Managing the paradox of strict goals and agility: Why private capital owned companies have an advantage even in times of crisis
THE STRATEGIC THINKER
Crises like COVID-19 bring with them uncertainty from which new behaviours will emerge. This has raised a range of questions on which of the behaviours will be really here to stay and which ones will just be transient. As a result of the current pandemic, will we stop most business travel for good? Will employees decide to work from home for most of the time? Will we dramatically increase purchases online and our use of telemedicine?
At the start of the pandemic, we had in-depth conversations with three directors with experience in both private and public boards, in Australia and overseas. We wanted to better understand the role of private capital in innovation and growth. During the discussions, some drivers emerged that pointed towards the value that private capital creates in setting the strategic direction of the companies invested into.
Private capital directors spend more time on strategy
Part of these findings are not new, as past research has highlighted that private capital directors spend more time than their public counterparts in discussions with management regarding strategy topics. Strategy is a very interactive endeavour in private capital-owned companies. Collaboration per se tends to be associated with more diverse views and leads to robust conversation. What is it about this collaboration in private capital-owned companies that becomes particularly useful now?
There are two aspects of private capital that may seem paradoxical but actually work very well together, and which public companies often lack. On one side, in private capital-owned companies there is a clarity of goals and milestones that often does not happen in other types of ownership. On the other side, there is an agility in adapting to contingencies that allows private capital companies to adapt to external circumstances much faster than other entities.
Indeed, for the majority of companies, the start of private capital means the start of a clear project. Douglas Potter, founder of Boab Capital Group said that “a private equity investment is almost like a project. You start this investment relationship with a very, very clear plan. There is a clearly delineated business plan/investment case that the shareholders, the management team and the board all sign up to − it's all aligned.” He adds that private capital companies do not live in an endless continuum of daily share prices and quarterly reports as public entities do, instead “there's a Growth and Capex plan which is articulated on day one on what money is going to be invested at what point in time and in what assets to facilitate the outcome. And of course, there's a clear line of sight to an exit or end point.”
Private boards work closely with management
This does not necessarily mean that there are rigidities, or a once a year strategy review event like in public companies. It’s very much about continuously checking milestones and adjusting, and continuously interacting with and reaching out to the network, as pointed out by Simon Feiglin, Managing Partner at the Riverside Company. Simon also added “an analogy that I've heard several of my colleagues use which I think is a good one is, for this to work, we need to be chameleons. So, what does that mean? It means that there is not a one size fits all solution.”
Directors in a private company can focus the majority of their time on strategy, building value and resolving issues in order to “take the business forward” versus in a public company where to meet compliance of a traded security directors are required to spend significant time on governance. Often this governance is self-protection because of our current laws around public disclosure, director liabilities and solvency trading. Private company directors can therefore support the company in building value without having to worry about public disclosure, especially in a competitive situation where it may not be in the best interests of a company to actually release certain information into the public domain.
Douglas points again towards a mindset that is fundamentally different. The constant evaluation and the number of times you meet with management is fundamentally different from public companies. He said that “the level of shareholder driven critical analysis which gets undertaken in a private equity structure can be almost continuous with the benefit of being internal forensically-driven analysis compared to a public company where general market level analysis relies on broker research reports which are external and so is unequivocally different. For example, in the private equity structure, you'll typically never struggle to meet with management at a number of levels and just not C-suite. In contrast, the traded nature of a public investment means asymmetrical information must be avoided across the market concurrently with adherence to continuous disclosure obligations.
Transparent and regular communication is key
Indeed, the quality and amount of information available to private equity directors and their access to any level of management place them in a superior position to add value. Dr Michelle Deaker, Managing Partner of OneVentures, emphasised that: “In a lot of our companies, we have really good reach right down many levels of management. Sometimes we actually know a lot of people in the company. […] And if you have a good, open, transparent company, you don't mind if your directors are communicating openly. We see ourselves as operational investors and will even embed ourselves into our portfolio companies.”
When we spoke with Michelle in April, it was in the midst of the Australian lockdown, and she confirmed that in private capital companies “we’re in a lot more regular communication with the CEO. So, we're always on email and we're always discussing pertinent matters to help our companies reach new milestones or value inflection points − it’s a very interactive relationship that you have with the management in a private company world. Like right now, with all our companies, we’ve worked with management to build scenario plans, we’re doing weekly calls on the company, to check in on the business and tracking the key metric[s] (the key performance indicators of the business) and making sure that there’s not some sort of deterioration happening. We chair our boards often as well particularly where we are one of the major shareholders. Holding that CEO-Chair-Board relationship allows us to influence the direction of the company and actively support the CEO on his execution. We can also help manage the other stakeholders around the board room, negotiations with incoming investors and where required major customer relationships – it gives us the authority.” The frequent interaction allows for the exchange of ideas and reprioritisation of focus areas when the need arises, despite earlier agreements in place. In her view, “it is giving the CEOs a framework but also the data and information to support the business to make decisions. That again, adds value for shareholders.”
Time constraints can impede investments
In fairness, being a private capital project also has drawbacks. The urgency placed on getting returns in a specified timeframe does impede investments which in turn may go beyond such a timeframe. That is, in some private capital arrangements there can be a direct investment structure, like the one that Douglas Potter has put in place at Boab Capital Group. In fact, the private equity model does put an artificial end to the investment, despite the same investors potentially coming back on-board through successive secondary exits. With Boab’s pension direct investing strategy, Douglas explains that “it is all about setting up a long-term investment, ultimately with no constraint around the timeframe. And so, you're looking to build sustained, long-term growth in value.” In the case of a direct investment approach, there is a partnership between the institutional investors (e.g. pension funds) and the private equity firm, established over a longer timeframe potentially up to 20 years or more. This clearly allows us to take the bumps out of a crisis and smooth them out over a longer period of time.
The rise and rise of digital
How are digital mediums going to change these director-management interactions is an open question and something that we are very much keen to explore further.
Whether you are in a private-owned company or in a public one, no doubt the amount of online interaction has increased during COVID, and it’s most probably here to stay to some extent. Travel bans in place, as well as general concern about the spread of the virus have made millions of people work from home and rely on broadband and videoconferencing platforms to keep their work going. Does the increased use of digital mediums impact the effectiveness of information gathering, and therefore does this impact strategic conversations and decision making? The pandemic has catapulted businesses and the population in general into using technology to ensure businesses can run normally as much as possible. However, every business has its resources and every industry has specific dynamics that directors need to take into consideration to make decisions faster and with confidence. Whether these behaviours are here to stay and might then have an impact in the long-term if interactions are going to be exclusively held online, is an open question for private and public businesses alike.
In a time of crisis, when uncertainty is sovereign, balancing strict goals and milestones with the ability to continuously re-evaluate them is a must for any company. Private capital-owned companies may be very much at an advantage here. The discipline and agility imposed are likely to make them thrive during this crisis and be there at the end. As an evolving (natural) system, this is something to monitor over time, reflect upon and readjust when necessary. What directors have learned during the crisis is very much a topic that is informing our current research to help better prepare them on the other side.
The article first appeared in the Australian Investment Council website.