Private Company Governance

PRIVATE COMPANY GOVERNANCE

T H E CALL FOR SHARPER FOCUS

IN ASSOCIATION WITH: CONTENTS

Foreword ...... 2

Key ﬁndings ...... 3

About this research ...... 4

Spotlight: Risk, competition and strategy ...... 5

Q&A: Marjorie Bowen, independent director ...... 8

Greater depth: Boards looking for more ...... 9

Technology can help… ...... 10

…But with more data sharing comes greater risk...... 11

Other key ﬁndings...... 12

Conclusion: Fine-tuning ﬁnancial oversight...... 15 F OREW ORD

Private businesses and their owners face choices in terms of corporate governance. What’s the right governance model for the company? What are the challenges faced in optimizing governance structures and processes? How does governance align with the ﬁnancial goals of the company and its owners? These governance issues factor into the traditional valuation discount applied to private companies. How do we overcome this discount?

Getting beyond the discount —real or perceived— requires private companies to take a hard look at governance structures and processes, ﬁnancial controls and, as our survey with Forbes Insights highlights, conﬂicts of interest.

Do the costs of greater rigor in strategy formulation and risk management pay off in terms of valuation or access to capital? How can financial processes, information flow and the finance organization be improved? And what do today’s data-driven reporting and business intelligence technologies contribute to performance, and at what cost?

Beyond such fundamental decisions, governance models of all companies are in constant need of ﬁne-tuning. Is the organization obtaining sufﬁcient insight regarding its full range of risks and opportunities? Are owners and management teams sharing the right information with the right set of advisors and board members? Is the governance in place today optimal for the vision and objectives of the company and its owners?

These and many related issues form the focus of the accompanying research— which we offer with our compliments. We hope you will ﬁnd what follows both informative and thought-provoking.

Sincerely,

Salvatore Melilli, Brian Hughes, National Audit National Private Industry Leader, Markets Group Leader, Private Markets Group, KPMG LLP KPMG LLP

2 | PRIVATE COMPANY GOVERNANCE K EY FIND INGS

The governance models of private companies are in constant need of fine-tuning and enhancement. The survey explores concerns such as: Are organizations obtaining sufficient insight regarding their full range of financial and operational risks and opportunities? Are owners and management teams sharing the right information with the right set of advisors and board members? Is adequate attention being placed on talent evaluation and succession planning in the finance organization? Overall, are governance processes and controls in place today optimal given the owners’ financial expectations?

Key ﬁndings include:

• The top three governance challenges cited by private company directors include improving risk management oversight, assessing innovation and emerging competition, and conﬁrming/establishing company strategy

• Other key governance challenges for private companies include achieving regulatory compliance, leadership succession planning and global compliance

• The most visible challenges to board effectiveness include budget/resource constraints, conﬂicts of interest (including the presence of related party transactions) and a compromised board due to an overrepresentation of controlling shareholders

• Directors believe that fast-evolving technologies—such as big data and related analytical tools—may help to spawn more relevant and efﬁcient reporting for management and the board

• Private company directors are looking to their governance processes and controls to improve M&A outcomes, enhance ﬁnancial risk oversight and optimize the ﬁnance organization through performance evaluation and succession planning

This report is based on a global survey developed by KPMG and executed by Forbes Insights. The survey was completed by 154 private company directors in September 2015.

Key demographics include:

• Board member: 100% were serving as a director for at least one private (non-public) company

• Company type: Non-proﬁt (17%), privately funded startup (38%), entrepreneur- or family-owned business (32%), private-equity-owned/venture-capital- backed business (39%), mutually owned/employee-owned/cooperative (16%)

• Annual revenue: $100 million to $200 million (17%), $200 million to $500 million (16%), $500 million to $750 million (20%), $750 million to $1 billion (10%), $1 billion to $5 billion (30%), more than $5 billion (6%)

• Industry: Software (10%), hardware (6%), consumer goods (12%), retail (10%), manufacturing (25%), energy (2%), ﬁnancial services (21%), professional services (12%), other (2%)

For an added layer of context, Forbes Insights approached a handful of senior executives with vast experience in private company governance. We wish to especially thank the one on record:

• Marjorie Bowen, independent director

4 | PRIVATE COMPANY GOVERNANCE S POTLIGH T: RIS K , C O M P E T I T I O N AND S TRATEGY

The research shows that private company boards need to sharpen their focus on risk, competition and strategy.

