Entrepreneurial Governance, the next step

Private equity has consistently outperformed public markets. In the past this was attributed to more aggressive capital structures and strongly aligned management incentives. However, with an increasing portion of value driven by operational improvements and rising awareness for ESG, private equity’s entrepreneurial governance is increasingly recognised as the foundation for stakeholder value growth. In their 2018 study on the topic, Partners Group concludes that “public markets have lost entrepreneurial ground to private markets due to an excessive focus on a corporate governance regime that has evolved far beyond its original mandate to protect shareholders”. Partners Group’s conclusion is that “Governance Correctness” has stifled entrepreneurial risk taking needed for value growth in public firms.

Clearly, entrepreneurial governance in private equity starts at the top, with the board and senior management. Funds are therefore pushing to strengthen their senior advisor networks as a way to build deep industry and executive competence for better board-level governance. EQT pioneered the approach from its inception. Their separation of top-level governance responsibility between the fund, the CEO and the Industrial Advisor/NED has served the fund well by providing clear checks and balances covering diverse aspects of inclusive value growth.

However, times are changing. One consequence of elevated deal multiples is more pressure to deliver profitable growth even faster. To do so, good governance is not only needed in the board room, but also at all other levels in the portfolio company, down to the shop floor – where “the rubber-hits-the-road”. Accelerating the adoption of better management processes at all levels and in all functions has become the biggest bottleneck to value creation. It explains the increasing number of Operating Partners, and trend we notice of funds providing more structured management training and best-practice exchanges between portfolio companies.

With a few exceptions, there is however still a lack of tools and scalable methods to systematically measure and improve governance processes throughout portfolio companies. Functional governance is left up to individual managers to define based on their past experience and “tribal knowledge”, with no standards or documented good practices. Most incumbent managers therefore struggle to challenge their own management processes in context of a new value creation plan and are often blind to “what good looks like”. It’s an area with broad variance and therefore great opportunities for performance improvement.

In order to address this challenge, Humatica looked at the few successful companies that have codified their management processes, like Danaher with their “Danaher Business System” and CGI’s “Management Foundation”. We adapted a proven methodology for measuring management process maturity from the IT industry and applied it to all functions. By codifying what good management processes look like for different industries and situations in a comprehensive “maturity model”, the quality of governance in any function can be assessed and better practices transferred.

This helps sponsors and portfolio company leaders to quickly pin-point and implement improved governance processes that enable on-time delivery of the value creation plan. And, it’s a lot faster and a lower risk way of upgrading governance than hiring-in “tribal knowledge” from the outside.