The goals and operations of a private equity company differ significantly from those of traditional private and public companies and non-profit organisations – and therefore the role of a chair of the board is also very distinct. At the heart of a successful relationship is the ability to deal with and understand the needs of a private equity investor.
But what are the key differences between a private equity investor and other company shareholders?
- Involvement: Private equity investors are typically more hands-on, and often involved in the day-to-day running of the business. The chair must be comfortable with this level of scrutiny of both themself and the management team.
- Control: A PE investor usually concentrates shareholder control in one or two key decision makers. A skilled chair must manage the potential benefits of this less fragmented approach, but ensure such influence is kept in check.
- Leverage: Private equity tend to acquire companies using significant financial leverage meaning that the chair must be comfortable with key issues of finance, managing a business with covenants, and building strong relationships with debt providers.
- Investment horizon: A private equity chair must be prepared to implement their work quickly. Most investor cycles tend to leave a narrow 4-7 year window, meaning that the majority of changes must be made in the first 12-36 months to maximise the exit valuation.
- Fund lifecycles: A good private equity chair will keep themselves appraised of the investors’ fund raising situation so they are not caught off guard by an unexpected decision to sell.
- Focus: A private equity chair needs to understand that PE investors are heavily focused on value creation. Once invested, they can achieve this in one of three ways; i) growing earnings, ii) increasing the exit multiple valuation of the business by making strategic improvements, or, iii) cash generation.
- Incentivisation: A private equity chair needs to have a strong understanding of how incentives work, both at the management and investor levels so they can avoid wasted energy, time and cost, and prevent the creation of perverse incentives that can lead to suboptimal outcomes.
- Speed: A private equity chair needs to be prepared to be on-call twenty-four hours a day to deal with the fast-pace of business.
How much should a chairman be paid?
Knowing how much to pay for a high-level executive chairman is complicated, with many influencing factors occurring across different industries.
For guidance on the standard rates of chairperson compensation, you can download our guide on this subject below.
What does a chairman do?
The UK Corporate Governance Code is a leading authority on governance globally and an excellent starting point for understanding board leadership and the role of the chairman of the board. While the code is aimed at listed companies, it was written so as to be an aspirational benchmark for companies of any size and nature. It succinctly summarises the duties of the board and chairman:
“Every company should be headed by an effective board which is collectively responsible for the long-term success of the company. There should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision. The chairman is responsible for leadership of the board and ensuring its effectiveness on all aspects of its role.”
What is the difference between an executive chairperson and a non-executive chairperson?
An executive chair is an employee of the company, whereas a non-executive chair is brought in from outside the organisation to hold it to account or offer an independent, non-bias point of view.
In the UK the company’s CEO usually holds the executive chairman role, while a non-executive chairman is seen as a true independent.
In the US, the chairman vs CEO distinction does not usually apply as the roles are typically combined. While there is also no compulsory governance code in the US, and different shareholders have different views on best practice (as demonstrated by some of the contradicting positions in the Commonsense Principles of Corporate Governance and the Corporate Governance Principles for US Listed Companies); most agree that the board should have some element of independent perspective within it. If it doesn’t come from an independent chairman, then it should from a lead independent director.
In private equity-backed companies where this separation exists, the relationship between CEO and chair is a crucial one, with the role of an independent non-executive chairman being integral to the ongoing success of the relationship between management and shareholders.
Why do you need a chairman in a private equity-backed company?
As private equity investors are involved with many of the chairman responsibilities such as setting the agenda, board appointments, remuneration and strategy it is fair to ask whether you still need a chairperson or a lead independent director?
Nurole works with a lot of private equity investors and what we see as a hallmark of the best investors is that a good chairman plays a critical role in the success of investments because they:
- act as a buffer between the management team and the investors
- are able to mentor and coach the senior executive team
- can bring in an outside perspective and challenge the assumptions of investors in a way that can be difficult for management
- bring a level of experience, industry expertise and operational insight that can surpass that of many private equity investors
- provide continuity at the board level if the private equity investors choose to exit, especially if they take the company public
What are the specific responsibilities of the chairman?
Chairman of the board responsibilities in private equity companies are not set in stone. The role of the chairman will vary by both geography and investor. In all cases, duties of the chairman should be discussed and clearly agreed upon upfront, together with clear quantitative and qualitative objectives that might include:
- Managing board meetings
- Leading discussions on proposals
- Setting/sustaining company agenda
- Effective communication with shareholders
- Ensuring that the board is capable of achieving the established goals
- Ensuring board members are informed and up-to-date
- Encouraging active engagement from all board members
- Mediating between investor and management
- Initiating change
- Nurturing development of all directors
- Establishing the induction programme for new directors
- Creating and maintaining a balanced and representative team
The hallmark of someone mastering the role of chairman is ensuring that his or her board is forward-looking. Many boards get stuck in the details of corporate control and fiduciary responsibilities, but private equity chairman cannot allow this to happen. A McKinsey article on how forward-looking boards should spend their time provides a useful framework for anyone thinking about setting such an agenda.
What is the difference between a chairman and a CEO in private equity companies?
The difference between chairman and a CEO is best understood in the context of the relationship between the board and the management – the management are there to run the company, the board is there to make sure the company is well run. The CEO leads the management, the chair leads the board. The two have to work hand-in-hand.
While the CEO is primarily concerned with the operational aspects of the company, the board is a step back, overseeing the company as a whole, and the chairman is the appointed leader of the board.
In general, the board is able to overrule the CEO, however the chair of the board - who is considered a peer to the directors - cannot overrule the board. Indeed, the chairperson in private equity companies is typically reliant on influence and their powers of persuasion, rather than any mandated authority.
