Steer towards success: What very successful portfolio company boards do

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In our previous edition, we began to look at how you can design and fill the boards of your companies so they will be more effective. This edition shifts attention to board processes. Board processes exist to help the company reach its goals. First, we’ll examine how boards organize their activities. Then we’ll look at how board members actually behave in and between board meetings to support the company’s achieving its goals, and how to build the trust that facilitates good interactions between the Board Table Garamond.001board and management. The purpose of board processes is to encourage good board behavior to happen, but sometimes bad behavior still happens, and drastic action may be required.

Structured board activities

Good boards have thoughtful structures for their activities.

Clear communication and shared understanding of value creation plan. Because aligning goals is imperative, a very clear and direct communication between the owner and the CEO regarding the owner’s goals, expectations, and priorities must occur on a regular basis. From the outset, it is important for the CEO to understand how value is determined and created, and the strategic priorities for the company. Many investors make the CEO explicitly focus on evaluating his/her direct reports, objectively, to ensure the company has the bench strength to meet investors’ goals for the company. Successful investors focus regularly and repeatedly in these conversations on these topics.

Meeting schedules and meetingsThe board decides when it will meet and what will be discussed in each meeting. The chairman and the CEO usually agree on an annual program of issues to be brought to the board, and boards usually meet four times a year. The four meetings follow a rhythm, addressing different areas necessary to the company’s success. Typically, an annual cycle includes a strategic planning meeting, an operating planning meeting, a human capital planning review, and an execution-focused meeting. Whatever the particular focus, at all meetings the board also:

  1. Examines progress on the executional tasks of the business
  2. Takes a look forward at potential market and competitive factors that could affect strategic, financial and operating results.
  3. Closely reviews initiatives that are crucial or behind, and also initiatives that are progressing nicely and where the board may be able to provide assistance or advice.
  4. Reserves time every board meeting to step back from that day’s agenda to look at the horizon. The willingness and ability of management to admit and learn from mistakes emerges when a collaborative, trusting relationship between the management team and the board has been built. Allowing some time in each meeting for free discussion or new ideas enables the CEO to mention something off the agenda that may or may not be worth exploring. When the board and management perceive and explore unexpected challenges, they can respond. They can also act upon unexpected opportunities, or even turn a challenge into an opportunity.

At board meetings, board members may use a table like the one above (under communication) to help them keep their minds and management’s minds on the key drivers of success.

Many firms have a dinner the night before the board meeting. In that less structured setting, management and board members can brainstorm strategy. The board may also hold separate strategy sessions that do not necessarily occur every year. These sessions may include people outside the board, such as subject matter experts or other managers in the company.

Information flow to the board. Most boards provide the management with a format for preparing board packs that combine elements investors need to see on regular basis with information management wants to share. Lead or controlling investors typically are able to examine the board pack before it is sent out to the board and may make changes and add material. The board chair (often the lead investor) and CEO agree to the specific meeting agenda ahead of time. Directors receive the formal board packs seven days to 10 days before the meeting.

Board activities outside of board meetings

As part of the overall governance approach, investors also have monthly two-hour financial operating calls led by the lead investor (who may be the chairman) or by the CEO. These meetings involve the whole deal team. Investors also review monthly dashboard reports or KPIs. In addition, the lead investor and/or chairman (if the lead investor isn’t the chairman) interacts with the CEO several times a week.

If the CEO and chairman are in sync and in touch frequently between board meetings, it’s important for the CEO and the chairman to keep the other directors informed of the outcome of those discussions.

The chairman must truly be an arbiter: eliciting the thoughts and feelings of the other directors and representing them to the CEO. The chair’s ability to listen and actually represent both the board perspective as well as from the management perspective brings out the best ideas and decisions. One non-executive chairman described his interactions with other board members as follows:

I don’t just take what they say and run with that to the CEO, I will challenge them, I will say I don’t quite understand that, give me a little reasoning here why this is more important than not and I think they know when they say this, I am going to say “So what?” so they really have to put together their thought process better. Then I will ask the board members “Do we have unanimity here?”

The chairman has a different relationship with a CEO than other board members. If the chairman represents control, the CEO needs an excellent relationship with that individual. “If the chairman doesn’t represent control, he becomes more of a conveyor of the board’s view, rather than his own. In that case, the CEO needs to understand which board members exert more influence by virtue of their ability to sway other members of the board. The CEO also needs good relationships with multiple board members – not merely the chairman.”

Good CEOs get permission from their chairmen to meet one-on-one with board members, and they do it on annual basis. These relationships can be built at retreats and other board social functions as well. The CEO should inform the other directors of decisions that have been taken in discussions with the chair in between board meetings. If the CEO is also the chairman, he or she should give the board the information it needs to help solve problems and make decisions.

The importance of trust, and how it is created

Board members who trust management can sleep more easily at night.  Trust between the board members and the management team is built (or damaged) by the discipline management demonstrates between meetings. If the management does what is says it will do, then trust will over time grow; if management doesn’t do what it says it will, then trust will falter. Similarly, how the board handles difficulties can build or damage trust.  Management will be more forthcoming admitting mistakes or expressing harebrained ideas if they know they will not be punished for them.

Ensuring that directors receive the board package several days before the board meeting and assuming that the board has read it helps build trust. “This leaves directors confident management is not running around putting out fires but has a discipline and a process to summarize what is going on” and address priorities.

Trust is especially important if the CEO is also the chairman, because investors tend to fear management’s ability to snow them with misleading information.

