Making the Board an Effective Crisis Manager

Directors of private equity portfolio companies have a curious double mission — not only to act as fiduciaries for the investors (protecting the value of assets and ensuring financial controls are in place, for example) but also supervising the strategic transformation of the company. A board member at various companies may, for example, oversee the sale of non-core assets for debt reduction or the execution of an add-on acquisition. The board’s role in these companies is magnified in many cases by the sense of urgency arising from relatively short holding periods and also by the relative thinness of management resources.

This is why many private equity investors seek associates and partners with prior careers in consulting — their data-driven approach is prized both in and outside of the boardroom.

PE firms usually make acquisitions with a number of hypotheses in mind, and empower the board to follow a certain strategic mission. What happens when that mission falls short? How should a board respond in a crisis?

Some boards do not acknowledge the failure of the strategy. Instead, they look for improved execution. A favorite story of mine involves a friend who consulted to a company that was marketing a flat LCD technology as part of a “smart” parking meter product. My friend convinced the company that they should market the product in something more ambitious, such as flat televisions. It was the change of the strategy, not better execution, that changed the fortunes of the company. (My personal contribution to the effort, which was over 20 years ago, was to ask why anyone would want a flat television.)

But how can boards generalize that experience to provide governance rules for crisis management? The answer is to demand that management defines, and then acts to promote the firm’s core products and core customers. A core product is one which has characteristics of sufficiently-high gross profit and steady demand so as to make the business sustainable. A core customer pays for the core product.

For example, years ago I represented an investor group in their purchase of a men’s dress footwear company. Management’s board presentations emphasized the fashion forward nature of their new product, an imported Italian loafer. To accompany this rollout, the company had plans for making inroads into high-end retailers.

After nearly a year into the investment, the sales volumes were good but the company performance suffered from lack of profitability and a deteriorating bank relationship. The board challenged the management story line that the high-end products were core; instead, we believed them to be a new business. What was the true core business?

It turns out the core product was a dress military shoe that was sold almost exclusively to the base exchange system. The demand was steady, engineering and support costs quite low and the customer paid on time. This contrasted the high costs of managing the export relationship and the extreme demands (and related outlays) of high-end retailers.

The board has misunderstood that management’s definition of “core” product included their own personal aspirations for the business. However, by demanding that the management presentation refer to the first principles of profitability and stability of demand, it was able to define the sustainable business and reorient the aspirations of management and the duties of the board to reap a handsome return.

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