Corporate governance

Tom Koor

How can the the board of directors create value? (V4)

How can the board of directors create value? V4

 What is the purpose of this article?

  • Provide a framework and process to enable discussion and action planning among owners/shareholders, boards of directors, and CEOs regarding the directors’ role in creating value.
  • There is no one-size-fits-all answer. The approach and action plan will be unique to the specific situation of each corporation.
  • The article does not address the implications of: shareholders agreements, voting trusts, term of loan agreements, the authority of regulators, and others who can make decisions or limit the value creation power of the board.

This article does not provide legal or financial advice.

You can download a PDF of this article from: How can the board of directors create value V4

What are the critical learnings in this article?

  • You must have clear agreement who has the ultimate accountability for long-term company performance and value creation.
  • Companies can both create and destroy value for the ecosystem members.
  • There are 7 inter-related components of talent.

Who is ultimately accountable for the long-term success of your company?

  • Boards are ultimately responsible for the long term success of their organizations. 1
  • My discussion around boards creating value assumes that boards are ultimately accountable for creating value. If this is not the case for your company, there’s no need to read further.
  • Many discussions regarding the value of directors use words such as “oversight”, “noses in, fingers out”, and other vague definitions of board accountability. It’s critical to be absolutely clear regarding board accountability.

What is value, and value to whom?

Is value (or wealth) simply the financial returns to shareholders and the C-Suite? Ecosystem members may have varied and conflicting perspectives regarding benefits and costs they incur.

The corporation can both create and destroy value (both benefits and costs) throughout its ecosystem. An example of value destruction is increasing worker compensation below the rate of inflation.

How is value creation (benefits) and value destruction (costs)allocated among members of the company’s ecosystem ? e.g. the directors, management, employees, shareholders, , and society?  For example, if an unprofitable facility is shut down in a region with no other employment, who should bear the cost of keeping the former employees fed and housed?  Should the corporation focus on shifting as many costs as possible onto society and minimize the benefits provided to society?

What is the company’s ecosystem?

The company’s ecosystem is the network of people and organizations, including stakeholders and third parties, directly and indirectly involved in the operation of the business through both competition and cooperation. The idea is that each entity in the ecosystem will affect and is affected by the others, creating a constantly evolving set and nature of relationships in which each entity must be flexible and adaptable in order to survive, as in a biological ecosystem. The actions and behaviours of the ecosystem vary, depending upon what attribute of the company is considered. For example, the ecosystem has different behaviours when regarding the second to second corporate delivery of products or services versus when the company is dealing with CEO succession.2

 

What are the seven components of talent?

#1 Self-awareness: e.g. Does each director understand their strengths, weaknesses, capabilities? Do they understand how others perceive them?

#2 Character: e.g.

  • Values, morals, and ethics. Warren Buffett supposedly said “…looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if you don’t have the first, the other two will kill you.”
  • Courage: It takes courage to make the right decision. The right decision is often not: the cheapest, easiest, lowest risk to the company and director, nor what everyone else is doing.

#3 Relationship skills: e.g. Ability to create and sustain a network of personal relationships. This includes persuasion and negotiation, which is key to managing different points of view and interests. Creating and maintaining followers.  A leader without committed followers is not a leader.

#4 Crystallized intelligence: e.g. what skill, knowledge, ways of thinking, mental paradigms, and facts must the managers have. It is key to have current and relevant information.

#5 Fluid intelligence: e.g.

  • The ability to solve problems without past experience. This is critical for innovation, which is coming up with new and better solutions.
  • The future is impossible to predict but the directors actions and decisions are focused on this unpredictable future.
  • The future will also be different from the past. i.e. there won’t be historical experience to draw upon.

#6 Cognitive skills: e.g. Able to collect and do fact-based analysis with sound logic and reasoning.

#7 The ability and interest to learn, and unlearn, quickly.

How does board talent impact value creation and growth?

  • The board’s VME sets the tone for the culture of the board, C-Suite and the entire company. What are the stories that people tell about what they see directors do and say?
  • Approving and committing to the purpose of the corporation. The purpose remains fixed while operating practices, cultural norms, strategies, tactics, processes, structures, and methods continually change in response to changing realities. 3 Many employees, including the C-Suite seek alignment between their personal purpose and the purpose of the company.  This can especially true for the most talented employees, whose rare skills are in great demand.
  • Approval of the decision making process and principles for the board and C-Suite.
  • Approval of the long-term value creation plan which include the long-term cash flow forecast, capital allocation, and talent creation/allocation. The scope of the talent creation/allocation includes; the individuals on the board and the C-Suite, and policies for the rest of your company. The board approves: director nominations (directors are elected by shareholders), compensation, development and succession processes. The board also approves and oversees the succession pool and development processes for potential C-suite successors.
  • The board approves the delegation of authority to the CEO and awareness process i.e. Does the CEO make the decision and not inform the board OR make the decision and then inform the board OR make the board aware of the decision prior to making the decision OR discuss the decision with the board.
  • The board approves policies which constrain the decision making of the board and the company.
  • Directors create and maintain relationships with members of your company’s ecosystem. Those relationships provide external knowledge.  Relationship with potential customers, suppliers, and employees can enable growth.  Relationships with investors, regulators, NGOs and others can help directors understand the implications of their decisions.

The board also decides how to allocate value creation and value destruction among: directors, management, employees, shareholders, and other members of your company’s ecosystem including society.

What about the processes and technology supporting the board?

  • Board value creation can be enabled, or hindered, by processes and technology.
  • Does your board know what processes and technology are required? This refers back to skill #4 above, crystallized intelligence.

What are your next steps?

Questions for your board and CEO/management to consider.

Ask the following questions and document the agreed upon answers, as well as points of disagreement.  Remember, the Supreme Court does not always have a unanimous point of view.

  • Is your board ultimately responsible for the long term success of your company? If not who is, and what is the board accountable for?
  • How do you measure the board’s collective impact on value creation?
  • How do you measure each individual directors impact on value creation?
  • How do you measure the competitive differentiation of the board as a whole and of each individual director?
  • How to you measure the skills of current and prospective directors?
  • What value has the company created, or destroyed? For shareholders, employees, other members of the ecosystem? Compare this to others in the industry and more broadly.
  • If your company is a global leader in value creation, why, and what role did the board play?
  • If your company is not a global leader, what actions and behaviours must your board directors take? What talent must each director have?
  • You must be specific regarding director actions and required talent. E.g. What if the board considers CEO appointment or termination as one of the biggest impacts on long-term value growth. Must a director have had experience in and accountability for: the appointment and termination of CEOs? Or C-Suite members? Or middle management?  Or is any experience at all required?  If experience is required, how many directors of those voting on the CEO appointment/termination must have relevant experience?  All directors?  Majority?  One?
  • How is the value creation role of the directors reflected in formal governance documents, including: board mandate, board chair mandate, committee and committee chair mandates, etc.
  • Do the directors have the potential to change, with coaching, or must they be replaced?
  • Review the director onboarding process. Consider having potential directors as board observers for one-year prior to nomination, at full compensation.  This is critical part of potential director assessment.
  • Recognize that the directors are not advisors to management. Create an advisory board for the CEO.
  • The directors may need external advice from subject matter experts with extremely deep domain expertise. Create an advisory board for the board.
  • What is your action plan, if any?

Footnotes

1 Professor Didier and Estelle Metayer, “Does your board really add value to strategy?”, IMD, Global Board Center, https://www.imd.org/research-knowledge/articles/board-strategy/

2 Adapted from Investopedia 2018 May 11

3 Page 17 The five most important questions you will ever ask about your organization (2008)   by Peter F. Drucker,  Jim Collins et al, I adapted.