Different kinds of board members don’t make a fundamental difference

Because this process is designed to serve up what people need when they need it, it should not vary with different kinds of members on the board (e.g., junior private equity professionals, outside directors). To get the most out of outside board members, the board chairman should have candid, open, and honest conversations upfront about how these outside directors can be most effective and engaged. “Here’s your role, here’s where you can be most effective and where we would like you to spend your imagination and thought.”

How do you deal with bad behavior?

The problems usually occur when personalities clash. “Personalities make a big difference. No matter what the resume says, any individual can be disruptive, combative or inattentive. People like this shouldn’t be directors, which requires collaboration skills above all.”

Good boards address the issue of problem directors quickly and make a change. It is never easy because feelings get hurt and friendships can be strained. Usually it is apparent who is causing trouble. If the dysfunctional director is a major shareholder, it is really tricky. One approach is to try and convince the individual to put someone else on the board who can represent the shareholder’s interest. Having other board members threaten to resign if the difficult person won’t step off is a possible tactic. If there is a real fundamental disagreement between board members who have big stakes, and nobody will step aside, it is demoralizing to management and can damage the business. The solution is usually to sell the business or buy out one of the disagreeing directors.

If a board member does not perform his or her duties, the consequence is being asked to leave the board. The same can be true for a CEO, or a chairman, or someone who is both. A non-executive chairman described the beneficial effect of removing a CEO who also had been chairman of the board, hiring a new CEO, and separating the chairman and CEO roles:

We have a very collegial board but a very frustrated board. The old CEO was very protective of everything, he would only let the board really know what he wanted them to know. He was not hiding; he would bring up bad things, but he would never really try to solve problems and that is what led to the problems that we had. The board was not really participating in the decisions to the point where a president was hired without the board really having the final say. We met ourselves as independent board members, agreed it was the path we have to take, then convinced the CEO it was time to leave. “The proper procedures in hiring a president were not followed; therefore, you lose your job” is effectively what was said. The board stuck together and as a result of that we made the decision to hire a new CEO. The old CEO wanted to stay on as Chairman and we didn’t want that so we got the agreement of the board and the backing of a lot of the management team to say that the new CEO would be hired as CEO only and not Chairman, and … [the incoming CEO] was very receptive to that. As a result, now that I’ve been non-exec chairman of the board for nine months, it’s clear to me the independent board members are truly represented versus that CEO-chairman role where they were only given the information that he wanted them to have. The working relationship between the CEO and board is tremendously better, there’s greater openness from the CEO and the management team and the board.

Conclusion

As discussed in our previous edition, the best choices about who should be on a board can vary with the characteristics of the deal and the needs of the company and the investors. As we discussed in this edition, the best ways to run the board and the interactions between the board and the management tend to not vary much across boards and using these approaches can help you achieve the goals you have set for your company and investment.


By Leslie Pratch

Much of my latest writing appears in The European Financial Review

About the Author

Leslie S. Pratch is the founder and CEO of Pratch & Company. A clinical psychologist and MBA, she advises private equity investors, management committees and Boards of Directors of public and privately held companies whether the executives being considered to lead companies possess the psychological resources and personality strengths needed to succeed. In her recently published book, Looks Good on Paper? (Columbia University Press, 2014), she shares insights from more than twenty years of executive evaluations and offers an empirically based approach to identify executives who will be effective within organizations – and to flag those who will ultimately very likely fail – by evaluating aspects of personality and character that are hidden beneath the surface.

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Getting the return you want: How some very successful PE investors build their boards

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By Leslie S. Pratch

This edition examines what you as a private equity investor can consider as approaches to make the boards of your companies work more effectively. It is the result of initial conversations with 12 experienced private equity investors and board members. If you are an experienced board member, you may agree, disagree or have another perspective on the topics discussed. If you share those ideas with me, I will try to share them with others in future editions. If you are less experienced as a board member, you may also have some additional thoughts, and likely will have much to learn from the experts sharing their wisdom.

A successful board is one that contributes well to helping its company reach its goals. For larger investments (e.g., KKR or TPG buying billion-dollar enterprises led by professional management), the board functions more like a public company board; it is thinking about the long-term health of the enterprise as well as achieving short-term goals. For firms making investments in smaller companies, the goal of the board is to achieve the returns estimated in the investment thesis documents, by the means specified therein or by other means.

Boards achieve these goals by making decisions and providing direction to the management team. Specifically, boards typically manage long-term performance (e.g., redefining key strategies to achieve the desired outcome at exit) and examine, adjust and add to the talent in the organization in relation to achieving the desired outcome. Boards typically also handle tradeoffs between competing objectives (e.g., culture and talent), prioritize long- and short-term goals, and oversee short-term performance.

The context and who the board members are determine how the board behaves

How a board carries out its activities can vary. You can think of the process of supporting the CEO and management in establishing the optimal strategy for the business, monitoring the implementation of that strategy, and challenging and supporting management in performing their duties as defined by three factors:

  • The context established in the deal within which the board must operate
  • The composition of the board, including whether the CEO and chairman roles are held by the same individual or different individuals, and the right mix of skills and backgrounds for different company situations
  • How the board members behave with each other, including what they aspire to do, how they communicate with each other, and how their personalities interact.

This edition covers the first two factors and we will take up the third in a subsequent edition.

The structure of the board drives the behavior of the board

The powers of the board are delineated by the company’s bylaws. By carefully writing the bylaws (and the provisions by which they can be changed) key investors can ensure control of the board on the most critical issues. The bylaws limit and influence the behavior of board members.

