity managers needed to demonstrate they were responsible corporate managers.
The sector’s stronger interest in corporate governance accompanied the global push in Environmental, Social and Governance (ESG) and the Principles for Responsible Investment.
How is the global private equity sector driving change in corporate governance?
Before the GFC, when the sector was making lots of money, the ethos was ‘trust me’. There was not always a lot of transparency and investors often did not know what private equity (PE) firms were doing. Institutional investors who allocate capital to PE firms were eager to demonstrate their own ESG credentials and required that PE firms they work with do the same. PE firms generally implemented stronger corporate governance within their organisation and in companies they invested in.
Where is the intersection of private equity and corporate governance headed?
The private equity sector has become a strong proponent of good corporate governance and I expect it to continue focusing on this area. We will see more private equity firms implementing governance systems in their business and in companies they invest in, and experienced directors joining boards of private equity firms or companies in their portfolio.
How do private equity firms implement governance strategies in firms in which they invest?
A lot of private equity is invested in mid-market companies, often family owned. The founder wants to make a full or partial exit from the business and his or her children do not want to run the business. The private equity firm might buy 60 per cent of the business and develop a plan to exit their investment within three to seven years.
Often, their first initiative is to bring the family company’s corporate governance into line with broader governance expectations and standards. A Board of Directors is formed and governance policies and procedures are soon implemented.
Do private equity-led boards focus more on investor protection or corporate performance?
The focus is definitely about performance. Private equity firms know the best way to protect investors (i.e. themselves) is through stronger business performance.
How does governance play into organisation value creation when private equity firms exit their investment?
It is critical. Implementing strong governance systems in portfolio companies, well before the private equity firm exits its investment, helps maximise value. It gives new buyers confidence that the private company is sustainable and can make a smooth transition to being a listed company through an initial public offering if that is the exit mechanism.
Private equity firms know they cannot implement governance systems just before their portfolio company lists on the stockmarket. Governance needs to be embedded in the company and board processes should be well established. Even if the board completely changes as the private equity firm exits its investment, as usually happens, a culture of governance within the portfolio company helps the new board.
How does a private equity board differ from a listed company board?
Boards of companies in which the private equity firms invest tend to be smaller, more nimble and less formal. Their directors typically are much more hands-on compared to those who govern listed companies and are closer to management.
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.
What can boards of listed companies learn from private equity boards?
The big learning is the focus on strategy, value creation and governance for performance. The board’s role is much more about helping the organisation grow than compliance. The emphasis is on achieving goals, often in a tight timetable.
Investment timeframes in private equity influence the style of governance. The board of a private equity-owned company knows the firm might only hold that investment for three to five years as they work towards an exit. It’s very different governing for a five-year outlook compared to governing a large listed company that needs to be sustainable for decades.
That’s not a criticism of listed company governance, simply a recognition that governing with a short-term or medium-term outlook is very different to governing with a long-term outlook.
Do you expect to see more experienced non-executive directors of listed companies join private equity-led boards.
Yes. Directors of private equity boards tell me they experience a breath of fresh air. They enjoy the greater governance focus on strategy, being part of something that is changing rapidly, and having a fixed goal and timetable.
They appreciate being able to focus on things that matter most in organisations, take more calculated risks at board level, drive value creation, and spend less time on compliance and box ticking. Working in a smaller board and more closely with management is another attraction.
What skills and personal qualities does a director need to govern effectively on a private equity-led board?
Directors need a strong understanding of corporate strategy and the industry in which the portfolio company operates. They need to be able to work in a more pressurised environment than listed company boards: private equity firms typically have very high expectations, are tough taskmasters, and not afraid to tell the board what they think. It can be a more aggressive governance culture than the listed company sector.
Practically, directors need to be willing to spend more time on their private equity governance role and have greater availability, because the roles are usually more hands-on.
Directors of private equity companies tend to receive more equity in their organisation, if successful, compared to directors of listed companies. Should all directors of commercial organisations have more “skin in the game”?
I’m against this trend. There’s a misconception that all directors are financially able to invest in companies they govern, or receive shares in lieu of fees. Having more equity in the organisation can cloud director independence and skew decision-making. Directors have enough skin in the game through legal and reputational risks when governing companies.
Are you concerned by the trend of earlier-stage companies bypassing venture capital or private equity and listing on exchanges to raise capital?
I understand why emerging companies go straight to an initial public offering or back-door listing if that is the only way they can raise capital. But it’s a risk when companies list too early and do not appreciate the financial, focus and compliance burdens that come with an exchange listing. They end up damaging their opportunity because so much resources are diverted to listing requirements rather than building the business.
A longer period of private ownership and investment and guidance from venture capitalists or private equity firms can make emerging companies much stronger before they list.
Will we see private equity companies take more listed companies private?
Possibly. A number of ASX-listed companies have been privatised through private equity takeovers, been fixed up, and returned to market. A bigger secondary private equity market (where firms buy and sell assets between themselves) creates more options for listed companies to go private. Corporate turnarounds, industry roll-ups and other value-creation strategies can be easier to implement in a private, rather than public, ownership setting.
What was the significance of the AVCAL Code of Private Equity Governance?
I’m very proud of the Code. It was the first time private equity industry in Australia had a codified set of principles about governance in the sector.
The Code was developed in conjunction with members of the ASX Corporate Governance Council who had helped develop the ASX Corporate Governance Council Principles and Recommendations; the Australian Securities and Investments Commission; and industry stakeholders. It took the best in governance and tailored it for the private equity sector.
The private equity sector has embraced the Code. I would like to think that people who had been uncomfortable about private equity recognised the sector’s effort to improve governance and bring it up to best-practice international standards in this area.