 What further reading should you do?

Tom Koor

How do you measure the success of your startup? V2

How do you measure the success of your startup? V2

 What is the purpose of this article?

  • The focus of this article is on startups where the intent is to create a large long-lasting company.
  • The startup may have equity investors (other than friends and family) or it may be bootstrapped.

This article is intended to enable discussion.  The article does not provide legal or financial advice.

You can download a PDF of this article from: How do you measure the success of your startup V2

What are the critical learnings in this article?

The measures of success depend upon who in your company’s ecosystem is doing the measuring.

Startup founders can measure success from three perspectives:

  • The customers’ perceptions;
  • Engagement with the customer; and
  • Internal measures, especially the monthly cash flow forecast and tracking,

What are the two types of founders?

#1 The startup represents their life’s calling. The intent it to create a company they can be with for the rest of their life.

#2 They understand they may have to exist the eventual successful company, due to acquisition or other reasons.

Most equity investors in a startup want to get a return on the capital, which requires someone to buy their investment. This often requires selling the company.  IPO’s are relatively rare. This can create a misalignment between the founders, who intended to create a long-lasting company, and the equity investors. Some founders retain control of their company by using dual-class shares and/or shareholders agreements.

Buyers may have many reasons to buy a company. E.g. Buyers (or investors) believe in future potential, even when the current situation may appear bleak.  The buyer can enable the startup’s success. Instagram was less than 2 years old, had zero revenue, and 13 employees. Facebook (now Meta) paid $1 billion U.S. to buy Instagram.

What is a startup?

Startups are not building a solution.  They are building a tool to learn what solution to build.1

The startup is a temporary organization designed to search out a repeatable, scalable, and profitable business with customers who are willing and able to pay to solve their problems and needs.

What are the possible outcomes for a startup?

The search for a repeatable, scalable, and profitable business with customers that are willing and able to pay to solve their problems and needs can end three ways:

  • Found a profitable business with major potential for significant scaling
  • Found a profitable business which has little or no potential for significant scaling.
  • Failed to find a profitable business. Company survives due to capital infusions by investors.
  • Failed to find a profitable business. Company fails.
  • Do an IPO
  • Be acquired.

Profit means that life time customer cash profitability exceeds customer acquisitions costs.  This implies that in a period of high growth, cash flow may be negative.

There are many types of financial success, including

  • The startup may have “failed” but still be acquired for a large amount of money. g. Facebook pad $1 billion for Instagram, which had no revenue and 13 employees.
  • The founders bootstrap the company, with no 3rd party equity investors other than friends and family. E.g. Zoho’s founder became a billionaire. The company is family owned.
  • The founders bootstrap the company and then. E.g. Mailchimp was sold to Intuit for $12 billion, 20 years after being founded. It was initially a web design consulting firm.

Measuring success depends upon who is doing the measuring. E.g.

  • Founders
  • Employees
  • Customers and users
  • Angel investors
  • Early stage funds
  • Venture Capital
  • Investment Bank
  • Strategic Buyer

What are the three sets of startup success metrics?

#1 Customer perceived metrics.

Understanding customer perception means that you have to listen to what the customer tells you.  This is NOT your opinion.

Documented customer problems and needs

  • What are your customers urgent problems and needs?
  • What would be the value to them if their problems and needs were addressed?

Documented customer value proposition

  • The value proposition is based on what current, past, and potential customers think, feel, believe, and perceive. The customers’ perception of net value they achieve, which is a combination of the benefits they achieve and their costs of adopting your solution. Their costs are often far higher than what you charge your customers.
  • How does the customer perceive your value proposition, relative to the competition? (And the competition always includes the current situation)

NPS Net Promoter Score

  • The NPS (Net Promoter Score) i.e. “Would you recommend our solution to others?” Follow on questions could be: “If so, why?  If not, why not?”
  • The appendix will direct you to further information regarding NOS.

Sean Ellis Product Market Fit test

You can start measuring NPS once customers start to use your solution, even in the pilot and testing phases.

You ask the question: “How would you feel if you could no longer use our product or service?”

  • Very disappointed?
  • Somewhat disappointed?
  • Not disappointed – it’s not really that useful?
  • I no longer use.

At least 40% of your target customers must say “very disappointed”.  If it’s less than 40% you need to reposition/change your product.  One approach can be to segment the answers to find a customer segment where the response is above 40%.

You must understand the group above 40%.  The 5 questions to ask them are: 1) who are you (demographically) 2) why did they seek out your product/service?  3) how are they using it 4) what is the key benefit 5) why is that benefit important?

Market Size

Market size is driven by the number of people who believe: they have a problem, they’re willing to pay to solve it, and you’re providing a competitively differentiated value proposition.

Market segments will be driven by: different sets of problems and related value proposition (i.e. this is why tiered pricing is needed), geographies, channels, etc.

#2 Your measurements of customer engagement

Non-revenue metrics can include:

  • Website visits – how many, what they look at, how long they spend on your website
  • LinkedIn followers and visits for your company profile
  • Newsletters – how many sign up, click on content
  • Number of incoming calls and emails
  • Number of meetings and zoom calls
  • Pilots and other paying customers using your solution
  • Letters of intents

Revenue metrics can include:

  • MRR (Monthly Recurring Revenue) from you solutions. This excludes revenue not-related to your solution
  • Customer retention or churn
  • Signed contracts with committed future revenues

#3 Business and Customer Profitability

Profitability is examined from a cash flow perspective, not accounting statements.

Your revenue must exceed the total of: CAC (Customer Acquisition Costs), COGS (Cost of Goods Sold), R&D New Development and G&A (General and Admin).

Your lifetime customer profitability must exceed your CAC. You need to always consider G&A in your profitability analysis.

In a high growth situation, your monthly cash flow may be negative, due to the time lag required for long-term customer profitability to cover CAC.

The foundation is your monthly cash flow forecast, linked to your milestones and assumptions. Your forecast milestones will show the impact of spending on: new product releases, new channels, new partners, CAC, churn, etc. Your tracking will show the actual results.

You must have scenarios, both for revenues and costs.  E.g. would you be profitable if stopped investing in major new product development? What if your churn rate turns out to be higher? What if CAC doesn’t decrease but increases? Etc.

The appendix provides further information regarding customer and business profitability.

What are your next steps?

  • Set up a financial process (including General Ledger) and associated software. The software would ideally support both financial and non-financial metrics.
  • Document your definitions of the different cost components.
  • Create you initial set of assumptions.
  • Start measuring customer perceptions and customer engagement from day 1.
  • Your monthly cash flow forecast and tracking is a critical tool to reduce the odds of running out of cash.

What further reading should you do?

Do you understand your customers?

https://koorandassociates.org/understanding-customers/do-you-understand-your-customers/

Appendix – Customer and Business Profitability

Your monthly cash flow forecast and tracking.

  • This is done on a cash flow basis, not accounting statements.
  • There are four major cost groupings
    1. CAC
    2. COGS
    3. R&D/Engineering/New Development
    4. G&A
  • Further grouping to consider include: customers (and related costs) by cohort, customer segment, channel, partner
  • The cash flow forecast includes:
    1. Links to major milestones
    2. Scenarios – remember, no-one can accurately forecast the future
    3. Capital infusions.

What are the definitions of the metrics?