The way the board works together is driven substantially by the interests of the investors who serve as board members. While board members have a fiduciary duty to the company, there may be conflict on the board that will be hard to resolve within the frame of “what’s best for the company” to the degree that board members’ interests as shareholders vary. Different funds may be at different periods of their life and may need different things – “somebody needs a home run, somebody needs to put more money into the deal, somebody needs to lower their basis.” This conflict can be solved by one investor buying out the others, and smart deal structurers include buyout mechanisms in the original agreements. Lead investors also can try to manage this challenge by making sure all key groups are invested in the same securities. Many PE firms insist that outside board members make a substantial investment of personal funds in the deal, ideally on the same terms and with the same structure as the PE firm.

Some investors try to ensure that management teams have as much of their personal net worth as possible invested in the same security investors do. If they bring in co-investors, they try to ensure co-investors have the same objectives. As one investor stated about a particular case: “We had to recapitalize a company and put the three big investors on the same page. After that recap, our interests were the same, same price, same security, same everything. That made for big cooperative decision making.”

The board is often supplemented by other governance mechanisms. For example, it may often be stated as part of the deal negotiations that lead and other investors will get certain information in between board meetings and will meet regularly with and discuss performance directly with the management.

Bylaws, capital structure, and the board and other governance mechanisms are the context in which the board does its work. Getting these elements right is important.

Board composition options

Private equity-owned businesses operate under a range of boardroom structures including combining the chairman and CEO roles and splitting them; with independent directors and without them; with industry specialists and without them. The company’s problems and challenges are a big factor in determining who should be part of the board.

Size. The right size for a board is five to seven and no more than eight people who open their mouths at a meeting and vote. Most PE investors think that that’s the number of seats to have. This sort of size constraint usually means you have to prioritize because there are more kinds of people you might want on a board than there are spots for them.

Types of potential members. Potential board members include: chairman, CEO, other members of the management team, representatives of the major investors, non-executive industry, sector, or functional experts, and outside operating executives. The CEO is always on the board. Almost always there are a few investors, and sometimes one or two additional management team members. Some firms add two industry or functional specialists. Some situations require a board observer seat.

Who should be the board chairman?

The board chairman is a crucial role. The chairman is responsible for leading the board, making sure that agendas have the right information and for driving the meetings. His or her role is to foster open, honest, candid and productive board communications involving all board members. The chairman is responsible for synthesizing board and communicating it to management. The chairman sets the tone and regulates the conduct of the board.

Choices for chairman include:  the senior deal team leader, the CEO, or a non-executive who is not the lead investor. Under what circumstances should the chairman be the CEO, under what circumstances should it be an investor; under what circumstances should it be someone else? In one model, the investor leading the deal serves as the chairman. By separating the roles of CEO and chairman, the board can more readily confront the management of the company with issues the latter would prefer not to raise. A non-executive chairman reduces the opportunities for the company management to obfuscate important issues at the board level and increases the likelihood that the CEO will perform satisfactorily.

Some PE firms almost always make the CEO the chairman. “We find it empowering to good CEOs to also be the Chair of the board, and we console ourselves that we usually have enough shareholder control and enough bylaw protection. It’s a big velvet hammer.” One situation where this can work is when almost all the value is created in doing the deal rather than in managing afterward. It’s desirable because it lets the CEO be empowered and it has very little downside. This can be the case when the main value of the acquisition is cheap assets that the PE firm believes they can sell for much more in the near future when they expect market conditions will have changed. The opportunities for these kinds of deals have decreased for PE over time because there are now lower-cost investment vehicles to use on asset-based plays. Another situation where making the CEO chairman makes sense is when you have a strong desire to do the deal and the incumbent CEO can control whether the deal happens and also has a strong desire to be the chairman.

A third possibility for chairman is an independent non-executive director. An independent non-executive chairman can provide strong leadership not biased by a leaning to either investors or management. Independent non-executive chairmen have the particular ability to be arbiters, and to combine aggressive leadership and independence from investors and the management. One independent non-executive chairman characterized his role as follows:

I talk to the board a lot, I don’t just take what the board says and run with that to the CEO, I will challenge them … I will say, “I don’t quite understand that, give me a little reasoning here why this is more important than not” and they know I am going to say “so what” so they really have to put together their thought process better. I will ask them if we have unanimity. When I have a discussion with (the CEO), I share it back with the board. I am very close to the pulse of the board. … I understand what their feelings and concerns are which makes it easier to go to the CEO and say, “Here’s what we on the board are seeing.” … If he says, “I get it, I understand their concerns, let’s talk about it,” we have a call. The CEO may say, “I know that this is an issue, let’s not have this as a recorded board meeting but let’s discuss it.” This open communication is the glue of an effective team. As a result, we are not fighting these wars in a back room.

An independent non-executive chairman may be particularly useful when there is a substantial risk that the CEO may need to be replaced.  Then the chairman can also become the CEO if taking on the CEO role is temporary. If the CEO needs to be replaced, an outside director can step into an interim CEO role. “You’re lucky to have one outside director who can be independent and break a tie. A non-executive chairman of the board who is really engaged is a good way to warm a guy up in the bull pen.” Otherwise it may be difficult to find someone quickly to be CEO.  “It’s hard for a really good guy to come on and take a job unless he knows he’s going to be successful.”

Who else might be on the board, what role they may play and what are the pros and cons of having them on a board, or circumstances where they are really important?