Despite the fact that many private company direc- the top three cited by senior private company tors (and investors) say that they are in near-constant directors were risk management oversight (28%), communication with company management on assessing innovation and emerging competition corporate strategy and !nances, the shortfall in the (28%) and con!rming/establishing company strategy perceived quality of governance remains signi!cant. (23%) (Fig. 1). Asked to assess a range of key governance challenges,

FIGURE WHAT ARE YOUR GREATEST CURRENT/ONGOING 1 GOVERNANCE CHALLENGES?

Risk management oversight 28%a Assessing innovation and emerging competition 28%b Conﬁrming/establishing company strategy 23%c Regulatory compliance 21% Leadership succession 18%d Global compliance 17% Board e!ectiveness 17% Director time and workload 16% Overreliance on management’s information 13% Divided ownership group 10% a41% ﬁnancial services b37% consumer goods c 40% retail d29% $100 million - $500 million

COPYRIGHT © 2015 FORBES INSIGHTS | 5 Other key governance challenges for private compa- mation provided by management (13%) or say their nies include achieving regulatory compliance, lead- boards operate within a “divided” ownership group ership succession planning and global compliance. (10%). The challenges—and the lack of insight into these issues—can contribute greatly to the private com- Size plays at least some role in terms of governance pany discount. challenges. The largest companies in the survey (over $1 billion) are more likely to view the assessment of Overall board e"ectiveness at private companies is competition and innovation as signi!cant challenges. also questioned by a signi!cant number of directors Smaller !rms (under $500 million), tend to place (17%) (Fig. 2). This may in turn be in#uenced by greater signi!cance on the challenges of strategic those who indicate directors may be overworked planning and leadership succession. (16%), say their boards exhibit overreliance on infor-

FIGURE WHAT ARE YOUR GREATEST CURRENT/ONGOING GOVERNANCE 2 CHALLENGES: BY SIZE?

All $1b+ $500m-$1b Under $500m

Risk management oversight % % % % 28 29 28 27 Assessing innovation and emerging competition 28% 34% 23% 25% Confirming/establishing company strategy 23% 25% 15% 29% Regulatory compliance % % % % 21 20 26 18

Leadership succession % % % % 18 11 15 29 Global compliance 17% 18% 23% 10% Board effectiveness 17% 14% 23% 14% Director time and workload 16% 23% 6% 18% Overreliance on management’s information % % % % 13 13 15 12

Divided ownership group % % % % 10 9 11 10

6 | PRIVATE COMPANY GOVERNANCE Against this backdrop, boards at private companies Other issues limiting e"ectiveness of many boards face challenges of their own. The most visible are include their serving in an advisory capacity only budget/resource constraints, selected by over a third (25%), irregular meeting calendars (23%) and of private company directors surveyed (36%) (Fig. 3). limited independent representation (22%). One in Over one in four directors surveyed, 28%, say their !ve directors, 21%, say their boards have inadequate boards face con#icts of interest, including the pres- access to or otherwise underutilize third-party ence of related party transactions. And one in four, resources/research—and 19% say their board lacks 25%, say their board’s e"ectiveness is hampered by an formal structure. overrepresentation of controlling shareholders.

FIGURE WHAT ARE THE GREATEST CHALLENGES 3 TO BOARD EFFECTIVENESS?

Budget/resource constraints 36% Conﬂicts of interest/related party transactions 28%ab Overrepresentation of controlling shareholders 25%c Board serves in an advisory capacity only 25% Irregular meeting calendar 23%de Limited independent representation 22% Underutilization of third-party resources/research 21%f Lack of formal structure 19%g a41% ﬁnancial services b39% $1 billion and up c36% manufacturing d39% audit committee chair e37% consumer goods f33% retail g47% retail