What is the relationship between board chairman and CEO in private equity companies?
Typically, the relationship between the CEO and the chairman of the board in private equity is a close one that breeds productivity throughout the organisation as a whole. Any significant separation of CEO and chairman priorities can result in suboptimal outcomes.
Inside the boardroom, CEO and chairman should work in tandem; the chairman should be the CEO’s greatest advocate, and behind closed doors, the chairman should be the CEO’s greatest critic.
Working this way, any and all differences between chairman and CEO are discussed openly and swiftly resolved.
What makes a good chairman?
Research by McKinsey on why some private equity firms do better than others has identified five areas which drive most value creation by private equity investors. An important function of chairman of the board in private equity is to lend support and add value on each of these fronts:
- Expertise: “In 83 percent of the best deals, the initial step for investors was to secure privileged knowledge: insights from the board, management, or a trusted external source. In the worst third of deals, expertise was sought less than half of the time.”
A good private equity chair will be an important source of industry specific expertise both ahead of the investment and during it.
- Incentive plans: private equity usually make 15-20% of the equity available to management. While there is no standard formula, the “most successful arrangements involve significant commitment by CEOs while ensuring that the potential rewards don't make them too risk averse. Formulas that failed to account for the individual circumstances of a company's officers or that spread incentives too widely proved less effective.”
A good private equity chair will play an important role ensuring the incentive plan is appropriately structured and distributed. At the same time, they will ensure it does not become an all-consuming distraction.
- Value creation plans and more efficient execution: the best private equity investors develop their own business plan. This will be built on the management’s plan but supplemented by his or her personal research. “Once developed, the plan is subject to nearly continual review and revision, and an appropriate set of key performance indicators is developed to ensure that it remains on track. Firms implemented such a performance-management system in 92 percent of the best-performing deals and only half as often in the worst.”
A good private equity chair will play an important role developing, implementing and monitoring this plan.
- Front load time commitment: typically the top investors place a lot of emphasis on the first 100 days of an investment. This is the time when new investors have the momentum to effect real change.
A good private equity chairman will help to drive the sense of urgency and time commitment upfront.
- Change management early: “In 83 percent of the best deals—but only 33 percent of the worst—firms strengthened the management team before the closing. Later in the deal's life, the more successful deal partners are likelier to use external support to complement management than are the less successful deal partners.”
A good private equity chair will play an important role in identifying weak management and ensuring their removal does not disrupt the remaining team, as well as spotting and hiring for gaps in the executive team.
What to look for in a private equity chair?
When recruiting a private equity chair, it is important to consider the following questions:
- Are they fit for purpose? Different chairpersons will be right for a company at different times. For example, if a company needs to go through a period of high growth, the profile of the chair will be very different from a company that needs to go through a restructuring.
- Do they have a relevant track record? If a chairman is to be able to influence a board effectively, there can be no “doubts in the room” about their capabilities. Having a chair who has been part of something similar before is likely to increase the chances of their success in the role materially.
- Do they have the required leadership experience? While many investors look for individuals with previous chair experience or former CEOs to become chairs, former CFOs often make excellent chairs. CFOs are used to persuading through influence in the background, which is an important skill for a chair.
- Are they equipped with the correct level of emotional intelligence? Given the importance of a private equity chairman in aligning the management, board and shareholders, it is critical they have the emotional intelligence to weave together the different parties across complex lines. Involving management in the chair selection process can be a useful way of ensuring cultural fit and management buy-in.
- Do they have time to do the job properly? The chairman role takes a lot of time to do well, far more than an independent director role. Companies are often better off with a first time chair fully dedicated to the role than an established chairman who has multiple constraints on their time.
What you can expect from the chairman of a company?
The workload of a regular member of the board is considerably more than meeting time alone. The role requires extensive preparation, reading, research, travel, ad hoc and committee meetings. This time quickly adds up, even more so for the chair of the board of directors where private equity investors are involved.
The chairperson must commit time to the mentorship of the CEO and other directors, as well as the general administration of the board. Major one-off time commitments might include significant M&A, refinancing, 100 day planning, exit planning, budget discussions, PR issues, succession planning or strategic reviews.
In the past, the role of non-executive chairman, depending on the size and nature of the organisation (and how much time is spent managing the board of directors’ responsibilities), traditionally required around 3-6 days worth of time per month.
In recent years, there has been a trend towards making this a full-time position, as companies look to battle against rapid changes in their industries. The consensus among most private equity investors is that in order to ensure they are available to dedicate sufficient time as required during a crisis that a chairman should not have more than 3-4 chair roles. Inevitably these crises can escalate at the same time (e.g. during an economic downturn), so it’s important that a chair isn’t overcommitted.
The role of the chair of the board of directors in private equity is as important now as it has ever been.
With guidance and support from someone at the very top of their game, a private equity-backed company can flourish.
Finding the right person for such an important role requires a lot of thought and consideration. The ideal candidate for a private equity company chairman will be more than just qualified; they will be passionate and involved from the very start.
One of the most common mistakes we see private equity investors make is relying on an existing network, rather than casting the net wider to find the best candidates. It’s like asking around the local village for a fast runner when you are looking to find someone capable of beating Usain Bolt in a hundred metres sprint. It’s not impossible that you will find that person, but the chances are extremely low. Only by casting the net much wider will you find the truly world class talent who can serve as a high-performing chair at the heart of your successful private equity business.
If you have other questions about the private equity chair role, like what should investors consider when writing a chairman role specification, what questions should you ask a prospective private equity chairman at interview, or what should prospective private equity chairs ask investors at interview, then please don’t hesitate to get in touch.
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