More people from the private equity firm or other investorsTypically, there are at least one other besides chairman (or two if CEO is chairman). You may have to add even more as part of arrangement with other investors.

Junior PE professionals. You may have two or three relatively junior professionals from your firm on the board who will run the numbers and make sure that short term targets are being met. The benefit of their being on the board is their development. Senior professionals need to leverage their time by giving some of the grunt work to junior professionals. The cost is that they take up a seat that could be used by someone who could add more value. An alternative to having them take a board seat is to have them work closely with the company’s CFO and attend but not vote at the board.

Other company officers. Some firms automatically populate the board with both the CEO and the CFO. Having the CFO on the board can be a good idea if you have the seat available and the CFO can provide useful insight and perspective from inside the company. On the other hand, CFOs often have limited ability to see the forest for the trees. If you don’t put the CFO on the board, you can have the CFO (or other officers) attend particular board meetings in order to inform directors and answer questions. Company officers can be used as a sounding board for determining the ease of implementing a planned course of action. Because the discussions are different when officers are present, boards need to have both types of sessions to make sure sensitive issues get aired (and they are limited in their ability to do that when the CFO is also on the board).

One sensitive issue when other officers are on the board is the CEO’s compensation. If there are other officers on the board, the board can meet in executive session with management team members excused to discuss and decide, or if there is a compensation committee, to hear and consider its report.

Outside directors. Outside directors may be operating executives who are functional experts or industry insiders. Outside directors can add value in strategy discussions and can win the trust of the CEO. This person can play an important role in supporting the CEO and fostering a more cooperative dynamic on the board, especially if the CEO has a voice in putting the person on the board, A CEO may be less concerned about a hidden agenda and more readily buy into an idea suggested by an outside director. Outside directors can sometimes bring credibility other board members may lack; an outside director who has been a successful CEO in a business can be more effective in a board role than someone who hasn’t had to run a balance sheet.

Outside directors are not viewed consistently as helpful because they typically are not deeply involved with the business as other board members are. Investors are often involved on a weekly, not a quarterly, basis and are performing the role of the board along the way, outside of formal board meetings. If you have a formal board meeting with an outside board member in the meeting, and with two people from your firm who are deeply involved with facets of the business, “you are either dumbing down the meeting for the new person or the meeting is over the head of the outsider.”

Investors can recruit industry talent to the CEO and CFO roles. Investors can also bring their networks aggressively to bear in building a working board. For example, an investor in a frozen sweet goods business recruited his former boss, a CFO of a large baked goods business, to the frozen sweet goods company board, and this board member oversaw the installing of needed IT systems at the frozen sweet goods company. This investor also recruited to the frozen sweet goods company board another person out of food service with end user relationships (e.g., Starbucks) who oversaw rebuilding the frozen sweet good’s company’s food service organization.

On the other hand, many investors view bringing in functional expert to compensate for a weakness of the CEO as having dubious value. “They don’t make great members because only 20% of the meeting is dealing with that.” You can get the benefit of the expert’s perspective and value without putting them on the board by hiring them as advisors.

In almost any deal, some outside independent perspective is very valuable. Many firms get this perspective by putting two or three fully independent directors on the board of every company, to create highly customized boards that align with the investment management plan. In these models, the early board activities are “business building” – first, focusing board members to use their expertise on systems and processes the business really needs, and second, to install systems and processes that the board really needs, such as the board packs and helping management get the financial data that they want. For example, the business may not have collected the right kind of data for balance sheet management. The board’s subsequent conversations shift to strategic development and growth. Here, “conversations become quite rich where we’re batting around strategic topics around how to improve the value of the business.”

Other firms get this outside perspective without having independent board members by using outsiders as advisors or consultants. You would particularly want to have independent outside board members when having independent directors is a differentiator in terms of businesses that are willing to partner with you. An independent director might be important if it adds to the value creation and you think the CEO will respond more readily to a board member’s suggestions than to an advisor or consultant.

Operating partners. Putting operating partners of the investment firm on the board requires care. Because they are operators, some operating partner directors may seem to the CEO to want to run the company themselves. They can undermine the confidence of CEOs. “Operating partners have a skillset and have insight into what the CEO is doing but may want to run things and make the CEO fearful.” Operating partners with domineering personalities can develop a reputation for being unpleasant to work with and alienate potential deals. A good operating partner needs to have more than operating skills; they need to understand their role and how they are going to interact with the company’s management.

Former owners/ founders. When private equity buys businesses from founders, founders often stay involved but the private equity investors take control and usually propose changes. “There is some dissonance through redirecting how the company functions and where it is going. You deal with the sacred cows and there’s a lot of trauma.” It is challenging to have founders with board seats but who are no longer running the business. “They can be bitter and disruptive or sit in the corner silent and change the whole tone of the meeting.” Former owners/ founders can be hard to deal with in those circumstances, because they probably don’t want to not attend or to resign. If you promise a board seat to founders who were leading the day-to-day business, they may say they have a legal right to be on the board. To minimize the disruptive effects of a founder, some firms resort to having only one official board meeting a year. Others give the founder or founders another role but not a seat on the board. “To the degree that is possible, we don’t have the founders on the board unless we feel really good about them.”

When there is a grumpy founder or concerned management team, a PE firm can give sellers the option of appointing an independent board member from a list the PE firm provides. “There are entrepreneurs who have a tough time going from an environment where they are in control to one that there’s not in control. Having them appoint an independent board member has worked pretty well. It’s certainly better than having them on the board directly.”