CAC includes all the costs to acquire a new customer:

  • Sales
  • Marketing
  • Onboard
  • Related compensation of the people.
  • Overhead associated with the people.
  • Technology to support CAC.
  • Legal expenses associated with sales and marketing

If you have a freemium business model, then all of the costs associated with the “free” service fall into CAC.

What comprises cost of COGS? Everything required to meet the direct needs of current customers.  E.g.

  • Customer support people, and software
  • Technology e.g. software, cloud services, communications costs.
  • Bug fix and minor enhancement to the software – after all you do need to retain current existing customers.

What comprises G&A?

  • Payroll administration
  • Recruiting administration
  • Finance
  • IT security
  • Corporate development e.g. M&A
  • CEO salary/benefits
  • Legal expenses (both in house and external), other than those associated with sales contracts

Let’s use QuickBooks to illustrate the concept of the financial metrics.

There is a GL line item for salaries.

Then then there is a class i.e. where does the salary belong?  (i.e. QuickBooks class)

  • CAC?
  • Cost of goods sold?
  • R&D/Engineering/New Development?
  • G&A?
Tom Koor

What is corporate governance? V3

What is corporate governance? V3

 What is the purpose of this article?

The purpose of this document is to enable founders, CEOs, management, investors, shareholders, boards of directors, advisory boards to create a shared understand of their company’s corporate governance.

This article does not provide legal advice.

You can download a PDF of this article from: What is coporate governance V3

 What are the critical learnings in this article?

  • Corporate governance is focused on the board of directors.
  • There can be many difference views regarding the definition of corporate governance, the purpose of corporate governance, ad the purpose of the corporation.

What is corporate governance?

Corporate governance is focused on the board of directors. Governance exists throughout the company, at all levels, and should be aligned with corporate governance.

A definition of corporate governance: “Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and members of the company’s ecosystem.  Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. “1

Based on the above definition, there are four aspects to corporate governance:

  • The focus is on relationships among different types of people.
  • Setting objectives. People set objectives.  The board directors, company management, shareholders, stakeholders and third parties all have different interests and personal objectives.  The conflicts of interest need to be understood and managed to agree upon objectives for the board and for management.
  • Determining how to meet objectives. People have to develop plans which reflect what they will do to achieve the objectives.  Both the board and management have objectives and plans.
  • Monitoring performance. The performance of people (the board and management) is monitored. Everyone needs to understand the personal consequences of not achieving objectives.

Also implied in the above definition:

  • Who can make decisions and how are those decisions made?
  • What are the consequences for decision makers who make poor decisions?
  • Who has the authority to act on behalf of the corporation and in what specific situations?
  • Who is accountable for behaviour and outcomes?
  • How are those people who are accountable for execution involved in decision making?

 What is the board’s decision-making model?

There are several types of decision-making models, including:

  • The jury – 12 non-experts make a decision.
  • The parliamentary or congressional model – non-experts make decisions, which may be based in whole or in part on advice.
  • The judge model – a expert in making decisions based upon rules & principles.
  • The meritocracy model – an expert making decisions based on personal experience and skills.

Or some combination of the above.

What are some of the challenges in company decision-making?

  • Group decision making does not require 100% of the decision makers to be in agreement.
  • The decision making process and enabling technology may hinder decision making.
  • Not everyone’s input can be reflected in a decision.
  • Those not supporting the decision make hinder the successful execution of the decision.

What are the challenges of understanding corporate governance?

Discussion around governance is often very silo based and depends upon the specific background of the governance advisor e.g.

  • Lawyers often start with the Business Corporations Act. Sometimes the legal framework is a social purpose corporation, such as a B Corp., a partnership or a joint venture.
  • Regulators often start with financial risk management guidelines.
  • Accountants often start with quality of financial statements.
  • Consultants have a variety of different points of view.
  • IT (Information Technology) governance advisors have an IT-centric perspective.
  • Private corporations may have unanimous shareholder agreements, which limit the decision making and accountability of the board of directors by reserving certain decisions for the shareholders.
  • Any corporation could have a voting trust comprised of some or all of the shareholders.
  • Financing agreements may have terms and conditions which constrain the company’s decision making and may even provide the financers with decision making authority in certain situations.
  • Values, morals, ethics, company purpose and culture may not be seen as a critical part of corporate governance.

Etc.

Often there this is a legal perspective of acting in the best interests of the corporation or the shareholders or other members of the company’s ecosystem.  What does this actually mean? Two example questions, for which I don’t have the answer:

  • If climate change is real, should the company reduce or eliminate it’s impact on global warming, even if that reduces company profits, shareholder dividends, and compensation for the board of directors and C-Suite?
  • Should the company lobby governments to reduce or eliminate environmental laws and standards in order to increase company profits?

After company management, its board, and its shareholders have heard from several different advisors, there is a confusing and disjoint picture of governance with limited shared understanding.

Sometime there is confusion between a fiduciary(i.e. decision-making board vs an advisory board. 

  • The decision-making board has the authority to make decisions and is accountable for the results of those decisions.
  • The advisory board has no authority to make decision and is not accountable for the actions of the board of directors, C-Suite and others in the company.

 What is the purpose of the corporation?

What is the purpose of your corporation?  Is it solely to make money for shareholders and the C-Suite?

Why have societies and governments put in place the legal and regulatory framework for corporations?  Is it to enable the creation of financial wealth for shareholders and the C-Suite?  Is it so a “business can thrive and sustain growth while enhancing the wealth of its stakeholders and the well-being of societies in which it operates?”2

The U.S. perspective on the relationship between the corporation and society has changed radically since 1981

 In 1981: “Corporations have a responsibility, first of all, to make available to the public quality goods and services at fair prices, thereby earning a profit that attracts investment to continue and enhance the enterprise, provide jobs, and build the economy.” “Business and society have a symbiotic relationship: The long-term viability of the corporation depends upon its responsibility to the society of which it is a part.  The well-being of society also depends upon profitable and responsible business enterprises.”3

In 2016: “Core guiding principles: The board approves corporate strategies that are intended to build sustainable long-term value.”5 There is no mention of responsibility to society.

Larry Fink, in his 2018 letter to CEOs, said “To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate…..Without a sense of purpose, no company, either public or private, can achieve its full potential…..And ultimately, that company will provide subpar returns to the investors”4

 The purpose remains fixed while operating practices, cultural norms, strategies, tactics, processes, structures, and methods continually change in response to changing realities. 5

 What is the purpose of corporate governance?

The purpose of corporate governance is to enable the achievement of the purpose of the corporation, consistent with the corporations values, morals, and ethics.

Corporate governance manages the broad set of conflicts of interests which arise. The OECD governance definition starts with relationships: within corporate leadership, as well as stakeholders and third parties.  Any relationship has the potential for conflict of interest, because company ecosystem members may have different or conflicting interests.  For example, how should both profits and costs be allocated among the ecosystem members, including: CEO, C-Suite, shareholders, employees, and society. This conflict become acute in cases of poor profits or losses.

Perhaps the greatest conflict of interest is deciding the degree to which the corporation extracts value from society versus creating value for society. An example is the decision on whether to whether to replace local community employees with lower-cost offshore staff which may benefit the off-shore communities or retain the employees in order to sustain local communities.

What are your next steps

#1 Survey the board of directors, C-Suite, advisory board(s), and key other members of your company’s ecosystem to determine what they perceive to be:

  • The purpose of your corporation.

#2 Survey the board of directors, C-Suite, and advisory board(s) to determine what they perceive to be:

  • Your company’s corporate governance.
  • The purpose of your company’s corporate governance.
  • Your board of directors decision making model.

