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Issues in the governance of private equity-backed companies

2018-07-21 00:52:27

By Paul Kibuuka

We are coming to the end of our ten-part article series on private equity (PE) in Tanzania. To bring more insight into this important subject, in this ninth part of the series, we look at the ways in which a private equity investor will shape and influence the governance of your company and the issues arising therefrom, after the definitive agreement is executed and the investment is made by the investor in return for an equity stake.

Due to the developing nature of the Tanzanian market, most of the companies in Tanzania are family-owned and will have had no previous board members who don’t belong to the family. Bringing in a private equity investor can help you to introduce checks and balances and meticulous decision-making, thereby safeguarding the vital long-term future of your company.

It can also be a stepping stone in the listing of your company on the Dar es Salaam Stock Exchange with the new culture of corporate governance readying the company for the requirements of “going public”.

However, by investing in your company, the private equity investor assumes the risk of its reputation getting ‘soiled’ if the company becomes entangled in a corporate governance scandal. This is why the private equity investor is motivated to influence sound governance in your company.

The strength of this risk has increased in today’s Tanzania as companies face a higher degree of regulation and accountability—so much so that the private equity investor has become a hard taskmaster who will tactfully speak his mind to your company’s board. We cannot overemphasize the need to prepare for a new culture of corporate governance if you opt to bring in a private equity investor.

The demand by limited partners (LPs) for very high standards of transparency and disclosure in fund operations is another factor that motivates the private equity investor to strengthen your company’s governance after the investment is made. Not meeting these standards may mean the LPs avoiding to contribute capital in the future.

But, why is the private equity investor suited to influence the governance standards of your company? There are three main reasons—namely, the private equity investor makes a large investment in your company; invests for a relatively long period of time which ranges between 3 and 7 years, with possible extensions of 1-3 years; and typically has a small number of investee companies.

In influencing the governance of your company, the private equity investor will engage both the company’s directors and managers to improve governance standards. This will entail board participation to provide valuable guidance for the directors and managers.

However, the private equity investor will have to attune expectations for improved governance standards in accordance with the proportion of shareholding in the company and the Tanzanian business culture and environment.

As one size cannot “fit all” in corporate governance, it would be impracticable to swiftly implement governance standards from,  say, the U.S. here in Tanzania, where the legal and financial systems are not yet so fully developed.

With this limitation in mind, it behooves the private equity investor to be realistic in promoting sound governance in your company.

To borrow from the 32nd U.S. president Franklin D. Roosevelt Sr., “[remember, remember always, that]” the private equity investor is apprehensive whether the benefits of sound governance will lead to an enhanced return on its investment in your company via, for instance, a share sale upon fully exiting the company.

Sound governance protects the investment; however, there’s no assurance that the sound governance of your company will lead to a smooth and profitable exit for the private equity investor—although new research studies confirm findings of the existence of a positive relationship between share price and corporate governance.

All the same, private equity investors avoid badly governed companies because they are more susceptible to failure. We hope we were able to provide you with more insight into the governance of private equity-backed companies.

As a parting thought, if you desire to retain full control for your company, it would be prudent to opt for other financing options that can help bridge your funding gap.

Paul Kibuuka is the managing partner of Isidora & Company Advocates, a corporate, commercial and financial law firm. This article was published in The Citizen on Saturday, 21 July 2018

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