Generally, firms prefer not to have founders on the post-acquisition board but sometimes they have to agree to a board seat for them as a condition in buying the business.

Observers. Some situations involve board observers. This arrangement may give the investors the benefit of the observer’s insight into a company that operates in “a business line in which the investor is currently active or in which it is seeking to expand”without giving the observer fiduciary duties. The arrangement may promote a relationship with a potential strategic partner. To avoid the observer’s gaining undue influence or access to privileged information, the arrangement needs to be documented carefully. The American Bar Association (ABA) recommends that the board observer agreement “expressly provide that the observer has no right to vote on matters brought before the board (or any committee), and that the observer’s presence will not be necessary to establish a quorum at any meeting.” The ABA adds that the board observer agreement “should not grant the observer any veto rights over corporate matters.” Even if the observer cannot vote on corporate matters, the board may occasionally seek the observer’s input.

Getting the context right and getting the composition right sets the stage for a very effective board but the board still needs to act in the right ways, which will be the subject of the next edition.

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Getting Systematic about Management Assessments

By Leslie S. Pratch

When you’re acquiring a company or building a management team, assessing skilled managers effectively can lead to improved ROI. Private equity investors can do more to achieve sustained success by making the process as systematic, rigorous, and efficient as possible. Having a system in place to guide judgments about management talent can add value.

A systematic process can have different roles for different team members at different stages in the deal:

A competency model outlines the behaviours that a firm’s managers should demonstrate as leaders. Competency models are based on the critical elements of accurate job descriptions and are the foundation of most systems for assessing managers.

In this letter, I’ll describe the first step: crafting the position description, which is the basis for the competency model and the assessment. In future letters, I’ll outline how to create the competency model and how to use it wisely.

DEVELOPING POSITION TEMPLATES

Begin by developing a position template. You and your firm undoubtedly have had some discussion of the position. Typically, a template includes:

1. Business Context

What is the strategy and what is the business model?

2. Critical Business Imperatives

What are the priority activities necessary to realise the strategy/objectives, and how will culture inform the execution of strategy?

  • The current and future nature of the team. What type of person would best complement the existing team? How should the team evolve?
  • The most important activities the company must do to realise the strategy (e.g., closing a major account, developing a major OEM partnership, completing a critical product development, or building the organisation).
  • The culture of the organisation. What are the organisation’s values? Management style, communications, and approach to training and development of people?

3. The Job

  • Job title and purpose.
  • Dimensions: budgets, people, materials, capital investment and key result areas.
  • Nature and scope and in particular, the difficulties and challenges in doing the job well.
  • Key relationships, both internal and external
  • Principal accountabilities: what are the two or three key objectives and the job’s expected contribution to the organisation; what is most important to the organisation from this position?
  • Performance measures related to the critical business objectives.
  • Time-span horizon of the role (how long it will take to achieve the longest task in the role).

4. The Person

What is the definition of the ideal candidate? Characteristics might include functional/ professional/ technical skills, work experience, career flow, prior level of performance desired, and key required competencies.

The ideal candidate definition is specific to a specific job at a specific portfolio company at a specific moment. The two or three principal accountabilities or tasks the jobholder needs to perform in order to be considered successful drive this definition. For example, what behaviours, actions, and contributions would a high-performing jobholder make in carrying out these critical tasks? Finally, what are the competencies associated with these successful behaviours, actions, and contributions?

WHO SHOULD DEVELOP POSITION DESCRIPTIONS?

Members of the deal team most closely involved with articulating the company’s strategy and overseeing its implementation should develop the position template, possibly assisted by a competent HR person and/or operating partner within the firm. If the deal team uses third party consultants to provide expertise in the market or industry that the deal team lacks, then those experts should be involved too.

WHAT ARE THE TRICKY BITS TO BE SURE TO GET RIGHT?

  • Be specific and real. Start with the leadership challenges implied by the strategy. Focus your assessment of management capability during due diligence on what the management team needs to achieve. Link the position description tightly to what you actually need managers to do well — the critical business imperatives of the role — in order to carry out the strategy. Anticipate what might get in the way to achieving the position objectives.
  • Don’t be too specific. It’s easy to get carried away with making things too specific and while there’s no constant definition of what’s too specific, you want to focus on the critical “what’s” that must happen while not specifying the “how” in inordinate detail.
  • Don’t forget culture. Take culture into account. If you plan to change the company’s corporate mindset as part of the strategy, the CEO’s job description should include shaking up the organisation and its bureaucracy quickly and deeply and probably taking other necessary, aggressive steps.
  • Write position descriptions that can serve as the basis for position scorecards once you own the company. You may be planning to use financial or other performance indicators as part of determining compensation and bonuses. More specific performance measures that measure success at moving the company closer to achieving the strategy are valuable to monitor progress, and if you think about them as you write the position description you won’t need to get outside help after the deal closes to put these metrics together.
  • Think through how long the person has to achieve each performance measure. Is a key item to be achieved in three months or within a year?

WHAT HAPPENS NEXT?

After you have the position description, you can easily model the competencies for position. The competency model translates the requirements of the position into the set of skills you want to be sure the candidate has and suggests the indicators you can look for that will indicate that he/she has the skills.

In future posts, I’ll look at competency models and putting them to use.