#3 Analyze the surveys to identify the implication on value creation.

#4 Agree upon: the purpose of your corporation, your definition of corporate governance, the purpose of corporate governance, and the board’s decision making model.

#5 Review and revise corporate governance documents, processes, and technology to align with #4

#6 Review other governance within your company, to align with #4 and #5 above,

 Footnotes:

1 Based on “G20/OECD Principles of Corporate Governance”, 2015  I added the concept of third parties, https://www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf

2 Dr. Didier Cossin, Boon Hwee Ong, Sophie Coughla, “Stewardship fostering responsible long-term wealth creation”, IMD, Global Board Center 2015, https://www.imd.org/globalassets/board-center/docs/stewardship_2015.pdf

3 Ralph Gomory and Richard Sylla, “The American Corporation”, April 2013, page 6, The Wall Street Journal http://online.wsj.com/public/resources/documents/50b74ca9c91e6TheAmericanCorporation11292012.doc.pdf

4  https://www.blackrock.com/corporate/investor-relations/2018-larry-fink-ceo-letter

5 Page 17 The five most important questions you will ever ask about your organization (2008)   by Peter F. Drucker,  Jim Collins et al, I adapted.

Further reading

What is the purpose of your company?

https://koorandassociates.org/corporate-governance/what-is-the-purpose-of-your-company/

How can the board of directors create value?

https://koorandassociates.org/corporate-governance/how-can-the-board-of-directors-create-value/

Is your company planning to fail?

https://koorandassociates.org/avoiding-business-failure/is-your-company-planning-to-fail/

Tom Koor

What is a value proposition? V3

What is the purpose of this article?

  • Enable founders, investors, C-Suite, boards of directors, shareholders, etc. to understand what a value proposition is and to discuss their company’s value proposition.
  • This article encompasses all members of your company’s ecosystem, but focuses on customers and users.

You can download a PDF of this article from: What is a value proposition V3

What are the critical learnings in this article?

  • A value proposition is someone else’s perception of the value you provide, not your opinion.
  • All members of your company’s ecosystem have a perception of your company’s value proposition.
  • Your company’s growth and survival depend upon your understanding of the key members of your ecosystem and their perception of your competitively differentiated value proposition.
  • Some members of your company’s ecosystem may perceive a negative value proposition e.g. employees who are terminated as part of moving their jobs to lower cost employees elsewhere in the world.

 A value proposition is some else’s perception of the value you provide, not your opinion

  • This perception can be influenced by: facts, emotions, family & friends, social media, etc.
  • Perceptions are both based on fact and emotions. g. many people in the US believe that Donald Trump won the 2020 presidential election, although there are no facts supporting this.

How does someone perceive their value proposition?

Value proposition = (All their perceived achieved benefits) / (All their perceived incurred costs)

  • Perceived achieved benefits can include both financial and non-financial (e.g. time savings, convenience, status, alignment with personal purpose, values, morals, and ethics, etc.)
  • Perceived incurred costs can include financial (purchase costs, costs to switch to your company, other adoption costs, and ongoing costs) and non-financial (time, inconvenience, loss of status, mis-alignment with personal purpose, values, morals, and ethics etc.)

People may include in the value proposition impacts on other members of your company’s ecosystem as well as their personal impact.  E.g. cash paying customers considering buying from companies that pay employees a living wage or from companies that raise animals in a humane manner.

All members of your company’s ecosystem have a perception of your company’s value proposition. E.g.

  • Employees may consider: compensation, working hours, working location, alignment of your company’s purpose with their personal purpose, development programs which increase the value of the employee, etc.
  • Shareholders may consider: long-term shareholder price, company purpose aligned with shareholder purpose (reducing the company’s impact on climate change, increasing diversity (gender, race, sexual identity, sexual orientation, etc.) at all levels of the company.
  • Society may consider: your company’s impact on the environment, the % income tax your company pay’s vs the average taxpayer, whether you pay your employees a living wage, etc.

You need to understand both the customer and the competition.

  • What is the reason the customer wants or needs something?
  • How can you help the customer with what they need or want?
  • Do your customers believe your value proposition is more attractive than the customers’ current situation?
  • How do your customers perceive your value propositions’ competitive differentiators? And weaknesses?
  • How do your customers perceive your competitors’ value propositions differentiators and advantages? And weaknesses?

How is your company going to grow and survive in the marketplace?

Your company will fail if you are not competitively differentiated.

  • Your company’s growth and survival depend upon your understanding of the key members of your ecosystem and their perception of your competitively differentiated value proposition.
  • How other members of your ecosystem perceive your value proposition for them may enable or destroy your company’s success.
  • You may need to provide other members of your company’s ecosystem with a competitively differentiated value proposition. E.g. your current and future employees.

You need to provide your cash paying customers with a competitively differentiated value proposition.

  • You must take market share and business away from competitors.
  • Your customers need to decide to stop dealing with current suppliers and start dealing with you.
  • Your customers need to stay with you.
  • Your customers need to recommend your company
  • You may be creating a new market (e.g. Apple with the iPad)

What are your next steps?

Understand how the critical members of your company’s ecosystem think and feel about your company.

  • Survey the individual members of your board of directors, C-Suite, and key shareholder to identify who they believe are the critical members of your company’s ecosystem.
  • Also ask them what they believe those members view as your company’s competitively differentiated value proposition.
  • Then individually survey those critical ecosystem members to determine how they perceive your company’s competitively differentiated value proposition.
  • Collect the facts regarding those critical ecosystem members e.g. customer/market share growth, customer churn, employee retention, etc.
  • Identify the implications of the above information.
  • Determine what needs to change, in your ecosystem’s members of your company’s value proposition, to enable your company’s future growth and survival

 What further reading should you do?

Do you understand your customers?

https://koorandassociates.org/understanding-customers/do-you-understand-your-customers/

An example of a business ecosystem: What does the Toronto Startup Ecosystem look like?

https://koorandassociates.org/the-startup-journey/what-does-the-toronto-startup-ecosystem-look-like-v4/

Thomas Ripsam and Louis Bouquet, “10 Principles of Customer Strategy”, PWC Strategy& website, https://www.strategy-business.com/article/10-Principles-of-Customer-Strategy?gko=083a5

Tom Koor

Does your board compensation reflect board value?

What is the purpose of this article?

Enable investors, the board directors, and management to discuss the board’s impact on value creation and related compensation.

This article is focused on for-profit company boards, not: charities, government entities, or not-for-profit organizations.

You can download a PDF of this article from: Does your board compensation reflect board value

What are the critical learnings in this article?

  • The board of directors’ impact on value creation is unclear.
  • The relationship between director compensation and value creation is unclear.

Let’s assume your company has the principle that value creation is reflected in compensation. 

Many CEOs, C-suite, and senior executive appear to create massive value.  CEO compensation can range up to $100 of millions per year. Many C-Suite and senior executives make millions of dollars a year.

What does board compensation look like in one of Canada’s largest public companies?

This is a typical situation. I won’t mention the company name, which could distract the conversation.

  • The CEO compensation is more than $10 million per year.
  • The CEO compensation is about three times the total compensation of the board.
  • The average director compensation in this company is what a successful MBA graduate would make in their third year in tier 1 strategy firm.

What is the relationship between board compensation and value creation?

I don’t know. Do the differences between board compensation and management compensation reflect:

  • The board has little impact on value creation?
  • The board has decided to allocate the bulk of its value creation impact to others in the company’s ecosystem e.g. executives?
  • The boards of large companies view their contribution as charitable or giving back to society?
  • Or something else?