What are your current a!liations? What do you see as the benefits of enhanced I’ve worked with quite a few companies, but governance for private companies? currently, I’m an independent director on three Let me first say, there is also a spectrum of boards: one a public medical device maker, one public company boards—from those who really a publicly reporting entity—but its equity is 100% and truly value an independent board to those controlled by another company—and the third is a privately held company owned partially who have one because they have to. I am for- by private equity (PE) and a management/ tunate to have been involved with [the former] founder group. companies, where management is continually seeking best practices, they’re open with their What is your view on the state of governance at board, there’s no undue management or insider private companies? pressure on decision making. What I see in private ownership, governance is really driven by the nature and the objectives of the As for private companies [pursuing] greater gov- shareholder base. There’s a spectrum of owners. ernance, there are tradeo!s. The benefits are clear: you benefit from having a diverse group At one end of the spectrum, there’s the PE, hedge of highly experienced executives on your side, fund world, where they are very interested in governance, best practices and managing those enhancing your processes, strategies, planning companies with the best of both worlds: the dis- and operations. cipline of the public company without necessar- But this comes at a cost. Engaging [a slate] of ily all of the minutiae of reporting and disclosure. experienced and independent executives in stra- You have the management structure and com- tegic planning, financial analysis, audit and other mittees like a public company, but the focus is on a longer exit and not each quarter. committees—that takes time and money. And— it’s work for the owners or managers keeping the At the other end are companies that are major- board informed and collaborating. ity shareholder controlled, maybe family owned. They may have a board, but more in the spirit of How should owners decide how far to go in “we need someone to talk to—maybe looking independent governance? over our shoulder just a bit. We appreciate your view,” but that doesn’t mean we’re going to take Ultimately, I think it depends on the vision. succession planning seriously or take the other The board structure is evidence of where the actions you suggest. owners and managers are taking the company. The greater the alignment of your management What do you view as the key roles structure to your strategy; the more discipline in ? of governance the reporting; the better your controls; the more Boards are there to monitor management and you are functioning in ways similar to a public help them focus on long-term success. What is company: the more prepared you are to handle their strategy? How can they perform better? new investors and capital. If a private company Another key job is to hire and fire management. is committed to growth and leadership in its When you have PE and hedge fund participation, hire/fire is a key role. But when you have family industry, there will likely be board involvement. ownership, most of the hire/fire toolbox [goes missing].

Engaging [a slate] of experienced and independent executives in strategic planning, !nancial analysis, audit and other committees—that takes time and money. And—it’s work for the owners or managers keeping the board informed and collaborating.

8 | PRIVATE COMPANY GOVERNANCE GREATER D EPTH : BOARDS LO O K I N G F O R MORE RELEVANT METRICS AND INS IGH T

Governance at private companies can be further improved by providing greater transparency and insight regarding the ﬁnance organization.

The top two areas for improvement regarding Since !nancial risk management garners the top !nancial information and the !nance organiza- vote for where the board needs greater information, tion include !nancial risk management (over half, it is appropriate to point out the challenges in 54%, rising to seven out of 10 or 68% at consumer !nancial risk oversight. One in !ve private company goods companies) followed by treasury/capital executives, 19%, say their !rms face challenges in allocation (one-third overall but rising to just under attracting and retaining talent within their !nance half at manufacturing !rms) (Fig. 4). Third place groups (Fig. 5). Fourteen percent say they need more is a tie between tax and credit decisions, each !nancial expertise on their board, rising to one in registering 27%—though the former climbs to 47% four among consumer goods companies. Other key within retail. challenges include lack of transparency (13%) along- side limited accuracy and timeliness (12%) in internal !nancial reporting.

FIGURE WHICH OF THE FOLLOWING ASPECTS OF THE FINANCE ORGANIZATION’S 4 WORK WOULD YOU LIKE YOUR BOARD TO HEAR ABOUT IN GREATER DEPTH?

Financial risk management 54%a Treasury/capital allocation 33%b Tax 27%c Credit decisions 27% Controller 25% Accounting 19% M&A 16%f a68% consumer goods b46% manufacturing c47% retail

5 WHAT IS YOUR TOP CHALLENGE IN FINANCIAL RISK OVERSIGHT?

Attracting and retaining talent in the finance organization 19% a Financial expertise on the board 14% Internal transparency of company’s finances 13% Accuracy and timeliness of financial reporting 12% Quality/consistency of third-party services 12% Audit committee workload 10% Implementation of new % accounting standards 8 Lack of independent audit 7% a26% consumer goods

TECH NOLOGY CAN H ELP…

The good news is that executives believe that fast-evolving technologies may help to spawn greater board effectiveness among private enterprises.