A version of this piece appeared in The European Financial Review

About the Author

Leslie S. Pratch is the founder and CEO of Pratch & Company. A clinical psychologist and MBA, she advises private equity investors, management committees and Boards of Directors of public and privately held companies whether the executives being considered to lead companies possess the psychological resources and personality strengths needed to succeed. In her recently published book, Looks Good on Paper? (Columbia University Press, 2014), she shares insights from more than twenty years of executive evaluations and offers an empirically based approach to identify executives who will be effective within organisations — and to flag those who will ultimately very likely fail — by evaluating aspects of personality and character that are hidden beneath the surface.

Leaders Who Always Get the Job Done

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By Leslie S. Pratch

Effective leaders must meet challenges and resolve them productively, day after day, for many years. They must constantly adapt to the unforeseen—and must mobilize, coordinate, and direct others. But when hiring executives, how do you know which candidates possess such qualities?  When they all look good on paper, how do you make a choice?  Given the frequency of CEO turnover, and the frequent cases of CEO failure after long, successful careers in the same place where they became CEO (e.g., Jeffrey Immelt at GE, David Pottruck at Schwab, Doug Ivester at Coke), it’s apparently not that easy. But it can be done, by including an analysis of executives’ readiness to acquire new skills and strategies for coping with complexity and change – in other words, their active coping.

Active Coping is a Style of Approaching Life, Baked into Who You Are

How a person approaches life’s challenges develops as a result of nature and nurture. Some people run from problems, some lash out at others, and some passionately wait and hope that problems (or even opportunities) will just go away.

Active copers, by contrast, are built to be capable and eager to deal with whatever obstacles and opportunities they face. Active coping is being ready and able to adapt creatively and effectively to challenge and change. Active copers continually strive to achieve personal aims and overcome difficulties, rather than passively retreat from or be overwhelmed by frustration. They move towards the problems and opportunities with open hearts and open minds.

In business, unexpected events occur, for which no playbook has been written. Active copers do not lose their footing in such cases, but rather thrive on the opportunity to seek out information about what is happening, rally the right team, and learn as part of the process of steering towards success.

Leaders with other personalities and styles may do as well in circumstances that can be predicted in advance, but active copers are the best people to have in place when the unexpected occurs.

Whereas active copers seek to confront and resolve, passive copers are reactive and avoidant. Passive coping is refusing to tolerate the full tension that a situation imposes, for instance, reacting before the facts are sufficiently understood. Passive coping is retreating from reality, tuning out information, and resisting change. It’s dealing with minor problems in order to avoid confronting the anxiety of major problems. In a crisis, passive copers will be prudently hoping that the problem goes away, or trying to do what they did before in vaguely similar circumstances.

How to get what you want (and how to move – fast – when you don’t)

board-537x350

Not everyone is equally good at all parts of the “private equity person” role – some investors are better at sourcing deals, buying companies, or raising money than at being director or leading the Board. To be great at guiding portfolio companies, you need to know when and how to work with a CEO who will not always (or maybe ever) be pleased with the Board. Getting each party to do its part in achieving the aims of the investors – a job they must do together – benefits from planning, skills, and knowledge.

Do the planning

  • Agree on the desirable Board culture  how do we want the Board to function, and how can we fail to achieve that? Managers should know that a culture of engagement and direct, robust debate is the norm for private equity boards. Be explicit about the purpose of Board oversight and questions. Also, articulate the scope of Board input – which matters does it DECIDE and on which matters does it ADVISE?
  • Identify the deliverables from the CEO to the Board. The CEO is responsible for executing initiatives for the year that emerge from the investment thesis. The CEO needs to provide the Board critical information about problems and new opportunities – and how he is addressing them. He should identify where he could use outside assistance (e.g., restructuring, hiring senior management) – and how he is seeking it and what role he would like the Board to play.
  • Identify the deliverables from the Board to the CEO (e.g., clear guidelines on what is expected, performance review, introductions, perspectives and guidance on strategic, operational, and financial management issues).
  • Discuss guidelines for interactions – and adapt them to changing circumstances as time goes on.  What will Board meetings look like (agenda, decision-making rules). What conversations between the CEO and Board members outside of formal Board meetings are expected? What other ways can or will Board members see what is happening in the business or market (e.g., talking with employees, talking with customers, talking with distributors, talking with customers’ customers)?
  • Clarify ahead of time the process of identifying when performance is an issue. Clarity of process is important. You need a plan to address problems that arise at the Board level, just as you have a plan in place if a factory burns down. You’ll handle problems much better if you’ve been clear ahead of time about how you are going to work together and about how you’ll handle the kinds of problems that could crop up while being aware that each circumstance is unique.A Lead Director working for a private equity firm that has a majority interest could say to a CEO, “Here’s the process that works for me. I set the agenda in Board meetings. I serve as a liaison between the CEO and the Board. I’ll coach and advise. But if something becomes a serious problem, the timeline for intervention will be short.”

    Your planning should include from the start a backup leadership plan (or succession plan).

  • Clarify skills. When a Board member offers a perspective or a directive on a business issue, CEOs may feel that an industry novice is trying to tell them how to do their jobs. It’s advisable to spend some time at the beginning having each party describe their perceptions of their own strengths and the strengths of the others. Generally, the CEO brings operating knowledge and valuable relationships with key employees and customers. Private equity directors bring insight from other settings and the ability to see the business from the outside.

Having a discussion about roles, process, and skills creates a more efficient investment. It is worth clarifying for managers what dealing with a board when a private equity firm has control means. Even if you’re recruiting a CEO, it may “go without saying” but it’s still worthwhile saying. “This is what we bring to the party, this is what we do to make it work, if you want a Board that won’t challenge you, don’t do a deal with us. You as CEO aren’t in charge to the degree you were in the past. You may have opinions and we want to know what they are but it’s our call if we disagree.”