The ability of talent to create value in a specific company is impacted by several factors, including:

  • The company’s brand or reputation.
  • Intellectual property.
  • Technology.
  • Processes.
  • Partners.
  • Capital.

What are your next steps?

Discuss and agree upon:

  • Does the board of directors have ultimate authority? If not, who does?
  • Does the board of directors have ultimate accountability for your company’s performance? If not, who does?
  • Does the board of directors have ultimate accountability for your company’s value creation? If not, who does?
  • What is your company’s overall value creation plan and metrics? Your company may not always provide value to every member of your ecosystem.  g. Cutting employment in one country as part of moving jobs to a lower cost country. The overall value creation plan includes board and management. The board and management will have more detailed individual value creation plans.
  • What are the principles used to determine the value creation of each person in the company, including board directors?
  • What are the principles used to determine how much of each person’s value creation should be in their compensation?
  • Based upon the above, discuss the compensation of the board relative to their value creation.

 What further reading should you do?

Professor Dieder Cossin and Estrelle Metayer “Does your board really add value to strategy?”, IMD Global Board Center

First sentence in the article is “Boards are ultimately responsible for the long-term success of their organisations.”

https://www.imd.org/research-knowledge/articles/board-strategy/

“Traditional corporate governance dooms your company to failure”, Koor and Associates

https://koorandassociates.org/corporate-governance/5786-2/

“Is your company planning to fail?”, Koor and Associates

https://koorandassociates.org/avoiding-business-failure/is-your-company-planning-to-fail/

 

Tom Koor

Traditional corporate governance dooms your company to failure. V2

Traditional corporate governance dooms your company to failure. V2

 What is the purpose of this article?

Help shareholders, investors, founders, the board of directors and C-Suite discuss and improve corporate governance.

You can download a PDF of this article from: Traditional corporate governance dooms your company to failure. V2

What are the critical learnings in this article?

  • You need to have a common understand about the purpose and value of governance.
  • You must focus governance on value creation and the ability to survive crisis.
  • You need talent that is qualified to make decisions which result in value creation and enable surviving a crisis. This talent must be supported by processes and technology.

What are some definitions of corporate governance?

#1 “Corporate governance is the system of rules, practices, and processes by which a firm is directed and controlled. Corporate governance essentially involves balancing the interests of a company’s many stakeholders, such as shareholders, senior management executives, customers, suppliers, financiers, the government, and the community.

Since corporate governance provides the framework for attaining a company’s objectives, it encompasses practically every sphere of management, from action plans and internal controls to performance measurement and corporate disclosure”1

#2 The Globe and Mail Board Games survey of corporate governance produces a score of a company’s governance based on 38 sets of criteria in 4 areas: 2

  • Board Composition
  • Shareholding and compensation
  • Shareholder rights
  • Disclosure

#3 OSFI (Office of the Superintendent of Financial Institutions), the Canadian Federal Government Regulator of Financial Institutions, has published its guidelines.  There are 4 major areas:3

  • The Board of Directors
  • Risk Governance
  • The role of the Audit Committee
  • Risk Appetite Framework

#4 Law firms often discuss corporate governance in terms of government laws, regulations, and court rulings.

What are the fatal flaws with many approaches to corporate governance?

  • The focus is on the processes and the degree to which processes are carried out. The impact on profitability and value creation for members of the company’s ecosystem has little or no consideration. Two examples; a) a company could score very highly on the Globe and Mail Board Games, while at the same time losing market share and shrinking profits. b) Facebook has transformed the world and generated enormous profits, while not being a great example of corporate governance.
  • Talent requirements often have little or no consideration in corporate governance. Competitively differentiated talent is the key to the company’s value creation for ecosystem members and for the company’s very survival.  The talent criteria and talent assessment of board directors and the C-Suite often have a limited role in corporate governance.
  • Following all the laws, regulations, and court filings do not result in large numbers of cash paying customers.  Many rapidly growing companies are in areas with limited laws etc.  Innovation often is far ahead of government regulation.
  • Corporate governance objectives and practices in a public company with no controlling shareholders are very different from those with a controlling shareholder or in private companies, especially those with unanimous shareholder agreements.
  • The traditional concept of a skills matrix for board directors is obsolete. Early-stage companies, Venture Capitalists, and Private Equity seek directors who are able to enable value creation.  g., I was in a meeting when a director asked if they were going to be nominated for another year.  The response was “what value are you going to provide next year?” A value creation matrix (formal or informal) is being used by companies focused on value creation.
  • Leaders get confused about their roles i.e. the degree to which they coach and mentor talent vs make decisions about talent. g., some board directors attempt to coach and mentor the CEO. It then become difficult to challenge the CEOs recommendations when the directors were involved in the creation of the recommendations.
  • Corporate governance is often focused only on the board of directors and C-Suite. Corporate governance is much broader than that.
  • The skills and experience necessary to make decisions is unclear. g. some governance advisors believe that no skills and experience are required when voting on whether to appoint a CEO or terminate a CEO.  The advisors cite the example of U.S. Congress or Canadian Parliament, where no skills or experience are required for any vote by any member.  Other advisors use the example of the Supreme Court, wh,ere every single justice must have the skill and experience to vote on every decision.
  • The competitive differentiation of the board of directors is often ignored. It is challenging to have a competitively differentiated company without a competitively differentiated board.
  • There is no clearly defined link, and common understanding, of how corporate governance specifically enables your company’s long-term value creation and ability to survive crisis.

 

What are your next steps?

  • Read “Is your company planning to fail?”4 I observe that most companies are successfully executing their plans to fail.
  • Agree upon the purpose of your company.
  • Agree upon your company’s definition of governance and the purpose of governance.
  • Assess your company components (talent, knowledge, processes, technology) relative to your definition of governance and the purpose of governance. This assessment includes the board of directors and C-Suite.
  • Prepare your plan to improve governance.

Footnotes

1 Investopedia 2022 August 22

https://www.investopedia.com/terms/c/corporategovernance.asp

2 Globe and Mail Board Games – 2022 August 222

https://www.theglobeandmail.com/business/careers/management/board-games/article-article-canada-corporate-boards-ranked-2021/

3 Office of the Superintendent of Financial Institutions – Corporate Governance – Sound Business and Financial Practices – September 2018

https://www.osfi-bsif.gc.ca/eng/docs/cg_guideline.pdf

4 Is your company planning to fail? Koor and Associates

https://koorandassociates.org/avoiding-business-failure/is-your-company-planning-to-fail/

What further reading should you do?

  • What is the purpose of your company?

https://koorandassociates.org/corporate-governance/what-is-the-purpose-of-your-company/

  • What is corporate governance?

https://koorandassociates.org/corporate-governance/what-is-corporate-governance/

  • What is a competitively differentiated board of directors?

https://koorandassociates.org/corporate-governance/what-is-a-competitively-differentiated-board-of-directors/

  • What are the decision-making challenges faced by directors?

https://koorandassociates.org/corporate-governance/what-are-the-decision-making-challenges-faced-by-directors/

  • How can the board of directors create value?

https://koorandassociates.org/corporate-governance/how-can-the-board-of-directors-create-value/

  • What are the core components of talent?

https://koorandassociates.org/creating-business-value/core-components-of-talent/

Tom Koor

Traditional risk management dooms your company to failure.

What is the purpose of this article?

Help shareholders, investors, founders, the board of directors and C-Suite discuss and improve risk management governance.

