Protecting Investor Interests: Quick Assessment, the Short List

Dec 052009

Governance, Oversight and Reporting: One of the most ignored corporate functions, particularly in start-ups, is governance. Oversight is the mechanism that investors use to keep track of the company’s performance and challenges. The lack of an effective board of directors and oversight is a condition that I frequently encounter. Investors attempt to engage in oversight through a range of alternative strategies, but none are as effective as a well run and populated board of directors.

Governance and oversight are actually a far more complex and subtle issues than it might initially seem. All investors rightfully insist on being involved in their portfolio companies. The real question is how and how much involvement. There are a number of approaches that I look for. All of them can have negative impacts on the company.

The Shadow CEO: This situation occurs mostly in start-up and middle-market, privately held companies and with investors who have had some success in their own right. An angel investor might insist on micro-managing the CEO of the company. The result is a form of castration. The CEO does not have the ability or authority to fill the leadership role. The team quickly realizes that the real power behind the throne is the investor. As a result, the team is dysfunctional and results suffer. Companies run in this way seldom prosper.

My Way or the Highway: I know one investor who reduces all of his investments to spreadsheets. He insists on detailed analysis and grumbles when the CEO or CFO does not know how to create complex spreadsheets. As a result, all of his portfolio companies suffer. There is little recognition that business is, first and foremost, about the team and teams are all about team members. The investor has a strong anti-humanist personality. Interpersonal issues are ignored and the teams tend to disintegrate. Another investor has a strong focus on product development but little patience for marketing and sales. This is mostly because her background is in the technology that allowed her to build a company and sell it out for a fat profit. But, as an investor, she confronts every challenge as if it was twenty years ago when conditions allowed such blind spots.

The Crazy, Rich Uncle: Another investor takes a ‘kindly uncle’ approach to ‘helping the kid get started in business’. Oversight tends to be a series of ‘firm conversations’ followed by another check. The investor, who built a couple of businesses and sold them, talks in terms of those businesses in their mature state. The lessons he delivers do not relate to the challenges that the CEO is facing. Lacking professional oversight, the CEO tends to tolerate the crazy uncle’s tendency to tell irrelevant stories as long as the checks keep coming.

When asked by investors about the best way to build a board for their companies, I always deliver the same message. “You stay off the board. Let’s find three potential board members who understand the space the company is operating in and let them provide oversight. They will report to you as shareholders”.

Protecting Investor Interests: Good governance is the key to enforcing performance metrics. Enforced performance metrics are the best way to avoid the problems discussed above. Protecting investors’ interest involves putting both in place.

From my experience, there is value worth saving in most portfolio companies. Some will not survive as a free-standing company. They will need to be merged into another, larger and more professionally run operation. Others will need major surgery. This is particularly true in cases where the core of the value proposition is very good but the management team is not the one to monetize it. I find this regularly in companies that have made strides in the past but are now stuck on a revenue plateau. The old saying ‘the people who got you here are not the ones who will take you to the next level’ is often relevant. It is rare that I recommend follow-on investment without alteration of the performance metrics and governance approach. Additional investment is a serious step and should be approached as an opportunity to ‘tighten up’ the understanding between investors and the management team.

In the advisory business there are lots of consultants who work with management teams. Their advocacy supports the team’s agenda. But there are few who operate as I do. I stand to protect the interests of the investors.

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