Only one side of the Board member-CEO interaction needs to be “mature” to make the process work – so make sure that the Lead Director is mature. A CEO who is mature and self-aware can live with Board members who aren’t perfect, and Board members who are mature and self-aware and other aware can live with an immature CEO. The problem is when nobody is self-aware and mature. It’s easiest if lead directors grow themselves, as opposed to fixing the CEOs.

Build the skills

  • Talk to someone who is a master at being a lead director. What does he do that helps him get the most out of CEOs and minimizes the risks? What methods work for him for delivering tough messages without making management teams defensive?
  • Learn from others’ experiences – talk to other investors at your firm about their successes and failures in guiding portfolio companies.

Get the information

  • Assess senior management. Does the company have the right CEO to execute on the strategic plan?  Insight into the management team before doing the deal is important. Learning by trial and error or after the house is on fire is expensive. Wouldn’t you like to know before the person lights the match and take the matches away from him? What are the CEO’s development needs? What interaction style would work best with him?Assessments can help clarify any concerns you have. One firm entered alongside an entrepreneur who insisted he remain the majority investor.  They wanted to understand why the entrepreneur was so careful to retain control and where he’d view them as crossing the line. They used the assessment to learn how to build the best possible working relationship with him.

    Also consider sharing the findings of the CEO’s assessment with the CEO – doing so conveys respect, builds trust, and sends the message that you expect management to be fully committed to the future success of the business.

  • Assess yourself – and share the findings with the CEO. What are your development needs? What is your interaction style? Share what you know in a way that can help your relationship work better. An investor who knows that sometimes he is too challenging could say to a CEO, “There’s something I’m working on and it’s a hyper-challenging style, so if you’re hearing hyper-challenging from me, let me know. I want to have a conversation about it. I’ll consider what you say, and decide if your concern in valid. But in any case, I welcome hearing it.”

What you can do

Working well with your CEO partner is vital to creating operational value, a major key to PE success in today’s environment. Consciously thinking about and discussing how you are going to work as a Board member with your CEO will make your success larger and much more likely.

Think about the boards you’re on. How many of these conversations have you had and would it be good to have one? Think about what, if anything, you contribute to the challenges on your most difficult board.

Leslie S. Pratch
Much of my latest work now appears in The European Financial Review.

 

How to Avoid an Ugly Mess

 

 

How to Avoid an Ugly Mess

By Leslie S. Pratch

Not every management assessment is the same. Picking the right assessment approach could mean the difference between having an outstanding investment return and having to explain an ugly mess to your partners. Different options answer different questions, so you need to figure out what you most want to learn.

What you might like to know

Has he done it before?

This question is good to ask when you know what you want and are sure it isn’t going to change. A good way to answer this question is with a talent and skill assessment. Search firms, many assessment firms, and many psychologists focus on past achievements. They document if the “candidate has done it before in a compelling fashion”. Typically, they use behavioural interviewing to understand how and when the candidate has “done it before”.

If you plan to exit the deal in three to five years, and know that the company won’t change and the world won’t change in that interim, and that there will be no unexpected opportunities and no unexpected problems, then this could be a good approach — for your needs.

How will he cope with change?

Will he capitalise on opportunity? Can he do something no one has ever done? How much do you care about how well the candidate will perform under new or unexpected conditions? You can pick someone who seems like he fits the bill but the world changes for better or worse. When it changes for the worse, you see how adaptable he is. But you may not know when it changes for the better, because the executive doesn’t take advantage of the change until the competition does.

In faster-moving or more uncertain markets, expecting the unexpected makes sense. You need someone with skills but ability to cope — which requires raw cognitive capability and a stable information-seeking personality much more than specific pre-defined skills — is also critical. Talent and skill assessments don’t address these at all. An approach aimed at understanding active coping capabilities as they will be needed for the business challenge fits well here.

How can you get the most of the executive?

Sometimes a candidate brings a lot but isn’t perfect. That introduces the other party in the interaction — you. How can you act so you capitalise on the executive’s strengths and proactively protect against his weaknesses as a leader? Talent and skill assessments won’t shed any light here; Pratchco’s approach to understanding personality as part of the assessment will.

How will he cope in a private equity environment?

The pace is fast and CEOs have to cope with having investors challenging their thinking. If they’ve been in a private equity environment in the past and you know the investors they worked with before, a talent assessment is adequate. If they’ve never been in a private equity environment or you don’t know the other investors, you should use Pratchco.

Are incumbents worth keeping, even though the strategy is changing?

You are inheriting a management team. They know the business and losing them would be a big loss. But they haven’t done what is being called for next, even if they thought of it (similar to founders’ problem with startup), so they will all fail a simple talent assessment. But they might very well be keeping if you could supplement them with your skills or add a team member at the right time. If you assume they can’t do it, you will have to hire a new team, which will lack the understanding of the company the original team had.

What’s in it for the executive?

Executives don’t generally relish the opportunity to be assessed. Putting them through a painful assessment that provides no value to them won’t be a great way to start a relationship and might even be a way to end one.

Talent and skill assessments document what the executive says and usually provide no value to the executive. Assessments that find underlying themes can help executives understand themselves better and can provide guidance that the executives can use to improve how they interact with others (including but not limited to you).