You many download a PDF of this article from: Traditional risk management dooms your company to failure

What are the critical learnings in this article?

  • Traditional risk management in many companies does not address some of the fatal risks:
  • The talent in the board of directors and C-Suite.
  • Understanding of the cash paying customer problems and needs.
  • Understanding the company’s ecosystem.1
  • Enabling company growth and value creation.

What are some definitions of risk management?

#1 “Risk management is the process of identifying, assessing and controlling financial, legal, strategic and security risks to an organization’s capital and earnings. These threats, or risks, could stem from a wide variety of sources, including financial uncertainty, legal liabilities, strategic management errors, accidents and natural disasters.” 2

#2 “Dynamic risk management has three core component activities: detecting potential new risks and weaknesses in controls, determining the appetite for risk taking, and deciding on the appropriate risk-management approach” 3

#3 “ERM (Enterprise Risk Management) is a forward-looking management discipline designed to provide board and senior leaders a top-down, strategic perspective of the portfolio of risks they need to proactively manage to achieve business strategy, financial objectives and, as of 2019, corporate purpose.”4

 What are the fatal risks not addressed in many approaches to risk management?

Driving growth and profitability are not highly important risk management goals in companies. McKinsey did a survey of what goals companies had for enterprise risk management.5Two industries were examined. The companies scored goals from1:low to 4:high.

Energy company scores:

  • Drive profitability and growth 1.8
  • Ensure regulatory compliance 2.2
  • Protect value: 3.4

Advanced company scores (high tech and assembly)

  • Drive profitability and growth 1.0
  • Ensure regulatory compliance 4.0
  • Protect value: 2.5

The greatest risk to a company is not having competitively differentiated talent.  It is talent that understands the company’s ecosystem, provides value to key ecosystem members (e.g. cash paying customers and users), creates competitively differentiated solutions, acquires the necessary technology, make decisions, executes decisions, etc.

Many company leaders (board directors and C-Suite) believe that the only talent issues lie deeper in the organization and not with themselves.  Few have asked “Am I the right person”.  I recall a wonderful meeting with a board director who had great self-awareness.  He resigned from a large company board.  He told me why he felt his value to the board had dropped.

The second greatest risk is not understanding the cash paying customers problems and needs, as well as the perceived value of meeting those needs.

The third greatest risk is not understanding the company’s ecosystem5 or even realizing that the company has an ecosystem.

What do I observe about traditional risk management?

  • Traditional risk management is focused on secondary risks, many of which are addressed by management and staff below the C-Suite.
  • The above fatal risks, especially the talent and capabilities with the board of directors and C-Suite, are often not addressed.
  • Companies controlled by hedge funds, private equity, venture capital, and sophistical family office often do address the above fatal risks, especially the talent.

What are your next steps?

  • Determine who is accountable for ensuring the appropriate talent is on the board of directors, along with the necessary processes for: assessment, recruitment, development, and exiting.
  • Determine who is accountable for ensuring there is a shared understanding of customer problems and needs among the board of directors, C-Suite, and the rest of the organization.
  • Determine who is accountable for ensuring there is a shared understanding of customer problems and needs among the board of directors, C-Suite, and the rest of the organization.
  • Determine who is accountable for ensuring that there is a shared understanding of the company’s ecosystem.
  • Assess how the above items drive your company’s short and long-term actions.
  • Identify who is accountable for the improvements and the results of the improvements.

 Footnotes

1 “A business ecosystem is the network of organizations—including suppliers, distributors, customers, competitors, government agencies, board of directors, C-Suite, employees, and so on—involved in the delivery of a specific product or service through both competition and cooperation. The idea is that each entity in the ecosystem affects and is affected by the others, creating a constantly evolving relationship in which each entity must be flexible and adaptable in order to survive as in a biological ecosystem.” Adapted from Investopedia 2021 Jan 20

 2 IBM Risk Management article – 2022 August 22

https://www.ibm.com/topics/risk-management

3 McKinsey 2022 August 22

https://www.mckinsey.com/business-functions/risk-and-resilience/our-insights/meeting-the-future-dynamic-risk-management-for-uncertain-times

4 Ernst & Young

https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/home-index/ey-alm-pacesetter-research-enterprise-risk-management-2020-2021-full.pdf

5 Enterprise Risk Management Practices: Where’s the evidence? February 2014

https://www.mckinsey.com/business-functions/risk-and-resilience/our-insights/enterprise-risk-management-practices-where-is-the-evidence

Tom Koor

What will be the board and C-Suite talent requirements? V2

What is the purpose of this article?

Enable the board of directors and C-Suite to have a discussion regarding their talent requirements and how to manage those requirements.

You can download a PDF of this article from:  What will be the board and C-Suite talent requirements V2

What are the critical learnings in this article?

  • A company without a competitively differentiated board of directors and C-Suite will not survive.
  • Define the current and future value contribution required from each role. Assess each candidate’s capabilities in terms of their historical impact on value and their future potential to impact value.

What type of company is this article appropriate for?

  • Public companies with no controlling shareholder or group of shareholders (e.g. no founders with dual class shares, no voting trust).
  • This article is not designed for private companies with a unanimous shareholders agreement reserving key decisions (e.g. CEO appointment, value creation/strategic plan approval) for shareholders or investors.

Your company’s future is uncertain.

  • The future global environment is uncertain. (e.g. technology, politics, the economy, climate change)
  • Both the future members of your company’s ecosystem, and their interactions are uncertain. Members of your company’s ecosystem include: customers, employees, local communities, society, and investors.
  • Becoming or remaining a large company requires understanding the problems and needs of customers who are willing and able to pay. These problems and needs often change over time.
  • Becoming or remaining a large company requires creating and maintaining competitively differentiated solutions and assets. These solutions and assets will be constantly changing and evolving in your company’s uncertain future.

Why do you need a talented and competitively differentiated board of directors and C-suite?

  • It is your company’s competitively differentiated talent which develops competitively differentiated solutions and assets based on a competitively differentiated understanding of your company’s ecosystem members.
  • Capital availability has grown dramatically over the past 10 years, and is close to unlimited. The availability of quality talent has had little growth.  The scarcest talent of all are those people who are able to grow and develop the capabilities of others. Great teams need great coaches and advisors.

What drives talent requirements for the board of directors?

The director can enable long-term success and value creation via the decisions they make; and the actions they take.

The decisions may include:

  • Appointment, termination, and compensation of the CEO.
  • Review and approval of the CEO’s value creation plan (often referred to as the strategic plan)
  • Ensuring there is a pool of successors for the CEO and the C-suite.

The value creation actions may include:

  • Representing the company with key members of the ecosystem such as government.
  • Introducing the company to the directors’ network of relationships such as: investors, potential employees (including CEO and C-suite successors), suppliers, business partners.

The directors must have history of enabling value creation.

  • Directors are like airline pilots. They aren’t needed when the company is smoothly executing the flight plan.  The directors are needed when there are problems, crisis and black swan events. E.g. replacing the CEO.
  • Each director needs a history of decisions which have resulted in major value creation. For example, past appointments of CEOs who successfully executed their value creation plans. If a director has no history of appointing CEOs, or approving C-suite members, then you need to carefully consider whether they should be nominated. Director education is insufficient.  You cannot learn to ride a bicycle by only reading about it.  You actually have to get on the bicycle and ride it, and perhaps fall many times.
  • If directors are expected to directly create value by their own actions, then they should have a history of actions which have created value.
  • The directors as a whole need relevant current understanding of: customers, target markets, adjacent markets, key components of the company’s ecosystem, and the global environment.

