By Nir Kossovsky, Steel City Re
The retail sector is a prime target for private equity firms, as investors provide capital and expertise to both early stage retailers with promising expansion potential and established brands seeking support for new strategies and hoping a new capital structure will enable greater agility and innovation.
However, in the wake of disappointing IPOs by Uber and other well-known brands and Chapter 11 filings by several prominent private equity-backed retailers, investors are paying more attention than ever to intangible assets like reputation when considering companies for their portfolios. In Uber’s case, for example, prior to its IPO, its S1 filing disclosed reputational risk issues, warning that “failure to rehabilitate [Uber’s] brand and reputation will cause [the] business to suffer.” The performance of its stock since its IPO has been a wakeup call to private equity investors that what happens pre-IPO, no longer stays pre-IPO.
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In fact, a new “Private Equity Roadmap for Assessing Reputational Risk,” developed and published by Steel City Re, which analyzes and underwrites corporate reputational risk, notes that reputational risks “present themselves across a broad spectrum of companies…and highlight the need to add reputational risk to investment evaluation criteria as well as to governance and oversight practices for board members.”
The risk to board members — whether the company is public or private — is particularly significant, both in courts of law and the court of public opinion. Easily accessible sources of corporate information, social media channels, politicization of corporate issues and a societal culture that increasingly tends to demand individual culpability for corporate failures places corporate leaders in the cross hairs. Retailers are often highly visible brands and when reputational issues arise, the media and politicians are bound to be on the hunt for villains.
In addition, private equity firms count on their own reputations to add value to their portfolio companies — ultimately realized through enhanced valuations upon exit, through IPO or sale of the company. When a reputational crisis hits one of their assets and stakeholders consider it to be a failure in governance, it can erode confidence in the private equity firm itself, shattering its aura of expertise, and affecting valuations across its portfolio. The much-reported failures in governance at the pre-IPO company WeWork, for example, is casting a long shadow on its investor, Softbank.
There are several factors that are now among private equity investors’ considerations, as they seek to translate their management of reputational risk into higher valuations for their portfolio companies. Any business positioning itself to be attractive to these investors should take note.
First, investors will be looking at whether the current management team and board truly understand reputational risk. Reputation is based on expectations. Reputational risk is the gap between stakeholder expectations and actual performance. It is not merely the risk of negative media coverage, to be managed by marketing people. Companies need to know their stakeholders, understand their expectations and be prepared to meet them. Marketing and media management, including such things as CSR campaigns and ESG scores, may serve an important purpose, but they don’t address the underlying, fundamental reputational issues.
Reputational risk should be managed like every other enterprise-wide risk. It should be handled by risk managers, who understand how to work across silos and bring together myriad company resources to address operational issues that pose risks.
Savvy private equity investors are going to appoint board members who understand the risk and have the skills and experience to provide appropriate governance. They are going to require executives to develop ongoing processes to protect reputation, including continual assessment of stakeholder groups and their ever-changing expectations.
This ongoing assessment of stakeholder priorities and sensitivities is crucial, as our fast-moving culture continually changes the rules. Reputational tornados like gender pay, gun ownership and the #metoo movement are all examples. The Business Council’s recent admonition that the purpose of a corporation is to serve communities, employees and the environment — “serving all Americans” — as much as shareholders is also part of this phenomenon, placing added pressure on boards to understand the expectations of these disparate stakeholder groups and build systems that protect reputational value.
Companies that avoid the reputational land mines in our society are ones with processes that facilitate being alert to the subtle signs of lurking reputational crises. And when a potential crisis does hit, effective boards have protocols already in place to coordinate a response.
Investors are going to want to see evidence of a culture that welcomes honest self-assessment, and that is open to engaging objective, outside experts to help the board and leadership determine whether they are truly on top of changing expectations. Additionally, they are going to want to be prepared with a clear and compelling narrative, backed by third-party warranties, demonstrating both good corporate governance and effective enterprise reputation risk management — deterring and mitigating reputational attacks.
Private equity firms know it is in their own self-interest to ensure the reputational resilience of companies they invest in. Companies positioning themselves to be attractive to these investors need to be able to provide them with a level of comfort that they understand their reputational risks and are managing them effectively
Dr. Nir Kossovsky is CEO of Steel City Re, which analyzes the reputational strength and resilience of companies and provides tools and insurances to protect those companies, their officers and directors against financial losses when reputational crises occur.