A version of this post appeared in The European Financial Review

About the Author

Leslie S. Pratch is the founder and CEO of Pratch & Company. A clinical psychologist and MBA, she advises private equity investors, management committees and Boards of Directors of public and privately held companies whether the executives being considered to lead companies possess the psychological resources and personality strengths needed to succeed. In her recently published book, Looks Good on Paper? (Columbia University Press, 2014), she shares insights from more than twenty years of executive evaluations and offers an empirically based approach to identify executives who will be effective within organisations — and to flag those who will ultimately very likely fail — by evaluating aspects of personality and character that are hidden beneath the surface.

Serious Human Capital Management for Seriously Good Performance

Choice of the personnel

HR contemplating where to put the employee.

By Leslie Pratch

Private equity firms develop financial and strategic plans and manage their portfolio companies by them. But most private equity firms are more casual about avoiding human capital disasters, and very casual about ensuring the best results form human capital. Portfolio companies are generally left alone to manage their own leadership issues until problems show up — and they will.

Some larger firms have realised that unthinkingly ignoring human capital issues until there’s a big problem is a strategy for having big problems. Doing nothing and then having a problem 18 months later seems like a poor idea. In response, some larger firms have recently decided to use an outside consultant to deal with human capital or have hired an internal staff member to oversee management recruitment and to otherwise support portfolio companies on matters related to traditional human resources functions.

You need to know what’s happening with your key managers. Good private equity firms can earn even better returns by having someone know all the people who report to the CEO in a portfolio company and how they work together.

It’s not voluntary to give quarterly numbers, it’s not voluntary to discuss the strategy, and it’s not voluntary to be able to talk intelligibly about the status of your top management teams. Your standard operating procedure should be poking your noses into how your CEOs work with their management teams. Just as you don’t stop assessing the leading indicators of profit and cash flow, you should not suspend HR diligence after the deal is done.

Medium-sized firms also need a methodology to monitor portfolio company talent, and they likely will need help in executing it.

A Part-time Human Capital Advisor is the Right Solution for Certain Firms

A part-time human capital advisor can track the status of management teams on an ongoing basis and also be a resource to address situations before they deteriorate and cause financial damage. A part-time human capital advisor may be the best answer for any medium-sized firm with aggressive timetables and financial goals, a history of surprise poor performance by CEOs, and/or little knowledge about the portfolio company management teams and what’s happening in them. It can also be a great solution for some larger firms. It may be right for your firm if you are:

  1. A medium-sized firm that makes control investments in growth companies, investments in distressed situations, or buyouts
  2. A large buyout firm that does not do in-house assessments of CEO candidates
  3. A firm with a history of replacing CEOs post-close and of being surprised by poor CEO performance
  4. A firm that needs better knowledge about portfolio company management teams

Someone who has taken the time to know investors’ value creation plan can be positioned as management’s advisor whose role is to help the portfolio company management succeed in carrying out the strategy.

What a Good Human Capital Advisor Actually Does

A good human capital advisor gets to know the managers, and with them, conducts a structured analysis of their jobs. With the manager, the advisor identifies key targets and metrics and documents the relationships that will be crucial for the manager’s success. Together, the advisor and manager make plans for building and measuring the progress of those relationships, especially the manager’s relationships with investors, Board, key customers, and key team members. Having assessed the baseline of each relationship and developed a plan for each relationship, the advisor then monitors the manager’s progress on the plan in the context of the business as it evolves.

If the advisor has done a thorough psychological assessment of the manager (typically as part of due diligence or just after the deal closes) the advisor starts with an enormous understanding of how the manager’s mind functions and how to be most effective in helping him or her change; the advisor understands where and why resistance arises for that person and therefore has a better chance of avoiding it.

An advisor focuses on how people interact. But just as a good CFO assesses progress and thinks about the business with a focus on finance but does not limit him/ herself to finance, so a good human capital advisor helps investors and CEOs assess progress and think about the business with a focus on key relationships and the functioning of its top managers but does not limit him/ herself to this perspective.

An advisor works all sides of each relationship. The advisor identifies a problem and then considers which behavior changes, by whom, would be the easiest route to the solution. Sometimes it’s the CEO who must change, but often the Board or investors can slightly adjust their own behavior and therefore remove or minimize the problem.

An advisor brings independent judgment and experience to bear on the business situation as a whole and to the challenges that the manager faces. The advisor’s goal is the successful achievement of investors’ goals. At the same time, though, the advisor facilitates the development of the manager’s capabilities, so to the manager the advisor may feel or seem more like a coach.

Deliverables

The start-up phase of this service can include assessments, regular discussions with the CEO and/ or CEO and management team members, and then twice yearly Board updates with or without the CEO.

Benefits

This kind of advising/human capital monitoring leads to better solutions and more successful execution, and to problems not occurring even when things appear to be going well. It leads to the advisor’s being able to find problems as they arise and spot patterns that are important for investors to know.


A version of this piece was published in The European Financial Review

About the Author

Leslie S. Pratch is the founder and CEO of Pratch & Company. A clinical psychologist and MBA, she advises private equity investors, management committees and Boards of Directors of public and privately held companies whether the executives being considered to lead companies possess the psychological resources and personality strengths needed to succeed. In her recently published book, Looks Good on Paper? (Columbia University Press, 2014), she shares insights from more than twenty years of executive evaluations and offers an empirically based approach to identify executives who will be effective within organisations — and to flag those who will ultimately very likely fail — by evaluating aspects of personality and character that are hidden beneath the surface.