What drives talent requirements for the CEO?

There are three things only the CEO can do, and no one else in the company:

  • Create and maintain alignment of people with the purpose of the company.
  • Nurture the company’s values, morals, and ethics (often referred to as culture).
  • Hire the leadership team and ensure they work well together.

The CEO must be able to oversee the creation and execution of the value creation plan for the company, and modify the plan quickly as circumstances change.

What are the common talent characteristics of the board and C-Suite?

  • They must have fluid intelligence. Fluid intelligence is the capacity to think speedily and reason flexibly in order to solve new problems without relying on past experience and accumulated knowledge. The uncertain future means that decisions must often be made for which past experience and knowledge is obsolete.
  • They must be able to quickly learn new facts, knowledge, processes etc. and unlearn what is obsolete.
  • They must be passionately curious to understand the world around them.

What are the other sets of critical talent supporting the board and C-Suite?

  • World class teams need world class coaches. The athletes who win gold at the Olympics also have the best coaches in the world.
  • The CEO needs a coach or advisory board, as part of the ongoing development of the CEO. The board of directors cannot coach or mentor the CEO due to conflict of interest.  g. A director could not vote on something which the director has coached the CEO to create – the director would be voting on themselves.
  • The board chair also needs a coach or advisory board.
  • Some members of the C-Suite may also need coaches, especially if they are potential CEO successors

What are your next steps?

Create ongoing process for managing Board of Directors, CEO, and C-Suite talent.

  • Outline the members of your company’s ecosystem, including customers.
  • Describe the components of the global environment which may impact your company’s ecosystem.
  • Create multiple future scenarios for your company.
  • What are the implications for the talent you may need: board of directors, C-Suite, CEO advisory board, and Coach(es) for directors.
  • A company without a competitively differentiated board of directors and C-Suite will not survive.
  • Define the current and future value contribution required from each role. Assess each candidate’s capabilities in terms of their historical impact on value and their future potential to impact value.
  • Determine whether or not the board has a role and accountability for value creation. e.g. relationships with 3rd In private companies, the board and shareholders/investors often have a role and accountability for value creation. In many public companies the board does not have a value creation plan. The only value creation plan is the one the CEO is accountable for.
  • Prior to a new director being nominated, they should be a compensated board observer for one year. This allows them to be evaluated.

What further reading should you do?

Why are values, morals, and ethics important?

https://koorandassociates.org/values-morals-and-ethics/why-are-values-morals-and-ethics-important/

What is the purpose of your company?

https://koorandassociates.org/corporate-governance/what-is-the-purpose-of-your-company/

Is your company planning to fail?

https://koorandassociates.org/avoiding-business-failure/is-your-company-planning-to-fail/

Traditional strategic planning dooms companies to failure.

https://koorandassociates.org/strategy-and-strategic-planning/traditional-strategic-planning-dooms-companies-to-failure/

Tom Koor

What is public company governance? V2

What is the purpose of this article?

Provide a framework which enables public company shareholders, boards of directors, C-Suite, and other to begin discussing what is governance.

This article is written from a Canadian perspective.  Governance varies significantly around the world.

This article does not provide legal advice.

You can download a PDF of this article from: What is public company governance V2

What are the critical learnings in this article?

You have to determine what exactly is meant by governance in your public company’s specific situation.  No outside expert can tell you because there is no one single answer

What is a public company?

The definition and characteristics of what is a public company depends upon the where the company is legally based.

  • In Canada a public company is “a company whose shares trade on a stock exchange”1
  • “German Public Limited Company (Aktiengesellschaft-AG) is a company having a legal personality of its own. It ownership is organized via shares of stock. As a general rule, the shares of stock can be transferred by the stockholders.  A public company can be listed on a stock exchange (listed company) or not (unlisted public company)”2

What is corporate governance?

“Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and members of the company’s ecosystem.  Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. “1

This definition has 4 components:

  • Relationships among the company’s ecosystem members.
  • Decision making i.e. setting objectives and approving action plans.
  • Action plans i.e. means of attaining those objectives.
  • Performance monitoring of the objectives, action plans, relationships.

Discussion around governance is often very silo based and depends upon the specific background of the governance advisor e.g.

  • Lawyers often start with the Business Corporations Act. Sometimes the legal framework is a social purpose corporation, such as a B Corp., or a partnership or a joint venture.
  • Regulators often start with financial risk management guidelines.
  • Accountants often start with quality of financial statements.
  • Consultants have a variety of different points of view.
  • IT (Information Technology) governance advisors have an IT-centric perspective.
  • Values, morals, and ethics may not be seen as a critical part of corporate governance.

Etc.

Often there this is a legal perspective of acting in the best interests of the corporation or the shareholders or other members of the company’s ecosystem.  What does this actually mean? Two example questions, for which I don’t have the answer:

  • If climate change is real, should the company reduce or eliminate it’s impact on global warming, even if that reduces company profits, shareholder dividends, and compensation for the board of directors and C-Suite?
  • Should the company lobby governments to reduce or eliminate environmental laws and standards in order to increase company profits?

After company management, its board, and its shareholders have heard from several different advisors, there is a confusing and disjointed picture of governance with limited shared understanding.

In Canada, there is a broad range of decision making authority in a public company. Some of the possibilities are listed below.

  • Public company with no controlling shareholder. Shareholders elect directors and approve major change. Thus, the board directors have the bulk of decision making authority, but may delegate much of this authority to the CEO.
  • In certain cases, shareholders with a large equity or voting interest in the company have the legal right to appoint a director or directors.
  • A public company may have a voting trust. One person had the authority to vote all of the shares in the voting trust.  There are situations where the voting trust controls more than 50% of the votes. This often enables the person who votes the trust’s share to have major influence on company decision.
  • A public company may have dual class shares. Some shares may have no voting rights. Some shares may have multiple votes.  Thus, a person, or group, with a small amount of equity may have voting control of the company.  This may occur with company founders or the founding family.
  • Financing agreements may have terms and conditions which constrain the company’s decision making and may even provide the financers with decision making authority in certain situations.
  • OSFI (Office of the Superintendent of Financial Institutions) requires pre-notification of the appointment of officers or nomination of directors for the financial Institutions OSFI regulates. OSFI then has the opportunity to share any concerns or comments.

An interesting example of public company governance and the role of the board of directors occurred in Canada in fall 2021. The board of directors of Rogers Communications (a multi-billion dollar company) removed Edward Rogers, the board chair. Mr. Rogers, who controlled 97.5% the voting shares, then removed a number of directors and put in place directors who re-appointed him as board chair.  What I observed was, if directors did not do as they were told by a shareholder, the shareholder would then replace them with directors who would do as they were told.

What are your next steps?

  • Identify the decisions within your company’s ecosystem which have the greatest impact on value.
  • Define who has the authority to make those decisions. As noted above, many decisions impact your company are made by people outside of your company.
  • Remember that some people, who don’t have legal authority, may still have moral persuasion powers (e.g. If OSFI in Canada expresses major concerns about a potential board director, what will the financial institution do?).
  • Look at the regulatory regimes and governance practices of the different jurisdictions your company operates in, provides services or products, or has suppliers in.
  • Consider different scenarios. Who makes decisions can be very different in crisis than in the situation where everything is wonderful.

 Footnotes:

1 https://www.bdc.ca/en/articles-tools/entrepreneur-toolkit/templates-business-guides/glossary/public-company

2 https://www.german-probate-lawyer.com/en/glossary/def/public-limited-company-aktiengesellschaft-ag.html

What further reading should you do?