In particular, executives see big data and related ana- allocation (38%) and improve audit and risk manage- lytical tools helping their boards to spot trends (41%), ment (36%) (Fig. 6). support management decision making in resource

10 | PRIVATE COMPANY GOVERNANCE FIGURE

6 HOW WILL BIG DATA AND ANALYTICAL TOOLS IMPACT HOW DECISIONS ARE MADE IN THE BOARDROOM?

Spot trends (hidden in the data) 41% Support management in allocation of resources 38% Aid internal audit and risk management 36% O!er greater assurance by third-party providers 36% Fine-tune external audit or accounting review 32% Greater coverage of corporate transactions 29% More insight on macro/micro trends 25%

…BUT W ITH MORE DATA SHA R I N G COMES GREATER RIS K

The downsides to the promise of big data are the associated data-sharing risks. Here, directors from private companies expressed concern over the security of their currently private ﬁnancial information.

Overall network security is the greatest red #ag at 22%, followed by internal or employee-related at 32%—climbing to 47% at !nancial institutions risks (16%) and third-party risk (16%). (Fig. 7). Systems integration ranks second in concern

Network security 32% a Systems integration 22% Internal or employee-related risks 16% Third-party risk 16% Unsophisticated record keeping 12% a47% ﬁnancial services

OT H ER KEY FIND INGS

The research also reveals other insights related to ﬁnancial information and the board. The survey shows that companies are:

• Using the board to get more value from M&A

Greater board involvement can enhance the e"ec- The same percentage of executives indicate their tiveness of corporate development and related M&A !rms can currently lay claim to a board-level expert within a private company setting. The survey probes in M&A. the degree of board involvement within an M&A setting. Forty-four percent of executives say their In addition, over a third say their boards are active board plays a key role in con!rming service and in establishing a transaction committee for each new !nancing providers (Fig. 8). Slightly fewer, 38%, say deal, while 30% say their boards do not become the board goes so far as to actively review deal involved until a transaction meets or exceeds a pre- metrics both before and following a transaction. set price/value trigger.

12 | PRIVATE COMPANY GOVERNANCE FIGURE IN OVERSEEING M&A TRANSACTIONS, 8 OUR BOARD:

Conﬁrms service and ﬁnancing providers 44% Monitors deal metrics during and after the transaction 38% Has a board-level expert 38% Establishes a transaction committee 35% Engages in deals above a pre-set price/trigger limit only 30%

• Engaging the board in succession planning for the ﬁnance organization

Boards should also play a greater role in succession resources such as consultants and search !rms, rising planning—another area that can have a profound to 32% among consumer goods !rms. The bad news: e"ect on the valuation of a private enterprise. Forty- 17% currently exhibit an ad hoc approach to succes- eight percent conduct an annual review with senior sion planning, while 14% conduct this work without leadership, rising to seven out of 10 among soft- board input. ware companies (Fig. 9). One in !ve hire external

FIGURE HOW DOES YOUR BOARD APPROACH SUCCESSION PLANNING, 9 PARTICULARLY WITHIN THE FINANCE ORGANIZATION?

a Annual review with senior leadership 48% External resources and search ﬁrms 21%b Ad hoc 17% Managed by senior leaders % (without board input) 14 a69% software b32% consumer goods

Though they may be private, such companies none- ing and best practices, say 39% of respondents. Other theless see value in a third-party accounting review bene!ts include speeding time to transaction in or audit. Nearly half, 45%, say such work can be M&A (32%), meeting the demands of suppliers an e"ective check on internal controls—including or lenders (31%) and generally, increasing credit- controls over !nancial reporting (Fig. 10). Third- worthiness (29%). party involvement can also be a boon to benchmark-

FIGURE WHERE IS THE VALUE IN A THIRD-PARTY 10 ACCOUNTING REVIEW OR AUDIT?

a An e!ective check on internal controls and/or internal controls over ﬁnancial reporting 45% Benchmarking and best practices 39%b Speeds time to a transaction 32%c Expected or required by suppliers or lenders 31%de Increases creditworthiness 29% a59% manufacturing b50% ﬁnancial services c44% software d53% retail e37% consumer goods

