Boards and Private Equity: Best Practices for Success
October 30, 2020
If you’ve ever asked what role a board of directors can play in a real estate private equity fund, join Tami Davidman and Lisë Stewart as they provide a brief overview of the oversight that a board can provide and how a board of directors can help management effectively manage risk.
LS: Good. Thank you. Well, you're just the expert that we need to talk to. Let's just start out really high level here. Can you talk to us a little bit about how a board can exercise their oversight?
TD: I definitely can. But before we get to how a board can exercise oversight over the protocols and procedures in place at the fund, we have to talk about risk. As a starting point, director should perform an assessment to see where they think the risk resides in the fund. Risks can be identified both at the entity level and the process level. Risks at the entity level can include, how the fund manager keeps operations running smoothly in the case of a natural disaster or another business interruption or how the fund makes sure that there are no conflicts in the investments acquired so that they are purchased for the benefit of investors and not management.
Once these risks are determined, the board can review the processes that the fund manager put in place to address them, including a formal business recovery plan and Code of Ethics or Conflicts of Interest Policy. In terms of risk at the process level, these may differ depending on the fund strategy. For instance, a fund with a core strategy will have different risks than a fund with a value-add strategy. Once directors have determined the significant risks that a fund faces, they can then review the procedures that management has put in place to mitigate these risks.
LS: Okay. Well, that makes sense. You talked a little bit about process level risks. Can you maybe provide a little bit more detail around that and maybe what a board can do to provide investors with information, so they feel more comfortable about that.
TD: Sure. Let's start with the value-add fund as an example. For purposes of this example, we'll say that the fund acquired a multi-family residential property and plans to renovate the units. One of the risks in this situation may be, how does an investor get comfort that the funds they provided are being used for these renovations and not for management's benefit. This is where board oversight can come into play. The board can review and approve the budgets for the renovation, and also require that management provide a budget to actual, on a monthly or quarterly basis. The board can also review the procedures in place to make sure that there are appropriate segregation of duties. For instance, if payments are being made via wire transfers, one person should be entering the wire and a separate person should be releasing the wire.
LS:Right. That makes perfect sense. Though, I'm sitting here wondering, the boards always realize that that's kind of their responsibility to do things like that. I mean, I'm guessing that before a relationship even gets started, say between a fund, fund manager and the board, they should probably sit down and talk about some of these expectations, like what kind of information the board is really going to be expected to provide and what their oversight role is and kind of what the expectations of the fund and the fund manager are. I mean, do you find that, does that come up as important, that kind of communication?
TD: I think that one of the most important things between a board and a manager is maintaining open lines of communication. It's also really important for the board to understand the operations of the fund and the underlying investment property, because through that understanding the board will be able to identify risks and also assess that management has taken appropriate steps to mitigate those risks.
LS:Right. Yeah. In fact, we've been talking a lot about boards recently. I don't know how many of our audience know that we actually do a lot of boards work and in fact, we have a webinar coming up later on this week on that very topic, about how boards can be more effective. But I can certainly see from the perspective of your clients in working with the funds and fund managers that that emphasis on open communication, on managing expectations, making sure that the information flow is really critical between the two groups, would go a long way to solving some of those problems and in fact, we often talk about, it's so important to try to anticipate what some of the issues might be and talk about them, manage the expectations up front before people get frustrated. There's a breakdown in that relationship so, that's really useful. You've given us some important things to think about. Do you have any sort of closing thoughts about how boards and funds might just work more effectively together to make sure that everybody's successful?
TD: I think at the end of the day, having that board oversight provides an extra layer of confidence for an investor. It only benefits management to have that open line of communication with their board, to discuss issues as they arise so that the issues then don't snowball into becoming bigger issues that investors start getting nervous about.
LS:Right. Yeah. I completely agree. I think that emphasis on communication openness is the foundation of their success. Well, Tami, I really appreciate you taking some time out of your day today to kind of kick off this conversation. I think it's really important. To those of you who are out there listening, remember we do have an upcoming webinar on working with our boards and how they can be more effective. In fact, if you'd like some more information, you can learn more at eisneramper.com/REFamilies. That's where you can go to register and find more information materials. Again, that is eisneramper.com/REFamilies. Thank you again, everyone for joining us today. Tami, thanks to you.