Enhancing Private Capital Governance

A recent academic study of the Creative Destruction Lab Rockies program found that if an entrepreneur has identified corporate governance as one of their key development milestones then they are significantly more likely to attract mentor support. In that study corporate governance included how the corporation planned to attract and incent employees, how advisors and directors would be recruited, and how the corporate board would function. Angels and private equity investors realize the importance of corporate governance and indeed it is one of the important considerations during any due diligence examination. 

Savvy investors understand that private equity governance also includes the mechanisms they negotiate to help mitigate their investment risk. If an investor seeks a board seat as a condition of their investment then these mechanisms may lead to a divergence of opinion among board members. Building an effective start-up is a difficult task that can put great stress on all involved and developing effective private capital governance helps maintain alignment between all parties when challenges arise, and critical corporate decisions must be made. Understanding how to identify and manage these potential conflicts is important for an investor to become a value-enhancing member of the corporate board.

Governance begins with developing a strong leadership team and a board has a key role to play in building that team. Andrea Drager, Partner at Azure Capital, observes that ​“Providing access to ownership in the business for founding teams and the critical early hires is an important arrow in a founder’s quiver to attract and retain the right talent.” According to Mike McCauley, General Partner and Cofounder of Garage Capital​“One of the most common problems we see in companies that do not end up finding success are issues within the founding team.” Both Andrea and Mike recommend a corporate structure that allows for an employee option pool, that requires standard option and share vesting, and that includes a shareholders’ agreement. The development of these agreements requires careful deliberations and conscious effort by the senior leadership team and the corporate board.

Governance also entails that a board requires management to develop proper corporate controls. Brad Pierce, an independent lawyer with extensive experience in the Canadian VC market, observed ​“I think probably the primary reason… a lot of them either fail or just fizzle out, is that they do not develop the structures or the networks that are key for their success in terms of their ability to raise further funding and allow them to scale their business”. Brad notes that guidance for entrepreneurs is available at a ​“very cost-effective rate” from many sources so ​“there’s no excuse” for start-ups not creating effective corporate structures and systems. 

It is also important to realize that while governance needs to evolve as the corporation grows, it is an important consideration at all stages of development. Jim Gibson, a serial technology entrepreneur, angel investor, and author says, ​“If you believe that you have a company and a product and a solution that is going to grow and need capital, you need to act and behave in a governance model one step ahead of where you’re actually at. If you’re trying to raise an early stage round where you’re raising in the hundreds of thousands of dollars, you need to act like you’re raising an institutional round of Series A financing”. It is important for directors to realize, however, that their asks of a management team need to be thoughtful and not overburden them. Patrick Lor, Managing Partner, Panache Ventures notes that directors of start-ups need to understand the challenges of early-stage ventures and ​“not just throw the rule book at them, but walk through the risk management process with entrepreneurs and help them understand when to be cautious and when to be aggressive”.

The challenge for an investor nominee to a corporate board is to understand that in the context of corporate governance, and during board meetings, their fiduciary duty to the corporation is their primary responsibility. Acting as a fiduciary requires ensuring that key corporate decisions concerning strategy, risk management, and human performance are made using a robust process that considers the interests of a diverse set of stakeholders. Board members also need to realize that they are peers and must have the courage to challenge the senior leadership team and their fellow directors if required. They also must be aware of potential biases in their individual and group decision-making when faced with critical corporate decisions and actively work to overcome any that arise.

The CVCA/ICD Private Capital Governance Program draws on academic research, guidelines for publicly traded corporations, and insights from leading industry professionals to illustrate how best practices must be adapted for use in private equity situations. The course includes both asynchronous, synchronous Zoom, and synchronous in-class sessions to allow participants to increase their knowledge and learn how to apply it in a series of case simulations. At the end of the program, the participants will have developed a better understanding of, and increased their confidence with respect to, how they should act to become a highly effective private equity board member.