A part from risk, if there is one feature that most distinguishes investments made directly into private companies from any other ‘asset class’, it is the very high importance and sensitivity of relationships and, more specifically, the relationship between the investor and the company’s top executive. This is because the decision to invest in a private company so heavily depends on the aura that the top executive projects, and because that same person is rightly perceived as the only one able to deliver the value proposition that is advertised.
Smart monitoring of such investments recognises the fact that the upside of the investment is in the hands of the management team and focuses instead on preventing the materialisation of the opposite scenario, that is, serious value destruction, or, to use a euphemism, the downside.
But no matter how smart the monitoring approach, in these situations the investor contemplating the implementation of professional monitoring of his investments in private companies will instinctively, at least at first, pull back from the idea on the grounds that any interference with the management team could only damage the relationship he has with them, and somehow also affect their performance and motivation.
This mindset on the part of the investor is extremely damaging. Not just because it prevents thorough investment monitoring, but more importantly because it inhibits the investor’s will to inquire about important aspects of the business and get precise and factual answers. The all-too-frequent horror stories about direct investments going bad have that in common: with hindsight the investor remembers the point at which he suddenly had misgivings about what was going on within the company, but somehow let it pass, and it was all downhill from that point onwards.
So here are two inescapable truths about direct investments: first, because they are appealing to the entrepreneurial instinct of the investor, they are in essence risky. And, secondly, far more than investments in other asset classes, they are critically dependent on the quality of the relationship between the investor and the company’s top executive. As a consequence, they must be carefully monitored to avoid significant loss of value, and this must be done without damaging the investor–management relationship.
Areas of concern
There are three particular areas of concern where the implementation of professional monitoring might affect, directly or indirectly, the relationship between investor and management:
- When the monitoring team actually starts interacting with company personnel. Many contacts will have to be established within the company to develop the basis for relevant fact finding, and any problem at this stage could generate resentment on the part of management.
- When the outcome of the actual work, the findings, are presented to management. The executives may disagree with the findings, and more generally consider the whole exercise as an encroachment on their prerogatives as managers.
- When these findings, once on the table, become part of the dialogue between investor and management. The main fear here is that the information gathered from monitoring would bring up elements that are alien to the ongoing conversation between management and the investor, and make things awkward.
These concerns are relevant and very real, and must thus be addressed thoroughly if the efforts put in are to reach their objective, that is to protect the value of the company while keeping management fully committed to delivering on the promised results.
Let us start with the first of these concerns, the potentially negative impact of having outsiders come in to the company and start asking questions. There is no doubt that the prospect of having to meet a stranger and facing questions about one’s work is not a very pleasant prospect for most people. Images of stern-faced auditors or arrogant management consultants come to mind. Knowing that there is a real hurdle to pass here, a conscientious professional will meet his interlocutors within the company with a simple truth in mind: no insight into the company’s inner working can be gathered without genuine interest in what his interlocutors actually do, and that interest is impossible without respect.
From that simple truth flows not only a work ethic, but also the building blocks that are required to ensure that the information gathering exercise taking place within the company is successful in every respect: first, undertake all the preparation work required before actually meeting one’s interlocutors; secondly, use interview techniques that lead to the right information while letting the interlocutor follow his or her own flow of ideas; and, thirdly, use feedback loops to ensure that the interlocutors remain in control of the information they gave.
Working with these principles and tools will ensure that the contact between those in charge of monitoring the company and the company itself is not traumatic. It will, on the contrary, establish a basis for a fact-based, professional and balanced relationship that will not be resented by company managers and therefore not damage the relationship with the sponsor of that effort, the investor.
The next area of concern for the quality of the investor–management relationship is the reaction of management to the findings coming out of the monitoring work. A serious review of company activity will cross all functional areas and check all major processes within these areas. It will look for any flaw in these processes that may lead to the company destroying value rather than generating it. No company is perfect, and this kind of analysis is bound to bring up facts that may put company managers on the defensive.
Here too, work ethics, communication and tools make a difference. The work performed by the monitoring team is not about creating a parallel management team. Delivering the upside on the investment is, and remains solely, in the hands of the management. The objective of the monitoring work is quite different; it is about creating a safety net that ensures that while management aims for the sky, it does not neglect, as is often the case, aspects of the company’s work in a way that endangers the whole venture.
Tools are very important too. Blunt assertions thrown in the face of management on the basis of a high-level and superficial review of their activity will indeed be resented, and they will achieve nothing good. But if the findings are based on a comparison between the company’s activities and a complete set of generally accepted best practices, and if they are presented as such, then these findings become an objective tool that management can use as a real help in their efforts to achieve their goal.
It is easy to forget how much management teams can get isolated in their own ‘bubble’ when under pressure. In these situations, being able to rely on periodic meetings with outside professionals to take an objective look at how the company is faring is not only of significant benefit for the investor, it often comes as a relief for the management team who feel that they have someone watching their back.
And finally, the last area of concern, the one that regards how the direct dialogue between investor and management itself might be affected. What happens when a range of new and precise information about the company is put on the table? That could be a recipe for uncomfortable meetings where both parties try their best to deal with abstract recommendations formulated by an absent third.
As we have said above, professional monitoring is not about shallow assertions but about comparing factual situations with the corresponding best practices. On that basis, the discussion between investor and management, far from drifting into misunderstanding and mistrust, actually evolves into what it should ideally be and so rarely is: a transparent dialogue on a subject of mutual interest, conducted by two well-informed parties.
All things considered, the introduction of professional monitoring of direct investments does not, as it may first appear, endanger the all-important relationship between investor and management. It is in most cases the lack of relevant information that leads to progressive degradation of that relationship. Professional monitoring does transform the corporate governance of a company, but it does so for the benefit of all those involved.
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