Understanding private equity governance

Introducing strong governance and expert boards to portfolio companies is at the heart of how private equity firms return value for their investors, writes AVCAL CEO Yasser El-Ansary.

With over $25bn in assets under management, the private equity (PE) industry is an important steward of a large slice of Australia’s capital. Because of that, the industry takes seriously its commitment to good governance in the management of companies and funds.

“Effective corporate governance structures are as essential to value creation in the PE industry as they are in any other type of industry,” the Australian Private Equity and Venture Capital Association Limited’s (AVCAL) Code of Private Equity Governance states.

PE funds are pooled investment vehicles managed by a fund manager with the goal of delivering returns to investors within a typical ten year fund timeframe. Investors are predominantly institutional, such as super funds, overseas pension funds, sovereign wealth funds (including Australia’s Future Fund) and funds of funds.

The business model involves deploying capital to invest in a portfolio companies, typically taking majority interests. Common types of deals involve taking public companies private or providing growth capital to ambitious, often family-run businesses.

Recent examples of successful PE-backed businesses include MYOB (public to private to public) and Link Market Services (private to public).

While public markets play a vital role in the Australian economy in allowing our largest companies to raise capital, it is sometimes of enormous value for boards to be shielded from the short-term exigencies that listing requires – a public to private transaction allows them to do this.

For public companies, much effort is spent engaging with analysts, media and a broad shareholder base, which can detract from the goal of long-term value creation. Away from the constraints of public markets, boards of PE-owned companies are often allowed a lot more time to focus on guiding the strategy of the business.

Given that most PE transactions involve a change in majority ownership, there will typically be a restructure of the company’s board.

Often this will involve appointment of one or two of the fund’s investment managers to the board, all of whom will have significant experience previously guiding other companies. But it also allows a board to examine its skills matrix more widely to ensure that it has the right attributes to guide the next stage of the business.

When PE acquires a majority stake in a family-owned business, strengthening corporate governance practices will be a key focus. Many of these companies will not previously have had non-family members on their boards. Bringing in PE is an opportunity to introduce checks and balances that are appropriate to companies of their size. This can introduce additional rigour to decision-making and safeguard the company’s long-term future. Bringing in PE can be a transitional step to these companies listing on public markets with the new governance frameworks preparing them for the requirements of a listed environment.

More broadly, the AVCAL governance code sets out binding principles and guidelines for the industry. Two bedrocks of the code are the need to embed ethical, responsible and rigorous decision-making by portfolio company boards and promote effective board composition and structures, including in some cases, expert external directors.

Under the code, portfolio company boards should be composed of appropriately qualified, competent directors who are sufficiently familiar with the current and emerging issues of the company’s business to provide strategic guidance to the company and effectively supervise and review the performance of management, including oversight of risk management.

AVCAL is in the process of further strengthening the code to ensure it remains contemporary with global best practice.

The funds that comprise the industry put these good governance principles front and centre of what they do because they realise when they invest in a company it is the only way to achieve the type of returns investors are after.

Related viewing: Hear from Clinton Jury, National Partnerships Manager for Private Business on how the AICD can work with directors, executives and business owners to improve governance and overall business performance.