To start to answer those questions, it’s important to understand why PE firms seek representation on the board in the first place. 

PE firms operate in a world of uncertainty – they don’t know what their return on investment will be in any single company they invest in. In fact, they risk losing everything if the growth plan fails spectacularly and the company goes bankrupt. 

Consequently PE firms naturally feel more secure if they get seats on the board so that they can influence the executive management and agree or veto changes made to the original business plan. Ideally that would be a senior director from the PE firm and usually a more junior colleague for back-up cover.

The PE house will feel even more confident in achieving the business plan if the board also comprises a chair or an independent NED with relevant sector knowledge and experience. In fact, many PE firms will only invest in a company if they can find a compatible, independent chair or NED who will invest alongside them. The non-executive is there to help the board achieve the growth plan and for the PE firm to realise its desired return on the investment in the business.  

As a rule of thumb, PE firms target an internal rate of return on their funds of around 20 to 30% (or more), which doubles the invested funds in three to four years – a ‘buy low, grow fast, sell high’ strategy.  Clearly, with the ultimate aim of exiting with an outsized gain after several years, it is no surprise that PE houses seek their own places on the board to protect their investment, as well as an independent chair or NED to help reach the full potential value of the business over the agreed time horizon.

The core competency of PE firms is doing deals and the people are mainly from finance and merger and acquisition backgrounds. As ‘money’ people they are specialists at allocating capital efficiently and, combined with great charm, they are excellent at getting deals done. As a result, their skill levels for the deal process are high. Ideally the PE director on the board has had some business experience outside PE or finance but a commonly expressed opinion of executive management is that many PE directors lack operational or management experience in industry. 

Against this backdrop, non-executives can add significant value to PE firms by bringing their technical, commercial and leadership skills, hard-earned in industry over multiple market cycles, to help the business achieve its goals. They fill any gaps in the board’s capabilities, whether functional-specific expertise such as finance, technology or marketing, or sector-specific experience, or both.  The best non-executives also act as an independent bridge between management and the investors, translating and navigating the unfamiliar world of private equity for management and, similarly, the nuances of the company’s business for the PE house. Additionally, they can filter any PE firm’s demands which may be unnecessary and a distraction to management. 

It is fair to say that management tends to believe that real value creation is due to the executive team, by growing the business and improving profitability. Where executives do recognise PE firms make a significant contribution to the value uplift, it is through providing capital to grow the business, helping to optimise the business plan, removing any constraints on management and bringing in missing expertise. 

By building a relationship based on openness, support and trust with the management team, chief executive and PE house, the non-executive can play a significant role in pulling all of these value levers. In this way the NED provides further confidence to the PE firm that their investment is being used efficiently.  

Furthermore, by investing their own money in the company on the same terms as the PE firm, non-executives have ’skin in the game’ and their interests are aligned with other shareholders. Everyone has a vested interest in the company doing well.

A board made up of executives, non-executives and private equity directors can have distinct advantages over traditional, executive director only boards.

With everyone’s interests aligned around the board table, there is a strong sense of personal ownership, together with clear and shared expectations of risk-return and the timeline of the investment. This enables the board to focus on results, expressed as a few, often simple measurable objectives. These metrics shape the board’s agenda and underpin universal agreement about what is important.

In private equity’s tireless search for superior returns, the focus is always on results. This means the board spends much of its time identifying innovative ways to improve productivity and drive growth. Independent of the day-to-day management, non-executives provide fresh eyes and, when prepared to ask the ‘dumb questions’ and risk looking silly, can often ‘hit the nail on the head’ with key strategic and operational insights.

Where appropriate, non-executives can also provide the executive team with timely coaching and mentoring, drawing on their long and wide experiences.

Conclusion

PE firms require non-executives to sit on the boards of their portfolio companies to help reach the target equity value over the time period that frames the investment and hence deliver the desired return on investment. Non-executives bring independence, hard-earned business acumen and sector experience to act as a bridge between executives and investors, and constructively influence decision-making. A board of executive, non-executive and private equity directors can be an especially powerful combination. Astute non-executives can contribute significantly in a variety of ways, with a constant focus on value creation – the common goal of all the shareholders.