Shelagh Donnelly Image
Shelagh Donnelly
Speaker, Trainer & Content Writer

Addressing governance issues for venture capital & private equity firms

July 24, 2019
0 min read
A visual representation illustrating the concept of addressing governance issues in venture capital and private equity firms, featuring interconnected puzzle pieces symbolizing the interplay between governance and these types of financial entities.

In many boardrooms, you may anticipate significant debate as an organization develops and approves its risk appetite statements. In the world of venture capitalism, entrepreneurs could be said to be risk champions. After all, venture capitalists (VCs) take calculated risks based on multiple criteria. Considerations include the management team, and an assessment of whether its determination and passion can translate to growth. Venture capitalists assess a business' potential to be scalable. The service or product, risks and risk mitigation plans are additional considerations, along with intellectual property (IP), financials and more. Exit strategies, and their timing, represent a further calculated risk.

Governance Issues For Venture Capital & Private Equity Firms

Venture capital firms invest in start-ups. Given higher risks that are associated with this stage in a company's life, venture capital firms may well invest in smaller portions than do equity firms. That's because equity firms are likely to seek investment opportunities in more mature businesses with demonstrated results. Such investments may represent lower revenues, but there's also less risk than with a start-up.

Given the risk/reward and sink or swim nature of venture capitalism, is it any wonder that those involved can be self-acknowledged rule breakers? Scott Lenet, a venture capital firm cofounder and president, is not the only person to have described venture capital and private equity as a wild west environment in which breaking the rules remains a fundamental principle. In a world of shifting business models, some tend to flex their muscles in deal execution and management rather than governance.

It's perhaps fitting, then, that the salt ponds around Silicon Valley aren't necessarily frequented by swans. If they were, governance would surely be the ugly duckling of those bodies of water.

In March 2016, then-Securities and Exchange Commission (SEC) Chair Mary Jo White had a few words to say at the SEC and Rock Center on Corporate Governance Silicon Valley Initiative. Among them, she offered, 'And beyond any specific regulatory requirements, some of the principles that characterize public companies ' transparency with investors, controls on financial reporting, strong corporate governance ' have applicability and relevance to private companies, especially those pre-IPO companies that aspire to go public, and should not be overlooked or avoided, whether or not mandated by federal law or an SEC regulation.'

White discussed risks associated with even mature start-up companies. She reflected that start-up businesses' governance procedures and internal controls were 'far' less robust than those in place at most public companies. In citing concerns over 'eye-popping' valuations and emphasizing the need for transparency, financial and internal controls, White highlighted the need for attention to good governance practices.

Modern Governance & Solving Issues

Given their high rate of involvement with technology businesses, venture capital and private equity firms should have an affinity for modern governance practices that enable boards and businesses to respond to emergent issues in real time. If SEC encouragement wasn't enough, firms can find further motivation in the findings of the Diligent Institute's May 2019 report, The High Cost of Governance Deficits: A Case for Modern Governance.

A key finding? Companies with strong corporate governance, the top 20%, outperformed the 20% of companies at the other end of the spectrum. The report shows that the top 20% outperformed the bottom 20% by 15% in the most recent two-year period.

Companies that experienced corporate crises fueled by governance deficits, on the other hand, underperformed their sectors. On average, the 14 examined companies underperformed their sectors by 35% one year following such incidents, and lost approximately $490 billion in shareholder value. The short message is that implementing good governance represents a competitive advantage.As a corporate secretary or other governance professional, you naturally want to point your board in the right direction when it comes time to adapt or change practices. Diligent has identified four steps that boards can readily take, and the first two go hand in hand; it should be a given that your board prioritizes its composition and its governance structure. Begin with the structure. Do you and your directors ever challenge the status quo, or assess board operations and structure? Think of the agenda packages you prepare, and the time required on the part of all the individuals through whose hands (screens) these reports pass, from development to posting to critical review in advance of your board meetings. Then consider that Netflix limits board materials at 30-page outlines.

Stepping Into the Era of Modern Governance

Netflix has developed and incorporated a transparent board-management communication model. Not only are discussions strategy-focused; a limited number of directors attend and observe routinely scheduled meetings of three separate executive bodies. This recently adopted practice is intended to be educational for directors. It's a given that, while directors may ask follow up questions post-meeting, and can share at the board table what they've learned, they do not participate in or influence the executives in their meetings. What kind of discussion would ensue at your organization should you raise the concept?

With respect to board composition, good data and effective succession planning can support the board's capacity to not only have the requisite expertise, but also diverse perspectives that support good questions and healthy debate. Data is increasingly valuable, and boards should be able to readily access it in order to monitor current board composition and upcoming needs. Diligent's Nomination and Governance application enables you and your board to identify gaps and candidates, and to benchmark against competitors' boards.

Ensuring access to quality, secure data is a third step Diligent has identified. Such data is critical to boards' capacity to understand and monitor risks and risk mitigation strategies. Analytics enable your board to leverage data and the very information to which shareholders, proxy advisors and potential activist investor may turn. Modern governance product solutions can alert your board to predicted shareholder voting actions. Your board can also use the system to monitor reputational risk.

A fourth modern governance step relates to ensuring the security of communications between directors, you and your board, and between any of your office, management and the board. Many have developed a false sense of security in that, while board materials are securely published to portals, individuals continue to use corporate or personal email or text messages to communicate ' even, sometimes, with regard to materials published to the portal. Your organization can elevate its security and its modern governance practices by making a shift to centralized board and management communications relying on secure messaging tools. Protected data rooms are available for document sharing.

Closing Thoughts on Venture Capital & Private Equity Firms

Reflecting again on previous SEC Chair Mary Jo White's remarks on Silicon Valley start-ups, it's worth noting the SEC's May 2019 approval of a new stock exchange. The national, Long-Term Stock Exchange (LTSE) will be Silicon Valley-based. Author, start-up advisor and technology entrepreneur Eric Ries proposed the establishment of such an exchange. The new exchange has been developed to appeal to start-ups and reduce short term pressures on public companies. It may also help drive a shift to increased adoption rates when it comes to modern governance.


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