Taking the board public

Michael Kelly is the managing partner of the board services practice and Simon Francis is a partner in the technology, media & telecom practice at CT Partners, a global executive search firm. Kelly can be contacted at mkelly@ctnet.com and Francis at sfrancis@ctnet.com.

For private equity players, an important step in preparing to take a portfolio company public is enhancing the board of directors and instituting a series of best practices most appropriate for publicly traded companies.

When properly done, this results in what might best be described as the ?Good Housekeeping Seal of Approval? for the planned IPO. Yet transforming a portfolio company's board to a state that best supports a public offering is a complex process. It hinges upon creating the right mix of directors, bringing in top quality people who have credibility and independence, and avoiding risks that could undermine the desired outcome.

To maximize the effectiveness of this strategy, it's best to start early ? ideally about 18 months prior to a planned public offering. Prior to this stage, it's likely that a portfolio company's board will be a small one, perhaps with just two or three directors, representing the investors, in addition to the CEO. Occasional outside directors, when they serve, tend to be executives who have close ties to the investor group, often from previous deals.

Boards like these are smart, nimble, and they don't tend to set or follow a lot of rules. Directors' meetings may run the gamut from quick, focused conference calls that get scheduled five minutes before they happen to day-long brainstorming sessions or anything in between. Effective as this approach may be, it is a far cry from the norm for publicly traded companies in this post-Sarbanes Oxley universe.

When should firms start building a board for the public markets? When the GPs conclude that an IPO is a genuine exit route, not just as a way to entice strategic buyers or raise existing offers. At this point, it's time to get serious about the composition of its board as well as the board's procedures. A private equity firm's goal may be to bring in a number of qualified, independent directors who will be able to serve on and chair the compensation, audit and nominating committees. Or, in certain situations, it may conclude that adding even a single, highly regarded independent director can make a big difference.

First impressions
No matter how many people are added at the pre-IPO stage, each recruit is important. However, we've come to believe the most critical recruit is the first outside director. As we and our colleagues have seen many times, this person will likely set the tone for the board, during the months in which it moves closer to the public offering. It's equally likely that this first board member will also set the standards by which other prospective directors will be measured ? and, hopefully, be successfully recruited.

That said, there is no one-size-fits-all definition about what kind of person makes the right first recruit to a portfolio company's board.

Who might that first recruit be? He or she will have the kind of cache in the marketplace that is born of a proven record of success, especially with other companies that have gone public.

The right ?facing?
Depending upon the particulars of a company's situation, that first recruit might be a seasoned business executive who is capable of, among other things, coaching the CEO and making important introductions and connections: an ?external-facing? director, in other words. Or, if the portfolio company needs to ramp up its general and administrative functions or focus on compliance, the right first director should be capable of taking the lead on infrastructure matters. Such an ?internal-facing? director might be a former CFO from a major company or a veteran of a Big Four consultancy. In any case, that first recruit must have the ?bandwidth? to be able to handle all these challenges and also be an active participant in the other searches that will soon follow.

Since director candidates with superior credentials are in great demand, it's essential to start the recruitment process as early as possible. Blue-chip private equity firms will have an edge over others, of course. As previously mentioned, 18 months is a feasible timeframe for a portfolio company with sky-high ambitions.

When that time frame is shortened, the challenge is not insurmountable ? in one instance, we successfully recruited six board members for a pre-IPO board in six weeks ? but it's far from ideal. Private companies and their investors run the risk of needing to take ?what's available? in the marketplace rather than having the luxury of being strategic in their recruitment efforts.

Mind the gap
With a strong first recruit in place, other board searches should follow along a clear progression. There are important issues that must be considered. First and foremost, of course, what does a gap analysis reveal about other skill sets that will deliver significant value to the existing board as it moves toward the public offering? Board membership may need to be expanded to eight directors in attendance, with those individuals selected who can fill the gaps.

Less obvious, but equally important, is the need for in-depth due diligence on any director candidates who are being considered. Will they fit the tone and personality of this pre-IPO board, understand the cultures of both the portfolio company and the investor groups, and carry with them no ethical question marks or hidden problems that might deflate IPO prospects? The right search partner will help private equity boards stay focused on these and other issues.

Who might join a board at this stage? Every situation is different ? that goes without saying. In one technology company that was owned by a well-known private equity firm, the goal was to bring in a ?customer expert,? someone who would help this business understand the customer's perspective on pricing, the competitive landscape, even the ?complete-ness,? or lack thereof, of the company's vision.

In thinking about that search, we might characterize it this way: if you're going on a date, it makes sense to ask a woman if your tie is straight, rather than a man ? she'll give you the more accurate assessment. The director who came in to ?straighten the tie? was a chief information officer from a Fortune 100 company. Good choice.

Sometimes it can make good sense to add an academic or two to a pre-IPO board. After all, leading universities are places where new ideas, technologies, and what might best be described as intellectual capital are incubated. For a company in the securities space, it might be appropriate to add a top-level mathematics scholar to the board. It all depends on who else is serving and the company's intended trajectory.

The independence trap
But let's get back to due diligence, because this is an area in which we feel that risks abound and the right search partner can deliver real value. We live in litigious times. When pension funds and others analyze an IPO candidate's board of directors ? and they will analyze it ? they will look long and hard at the independence of outside directors.

It's not in a private equity board's interests to have board members who seem independent but actually serve with each other on multiple boards. They might have various connections that, at first glance, could be overlooked but ultimately might raise questions for future investors. This can be a subtle issue, but it's an important one: after all, questions about a board's credibility and independence might not derail an IPO, but they might help diminish its payout.

?Clean? boards just don't have issues like those and it's a search firm's responsibility to achieve this. If you're employing a headhunter for your search, make sure they have databases and personal networks to be able to avoid potential problems and identify candidates who have the right skills while passing the due diligence test.

There's one more risk to avoid, and the best way to put it is bluntly. It may be hard to recruit people to a pre-IPO board ? but, once the company goes public, it's often even harder to get rid of them. That's true even if someone's personality clashes with everyone else's or a director simply fails live up to responsibilities.

Here's where comprehensive due diligence comes in. Boards want to avoid a situation in which someone comes in who looks good on paper ? or, over a cup of coffee ? but actually once got forced out of a job for incompetence. Or, he serves on three other boards, but his fellow directors all can't stand him.

The rest is relatively simple. With the right directors in place, it's time to start acting more like the board of a public company than a private one.

If they have not already been established, formal committees should be set up, at least for nominating, audit and compensation, with independent directors chairing them. The board should meet regularly, keep records, dot the i's and cross the t's but that's common knowledge.

Administrative matters like these are simple. Creating the right board composition and culture is more challenging, yet absolutely essential. The final result is worth the effort.