The Director’s Dilemma – June 2020 Edition
Contribution by Albert Froom, Managing Partner Leaders Trust Netherlands. Albert Froom is a founding member of AltoPartners and he was the Chairman of AltoPartners from 2006 to 2009. He is currently Global Practice Leader of Financial Services and a member of the Board Practice.
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The Director’s Dilemma - June 2020
Our June dilemma looks at the vexed issues of due diligence prior to joining a board. There is never enough diligence to cover everything; time, cost and effort must be weighed against risk in deciding where to draw the line.
Willow retired last year, she loves fashion and worked her entire career in a large retail company where she was the buyer of women’s leisure wear. She pioneered a project to donate unsold stock to women’s refuges and immigration centres, founding an NFP company, persuading her employer to donate stock, and enlisting friends at other stores to do the same.
A search consultant has just called her with an opportunity - a board seat at a company newly acquired by a VC fund. It sounds great.
The business now has an Australian head office, as well as a pre-existing office and manufacturing facilities in China, and sales offices in New York and London. The new owners expect a profit of AUD 15 million this year and see potential for rapid growth in Australia and New Zealand where the company previously had no outlets and maintained profitability in the US and UK. They may expand into mainland Europe towards the end of their five-year plan.
Previously the operations were part of a large group and there are no published accounts that separate out the operations which will form the new company. The latest available accounts are three years old and show assets of only $30 million, revenue less than $90 million and a tiny profit. The new company is only one month old and has no track record.
Willow is keen and cautious. She had a few tense trading periods in her career when many staff were laid off and she knows from her NFP board that directors can be liable for debts if the company becomes insolvent.
How can she do due diligence on a company that is so new and that has such a shadowy past?
The Due Diligence process hinges on getting VITAL business information, in this case, for a yes or no decision for Willow. If something nearly sounds too good to be true, it often is. So, Willow should be very careful and do an excellent due diligence.
She could carefully read the 5-year strategy and check it with relevant people in the industry. Since she pre-dominantly was a buyer, a finance and commercial look should help. Check with the competition if the outlook is seen also by others in the industry?
She could use the search consultant that called her to help her with the backgrounds of the Directors in place. Check the outcome with another search consultancy with knowledge of the industry (unus testis nullus testis!). By the way, she could check the VC’s behaviour or lack of funds by asking if the search consultant that called her works retained or no cure no pay (the latter is cheap, but with uncertain and questionable quality).
Talk to the Chair of the non-executive board. What is his/her reputation? Does he or she, share the same values as Willow herself? Willow has her heart on the right place probably, given the NFP actions, so her values are important to her. A self-assessment of Willow regarding a non-exec role, on values might be relevant. Her values are her moral compass in the Board. And the fashion industry needs to be very transparent regarding working conditions and environmental issues (China!), especially if they want to expand into Europe.
She by now will have learned to trust her gut-feeling on values. In this case that will give her the answer to do it or not, if not satisfied, don’t do it.
Willow should sign a confidentiality deed and access the data room that contained information for bidders, as well as the planning that (hopefully) lies behind the expected future profits and growth.
She should treat both the data of the previous owner and the plans of the new owner with a healthy dose of skepticism:
The vendor may well have failed to identify all the costs associated with running the business. It is common for the percentage of marketing, office, and HR costs to be inaccurate. These costs will now all change. Running a company in Australia is very different to running a business unit in China. The plans and forecasts will be based on estimates. These may or may not be acurate or even reasonable. Willow should get the names and contact details of the other board directors and key management personnel. If she can’t research the financials she must research the Chair, senior executive team, and other board members. If she joins the board her reputation will be bound to theirs. In particular she should check that they appear reputable and that each director brings a useful skill to the board. VC boards are often small so it is important that there are no ‘passengers’, only ‘crew’.
As there is little accurate historical data for conducting diligence Willow should focus on the people, product, and plans. She must be convinced that the product is reliable, viable and targeted to an appropriate demographic using a good mix of channels to market. She must also understand the assumptions behind the projected income and cost lines in the spreadsheets that suggest a profit is possible.
If she believes the business is viable and that she has something to add to the board she should proceed with getting to know the people and deciding if she wants to become involved.