What is the purpose of your company?

https://koorandassociates.org/corporate-governance/what-is-the-purpose-of-your-company/

What is corporate governance?

https://koorandassociates.org/corporate-governance/what-is-corporate-governance/

How does the board of directors create value?

https://koorandassociates.org/corporate-governance/how-can-the-board-of-directors-create-value/

“What CEOs really think of their boards”, Jeffrey Sonnenfeld, Melanie Kusin, and Elise Walton.  Harvard Business Review 2013 April

https://hbr.org/2013/04/what-ceos-really-think-of-their-boards

“Does your board really add value to strategy?”, Professor Dieder Cossin and Estrelle Metayer, IMD Global Board Center

https://www.imd.org/research-knowledge/articles/board-strategy/

Tom Koor

What is different about private equity governance? V2

What is the purpose of this article?

  • Enable shareholders, board of directors, and C-suite to have a discussion regarding what is different about PE (private equity) governance.
  • This article provides general concepts. You need to understand your specific situation.  You should consult your lawyers for legal advice.  This article does not provide legal advice.

You can download a PDF of this article from: What is different about private equity governance V2

What are the critical learnings in this article?

  • PE shareholders and PE governance is focused on value creation.
  • In a private company with PE shareholders, the decision making authority of the board of directors and of shareholders can be very different from public company governance.

Where does PE fit into the overall governance framework?

There is a broad range of how decision making is structured in different types of companies.

  • Public company with no controlling shareholder. A founder might still have effective control, even though they have less than 50% of the voting shares.
  • A public company may have a voting trust. One person had the authority to vote all of the shares in the voting trust.
  • A public company may have dual class shares. Some shares may have no voting rights. Some shares may have multiple votes.  This enables founders and families to retain voting control of a company even when they have a minority of the shares.
  • A public or private company may have PE shareholders. They may have certain rights, such as being able to appoint a certain number of board directors.
  • In a private company, PE may have a wide range of governance options.

PE and management are aligned with a common focus on long-term value creation.

Shareholders, the Board and C-Suite all focused on value creation with a common set of metrics.

  • Decisions are based on maximising this long-term value, even if short term quarterly or yearly profits are impacted.
  • PE firms often have exit time horizons, often between 7 and 10 years.
  • The bulk of potential management compensation is aligned with the value shareholders achieve when they exit.
  • There some PE funds with long-term or perpetual time horizons, which require more complex compensation structures and metrics for management.

Public company shareholders and management are often not-aligned.

  • Many public companies do not have long-term value creation metrics, targets, or regular reporting of results against these targets.
  • Many shareholders, such as pension funds have a long-term time horizon. The board of directors and management are often focused on quarterly and yearly targets, and achieving the public guidance they have issued.
  • Management compensation is often not aligned with shareholder returns. For example, when share value drops: management is often issued new stock options at a lower price; management is still given major bonuses; etc.

The PE asset class has outperformed public company markets.

PE has outperformed public market benchmarks over the last five-, ten-, and 20-year periods.1

Public companies often have little significant long-term value creation.

Mark Leonard, CEO of Constellation Software, in his April 20, 2018l CEO letter. “Qualified and competent Directors are very rare, and not surprisingly, the track record of most boards is awful. According to the 2017 Hendrik Bessembinder study of approximately 26,000 stocks in the CRSP database, only 4% of the stocks generated all of the stock market’s return in excess of one – month T-Bills during the last 90 years. The other 96% of the stocks generated, in aggregate, the T-bill rate over that period. This means that 4% of boards oversaw all the long-term wealth creation by markets during that period. Even more disturbing, the boards for over 50% of public companies saw their businesses generate negative returns during their entire existence as public companies.” 2

PE company board directors and shareholders have a deep understanding on the company.

PE boards and shareholders may:

  • Have deep involvement with the company, unlike many public company boards.
  • Have two-way communications with the CEO and C-Suit weekly or more often.
  • Have support staff to analyze ongoing company reporting and do follow-up questions.
  • Regularly assess whether or not there is the right CEO.
  • Require the CEO to have a coach.
  • May have a board director or PE shareholder deeply involved in critical value creation initiatives such as M&A.

Public company boards often:

  • Take the approach of “noses in, fingers out”, unlike private equity which has fingers in.
  • Have limited two way communications engagement with the CEO and C-Suite.
  • Only have third-party analysis of the company when there is a crisis or major event.
  • Assess whether there is the right CEO only when there is a crisis.
  • Do not have directors deeply involved in critical value creation activities.

The majority of public company directors have limited understanding of their companies.

A McKinsey survey of board directors showed that most had little understanding of their companies. Only 16 percent said directors strongly understood the dynamics of their industries, just 22 percent said they were aware of how their firms created value, and a mere 34 percent said they fully comprehended their companies’ strategies.3

What are some of the decision making differences between a public company with no controlling shareholder vs a private company controlled by PE shareholders.

In public company some of the decisions with the greatest impact on long term value are made by the board e.g.

  • Approving the CEO’s strategic plan.
  • Approving major business changes or major changes to financial leverage.
  • Appointing or terminating the CEO.
  • Nominating directors, who require election by the shareholders.

The above decisions in a private company controlled by PE are often made by the shareholders. Sometimes the shareholders may set the strategy and appoint a new CEO to carry out the new strategy.

Fundamental corporate transactions (e.g. sale of company, merger, sale of substantially all assets of corporation) often require shareholder approval.  The decision making process can be much faster in a private company.

PE shareholders may the authority to restrict or even over-ride the decision making authority of the board of directors.

  • PE shareholders may have a unanimous shareholders agreement, which specifically limits the decision making authority of the board of directors and reserves certain decisions for shareholders. In this scenario, PE shareholders have the potential to veto any board decision or make any decision on behalf of the company.
  • PE shareholders may have certain veto powers over certain company decisions even without controlling votes.
  • PE shareholders may be in a voting trust enabling one individual to make decisions based on the voting rights of all the trust members.

What are your next steps?

If you are in a PE governance environment, either a stable situation or transitioning:

  • Step 1 is to document the expectations of the key members your governance environment, which may include: PE shareholders, the board directors, C-Suite, regulators, etc.
  • Step 2 identify the differences in expectations.
  • Step 3 outline the principles and process for moving towards a common set of expectations.
  • Step 4 assess your legal governance documents relative to expectations and make the required changes. Not all expectations can be included in legally binding documents.
  • Step 5 put in place an ongoing process to monitor and manage expectations.

What if you’re not in a PE governance situation? Your next steps are the same. You will still need to understand and manage the expectations of major shareholders.

 Footnotes:

1 A year of disruptions in the private markets McKinsey Global Private Markets Review. April 2021, Page 22

2 https://www.csisoftware.com/docs/default-source/investor-relations/presidents-letter/presidents-letter-april-2018-final.pdf

3 “Corporate Boards need a facelift”, Eric Kutcher, (McKinsey Partner) McKinsey website, May 4, 2018

https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/the-strategy-and-corporate-finance-blog/corporate-boards-need-a-facelift

What further reading should you do?

What is corporate governance?

https://koorandassociates.org/corporate-governance/what-is-corporate-governance/

What are your company’s decision making principles?

https://koorandassociates.org/corporate-governance/what-are-your-companys-decision-making-principles/

What is the purpose of your company?

https://koorandassociates.org/corporate-governance/what-is-the-purpose-of-your-company/