4 minute read 4 May 2020

Private equity versus public boards: how different?

By Luke Pais

EY APAC Private Equity Leader

Extensive experience in M&A and fundraising transactions for strategic and private capital investors. Licensed to advise on corporate finance by Monetary Authority of Singapore.

4 minute read 4 May 2020

Awareness of governance models in public versus private equity-backed companies can help boards identify their blind spots.

Assets under management of the global private equity (PE) industry have grown nearly 80% over the last 10 years to be a leading alternative asset class. PE’s track record of creating value for investors can be traced to its governance model, which is based on concentrating equity and thus decision-making in only a few hands — the PE firm and management. This provides the alignment in interest, focus and expectations that are necessary to harness the engagement required to generate superior returns.

In addition, because the PE business involves general partners fund managers raising sequential limited-life funds, PE groups have a real urgency and reputational stake in efficiently executing on value-enhancing strategies and returning investors more capital than they invested.

These hallmarks set PE boards apart from their public company counterparts. Yet, because PE applies very high-conviction, but transitory, capital to generally younger and smaller-sized companies, it may not be so much a competing governance model to the more traditional public company model as it is a complement.

Having said that, the concentrated and illiquid ownership of PE-backed companies and the diffused and liquid ownership of public companies give rise to different board-level focuses and behaviors — and varying strengths and differences.

Public boards

In contrast to private company boards, public boards operate in a more complex and challenging environment given that they must manage a broader range of shareholders (and stakeholders) with diverse interests and expectations, while at the same time, be monitored continuously by the market. Compliance and risk management therefore tend to be the chief concerns, given their regulatory interface and diverse shareholders.

To sustainably operate in this environment, a public board’s strengths must include its ability to be process-oriented in complying with market and accounting rules, guard against reputation risk from how the company is perceived by the public, and address its broader responsibilities of supervising and oversight of management, including participating in the review and approval of the company strategy as well as succession planning.

With the board’s overwhelming focus on compliance and risk management, this could leave less time and resources to focus on strategy development and execution. This may make the company more risk-averse in terms of strategic and investment decision-making.

The same compliance-centric focus, combined with daily performance measurement by the market and quarterly earnings estimate releases, could make the board and company short-term oriented. Annual meetings, quarterly earnings and daily stock prices provide transparency, but could also discourage boards and the management team from having time horizons much longer than a year.

Private boards

With ownership concentrated and fewer regulatory requirements, PE-backed boards have a much more straightforward operational and value creation focus. PE sponsors work closely with management in developing the strategy — often prior to the close of the transaction and embedded in the “100-day plan” — as well as executing it.

In its role as chair of the board, the PE firm often brings in operating partners where needed and augments or replaces members of the management team. The strict investment and exit timetable of the PE investment, and need to return investors’ capital at an attractive multiple, drive this process.

By virtue of its equity being concentrated in management and the PE group’s hands, the PE-backed board benefits from a powerful alignment of incentives, expectations and engagement to create value over a five- to seven-year investment window. The board is also not distracted by capital market rules and transparency requirements that come with being a listed company. Growing experience-building boards, supporting management teams, and assessing and valuing companies, translate into highly knowledgeable boards with access to deep pools of CEO-level talent.

Yet, these strengths of the PE-backed board model can also be its weakness. For example, tightly aligned interest and the lack of truly “independent” board members may contribute to “groupthink” and the inability to properly identify and assess risks. Similarly, operating within a limited life fund provides a healthy urgency to create value but at the same time, this investment window may not match what might be optimal for the company and its broader stakeholders.

Complementary models

Whether public or private, a company’s board of directors functions as a steward of a company’s long-term performance and integrity. Thus, good governance is key to a company’s ability to create lasting value. Knowing the strengths and weaknesses of the two models of governance can help both PE and public boards identify their blind spots and be more holistic in discharging their duties. This knowledge would also be useful for directors involved with both PE-backed and public boards.

Instead of viewing the two as competing governance models, it may be more accurate to say that the public company and PE-backed governance models are complementary. A company in its young and growth phase or one undertaking many changes may be more suited for private concentrated ownership that provides the necessary focus and commitment to level up. Stable and larger companies may benefit from a public model of diffused and liquid ownership that addresses the strategic, financial, risk and governance challenges for longer-term sustainability.

Instead of viewing the two as competing governance models, it may be more accurate to say that the public company and PE-backed governance models are complementary.
Luke Pais
EY APAC Private Equity Leader

Summary

The concentrated and illiquid ownership of PE-backed companies and the diffused and liquid ownership of public companies give rise to different board-level focuses and behaviors. Knowing the strengths and weaknesses of the two models of governance can help both PE and public boards identify their blind spots and be more holistic in discharging their duties.

About this article

By Luke Pais

EY APAC Private Equity Leader

Extensive experience in M&A and fundraising transactions for strategic and private capital investors. Licensed to advise on corporate finance by Monetary Authority of Singapore.