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Creating an impactful and balanced board of directors is as much art as science. Juggling different personalities, skill sets, and motivations isnât easy. But as private equity investors well know, a successful portfolio company board can be a uniquely powerful force for value creation in middle market companies.
We talked to John S. Castle, Managing Partner of Branford Castle Partners, and Jeffrey Kadlic, Founder and Managing Partner of Evolution Capital Partners, about the role of a portfolio company board of directors, and how to assemble and manage an effective board.
In this article, Castle and Kadlic address topics including:
âAs investors, we can guide companies, but the answer canât always come from us,â says Kadlic. âItâs better if somebody else is saying the same thing,â or better yet, helping clarify or refine their advice.
According to Kadlic, âThe ideal board member is somebody who has been in that exact same space, done that exact same thing, and had a huge amount of success.â
Industry contacts are a non-negotiable, says Castle. âThe board should fundamentally be able to open doors for the company in the industry theyâre in, and facilitate meetings that will help the company obtain businessâ they might not otherwise be able to get. Â
Particularly for firms investing across multiple industries, itâs crucial to have a voice on the board with first-hand experience in the space and up-to-date knowledge of trends who can look at the company performance and know the right questions to ask, says Kadlic. For example, ââIf the industry has grown at 10%, why are we growing at 5%?â In order to ask that questions, you need to know the industry growth average.â
But there may be times itâs necessary to cast a wider net. âPeople arenât clamoring to be on the board of a $2 million revenue business unless itâs in Silicon Valley,â says Kadlic, whose firm invests in second stage companies with $4-10 million in revenue and 20-60 employees.
âWe look for people who have industry experience or business model experience,â says Kadlic. For example, Evolution Capital Partners invested in a medical training business looking to grow through geographic expansion. For that companyâs board, they considered a wide range of people who could potentially be a great fit â from someone in the restaurant business who has expanded through a franchise model to hospital administrators with deep industry knowledge.
While retirees will have ample time to devote to board responsibilities, they may not be best suited to provide introductions. âRetireesâ Rolodexes get stale fast â within 6 months,â says Kadlic. âWhen you make the announcement that youâve retired, you might as well have flown to Australia.â
Just as important as industry experience and contacts is the boardâs relationship with the management team. âThe main criteria for the board is, âWould the CEO call that person for advice?ââ says Kadlic.
To find board members, he recommends turning to personal networks, as well as CEO and LP relationships. LinkedIn can be a great source to identify potential board members; âyouâd be surprised how receptive people are.â
Potential future buyers or even customers can serve as effective board members, assuming the company is comfortable with sharing sensitive information or can set up necessary safeguards to protect intellectual property and other trade secrets.
Because Evolution Capital works with businesses at earlier stages, they find it useful to create a board of advisors in addition to a board of managers (the equivalent of a board of directors). The board of managers meets monthly and handles âmore foundational things that arenât necessarily strategic,â whereas the board of advisors is responsible for the strategic thinking expected from a larger companyâs board of directors. For similarly sized companies, this model can provide an advantage when recruiting potential board members as well. Unlike a board of directors, âwith a board of advisors, you donât necessarily have to give them a full financial statement,â which makes the idea of inviting potential strategic acquirers or customers more appealing, says Kadlic.
âThe first thing a board needs to do is listen,â says Branford Castleâs Castle. âSo many boards come in and say, âI know better than you.â There are few businesses where the existing management team or owner doesnât know the business to a greater extent than you do.â Â
âIf youâre a good private equity investor, you and your team have seen a lot of different circumstances or a lot of different aspects of companies that maybe the management team hasnât seen before,â says Castle. âYou might be able to examine a company, and say listen, we think that your systems arenât where they need to be. You struggle to get information to us and distribute information throughout the organization.â These insights are indispensable. But while a board might help a company improve communication and implement new systems, execution ultimately rests on the management teamâs shoulders. âIt almost doesnât matter what great laid plans there are from the board; youâre unlikely to have the type of outcome you want without the right management,â Castle says.
Ensuring the company is under the right leadership should be the boardâs primary responsibility after an investment. âIf the board does that one thing right, itâs 90 percent of the way there. They could pretty much drop the mic and walk away after that.â
As investors, says Castle, âwe donât like to change management. We really love when the manager that came with the business is the right person. The hope is to work with existing management 100% of the time. And frequently, we do.â
But there are times when it becomes necessary to bring on new or additional managers for a company. In these cases, the boardâs birdâs-eye view and past experience is crucial. The board must have the discernment and industry know-how to identify breakdowns in leadership. âFinancial concerns are part of it,â says Castle, but sometimes, larger industry or economic trends may be to blame for a companyâs triumphs or struggles. âIf the company is doing well, often that means the manager is making good decisionsâbut sometimes the manager is just the beneficiary of a rising tide.â
âAt first, being part of a board can be kind of exciting â thereâs a newness to it. You get a charge out of meeting new and interesting people; you identify low hanging fruit and make some early progress,â says Kadlic. âBut it gets more difficult over time to sustain that energy.â
Absenteeism isnât the problem so much as a general downturn in enthusiasm and preparation. People might dial into a meeting instead of flying in, for example. For some board members, this may just be a temporary dip in their level of commitment. But other times, someone may have run their course in terms of value add, in which case Kadlic says itâs the firmâs policy to have a conversation and go their separate ways.
The most engaged board members are, perhaps unsurprisingly, those also interested in writing a check. While bringing on board members as investors requires a valuation and can be a more complicated process as a result, Kadlic says that investors tend to be highly committed and more likely to keep up a high level of intensity over time.
Investors are often more likely to challenge the status quo as well. âYou donât want to end up with a yes-man board,â says Kadlic, âwhere they donât want to ask tough questions or donât want to have a confrontation with the CEO.â
The worst situation, he says, is one in which someone asks for questions, and thereâs âdead silence.â
âIt takes courage to say âNo, I think youâre wrong,ââ says Kadlic. He adds that âeveryone can benefit from a confrontationâ if framed the right way. âConfrontations donât have to be confrontational. It can be a learning moment for everyone.â
Ideally a board should spend 90% of their time looking forward, and 10% looking back, Kadlic says. However, given that itâs easy to get sucked into analyses of past performance, the job of the chair is to create and stick to an agenda, with discrete amounts of time allotted for each part of the discussion. Setting goals with the CEO is a crucial first step; Kadlic recommends identifying three things that, if accomplished, will make the meeting a success. The chair can then work backwards from those goals to create the meeting plan and communicate it to the board.
Throughout the meeting, ensure that the discussion stays concrete and actionable by keeping a list of to-doâs, e.g., introductions to be made or research to be done. At the end of the meeting, recap the to-do list, being sure to identify who is responsible for what and by when.
Kadlic also recommends a âcheck-outâ at the end of the meeting, in which every board member rates the meeting from a 1-10 in the concluding few minutes, and explains the rationale behind their ratings. Â
Ultimately, the best indicator of a boardâs success is the companyâs performance, says Branford Castleâs Castle. âIf the company performs well, well, then, everything worked out. If the company didnât perform well, then everybody is blamed to some extent.â
Within that broad distinction, an investor can also measure success by the strength of the relationships cultivated. âFundamentally, I think that the best relationships are ones where you have really smart and really capable people at the management level talking to smart and capable people at the board level. Thereâs a mutual respect between the two groups. With mutual respect you can accomplish just about anything.â