Note that just as technology is expected to improve Another key bene!t is greater capacity to drill down overall board e"ectiveness, executives believe that and explore complete data sets in more precise and advances in technology, data and related analytics interactive ways to provide value-added insights, should also enhance the value of services received cited by 36% of respondents. Thirty-one percent from their accounting !rms or independent auditors. of executives say these tools will also help meet the changing expectations of the capital markets for In particular, 37% of executives say such technolo- richer data to assess company performance. Other gies in the hands of their third-party providers will bene!ts include providing scalable audit tools that help to raise the con!dence level of the board, are able to work across multiple ERP systems (29%) investors and executive leadership in terms of the and leveraging company investments in technology quality and accuracy of !nancial audits (Fig. 11). The so that data from a company’s existing systems can be same percentage of participants, 37%, say such tools put to use to improve audit e"ectiveness (29%). can help identify new or unexpected areas of risk and control weaknesses.

14 | PRIVATE COMPANY GOVERNANCE FIGURE HOW DO YOU MOST EXPECT ADVANCES IN TECHNOLOGY, DATA AND 11 ANALYTICS TO ENHANCE THE VALUE OF THE SERVICE YOU RECEIVE FROM YOUR ACCOUNTING FIRM OR INDEPENDENT AUDITOR?

Help to raise the confidence level of the board, investors and executive leadership in the quality and % accuracy of financial audits 37

Identify new or unexpected areas of risk and control weaknesses resulting from the audit 37%

Offer a new capacity to drill down and explore complete data sets in more % precise and interactive ways and provide value-added insights 36

Meet the changing expectations of the capital markets for richer data to % assess company performance 31

Provide scalable audit tools that are able to work across multiple ERP systems 29%

Leverage company investments in technology so that available data % from a company’s systems can be effectively used in the audit 29

CONCLUS ION: FINE-TUNING FINANCIAL OVERS IGH T AND INFORMATION

Governance at private companies is by no means broken, but when it comes to ﬁnancial oversight and information, there is room for improvement. The research suggests that there is sufﬁcient cause to take steps to enhance current practice. Key areas for improvement include:

• Risk management reporting and analysis—financial and otherwise • Confirming/establishing company strategy • Succession planning within the finance organization • Data transparency and structured financial reporting • Technologies for reporting, control and analysis

So is the organization obtaining su$cient insight and board members? In essence, is the governance regarding its full range of risks and opportunities, in place today to optimize value? As the research including those that could enhance or hinder suggests, a closer look will likely highlight a range of corporate valuations? Is management sharing the issues requiring added focus. right information with the right set of advisors

You know KPMG, but you might not know KPMG’s Private Markets Group (PMG). We are dedicated to working with businesses like yours. Whether you are an entrepreneur, family business, or a fast-growing company, we under- stand what is important to you. By providing industry perspectives and proactive guidance, our PMG professionals help privately owned companies achieve their strategic objectives throughout each stage of the business life cycle. Our global network provides integrated audit, tax, and advisory services wherever you grow your business.

Learn more at kpmg.com/us/privatemarketsgroup. ABOUT FORBES INSIGHTS

Forbes Insights is the strategic research and thought leadership practice of Forbes Media, publisher of Forbes magazine and Forbes.com, whose combined media properties reach nearly 75 million business decision makers worldwide on a monthly basis. Taking advantage of a proprietary database of senior-level executives in the Forbes community, Forbes Insights conducts research on a host of topics of interest to C-level executives, senior marketing professionals, small business owners and those who aspire to positions of leadership, as well as providing deep insights into issues and trends surrounding wealth creation and wealth management.

FORBES INSIGHTS SALES

Bruce Rogers North America Chief Insights O!cer Brian McLeod, Commercial Director [email protected] Erika Maguire Matthew Muszala, Manager Project Manager William Thompson, Manager

EDITORIAL EMEA Tibor Fuchsel, Manager Kasia Wandycz Moreno, Director Hugo S. Moreno, Director APAC William Millar, Report Author Serene Lee, Executive Director Dianne Athey, Designer

RESEARCH

Ross Gagnon, Director Kimberly Kurata, Research Analyst

499 Washington Blvd., Jersey City, NJ 07310 | 212.366.8890 | www.forbes.com/forbesinsights