Re-Thinking Corporate Governance in the context of COVID-19 and crisis bailouts

This article and all the articles tagged Tactics or Ideas are opinion articles and therefore only reflect the view of the author. 

Corporate governance is the framework of rules and practices by which a board of directors ensures accountability, fairness, and transparency in a company’s relationships with all stakeholders (financiers, customers, management, employees, government, and the community.  Corporate governance framework consists of (i) explicit and implicit contracts between the company and the stakeholders for distribution of responsibilities, rights, and rewards; (ii) procedures for reconciling conflicting interest of stakeholders in accordance with their duties, privileges, and roles; and (iii) procedures for proper supervision, control, and information-flows to serve as a system of checks and balances (business dictionary)

The COVID-19 context, a global and painful health and financial re-shift, presents an opportunity for implementing greater incentives towards broader stakeholder engagement. The restructuring of portfolio holdings presents such an opportunity – as financial restructurings take place, corporate governance restructurings are also possible and should be on the table.  Diversification of thought and perspectives makes for better risk mitigation and thereby better financial and non-financial results. The current context presents an opportunity to explore different corporate governance structures including, steward ownership structures.

The response to the 2008 financial crisis was mostly significant-sized bailouts and financial restructurings, and one could argue, not enough of non-financial restructurings.  When corporations emerged from the negative impact of the crisis they indulged/engaged in significant share buybacks. This crisis is showing us that such a strategy has delivered questionable value for stakeholders as we witness market volatility and lower share prices.  We can all agree that big shocks – climate, conflicts, pandemics, and financial, have become more frequent so there will not be as much time between this and our next crisis. The Great Depression was the last major global event before 9/11 caused a seismic dislocation. Since 9/11, however, we have been experiencing global-level shifts with greater frequency. 

Currently, more bailouts are underway, and it is likely that after the crisis is over and profits soar again, we will see more share buybacks.  Is it time for rethinking crisis restructurings away from just financial considerations? Are we well placed to push for consideration around governance frameworks that create the necessary “infrastructure” for informing how entities are run with all stakeholder interests accounted for? As the shocks that require restructurings and “bailouts” become more frequent, should operating frameworks be structured to include inputs from a diverse set of players?  Is it time to ask that any corporation that wants a share of restructuring and bailout funding be required to, over a period of time, transform its ownership/governance structure to one that enables more diverse opinions? In private markets investing, particularly in impact investing, are financial and governance restructurings a minimum response given investor focus on delivering financial and impact returns.

Is it time to implement more ownership structures like steward ownership, as mentioned above, to help protect more diverse stakeholders in normal and pandemic times? Steward-ownership refers to a set of legal structures that instill two core principles into the legal DNA of a business: self-governance and profits serve purpose. These structures ensure that control (voting rights) over the business is held by people inside the organization or very closely connected to its mission. Voting control in steward-ownership forms is not a saleable commodity. Profits in steward-ownership are understood as a tool for pursuing the company’s purpose. After paying back capital providers and sharing economic upside with stakeholders, the majority of profits are reinvested in the business. Steward-ownership forms include an asset-lock, which prevents the proceeds from a sale from being privatized.  This structure aligns decision making power with active stakeholders close to the business, instead of remote investors or shareholders. 

We pose these questions to invite expert thought pieces of examples of structures and case studies from different jurisdictions (see our style guide).

“From now on, it’s in the best interest of our management to put our social mission first, even if that means slowing down our growth. Everyone working in the company is incentivized, first and foremost, to make decisions that benefit not just the owners of the company, but all other stakeholders, the environment, and society at large. After this change, we can finally—confidently— say that our company will always be a force for good in society.”: Juho Makkonen, Sharetribe Co-Founder and CEO 

Covid 19 is a lesson in why alternative investment structures are needed

This article and all the articles tagged Tactics or Ideas are opinion articles and therefore only reflect the view of the author. 

Covid-19 is teaching us many lessons that take the form of “that thing we used to do, or that idea we used to feel safe thinking, turned out to not be that good an idea after all.”  Covid 19 is teaching us the value of resilience and flexibility.   

Companies that need cash and wish to borrow to survive the crisis have no idea when their cash flows will once again become predictable.  Companies that thought they had predictable cash flows and have borrowed against those predictions are now stuck with fixed payments they can’t meet.  

The core problem with traditional debt for social enterprises is agreeing to fixed payments against variable revenue streams, negotiated early in a company’s life when revenue is most unpredictable.  Many enterprises in the countries where Covid-19 lockdown measures have been implemented are going to fail. It’s not true that “no one saw this coming.” Covid-19 specifically, yes; but unpredicted swings in revenue early in the life of a company?  Both foreseeable and foreseen.  

There is an alternative, but it’s been practiced only at the fringes.  This global crisis presents the opportunity to reconsider how we structure early stage investments.  For the many companies in trouble, Revenue-Based Finance (RBF) approaches are among the most promising ways to restructure debt to assure repayment in the long run.  Little has changed about the long-term prospects of most of these companies; yet many have total uncertainty about near-term revenues. A return to revenue growth is likely, but the timing is completely unknowable.  This type of situation is a perfect recipe for the use of RBF.

For new financings, the benefits of RBF have never been clearer.  If a crisis can quickly slow the economy once, it will happen again — why not design our financing structures for flexibility and resilience?  Revenue-Based Financings are investment structures that link the returns to the investor with a company’s revenue. This type of structure is in the interest of both the social enterprise and their investors.  There are many ways to structure RBF and you can learn more about structuring options at impactterms.org  

Because the payments due to investors from RBF structures vary with company performance, they are designed to handle exactly the kind of stress and uncertainty we are seeing in this crisis (and others like it in the future). A company that borrowed using an RBF structure, instead of traditional debt would not be forced to make payments that they can’t afford but if they miss put them in default. Its action also saves the investors in the company. Yes, the investors’ returns will likely decline as payments get pushed to the future, but that’s a much better problem than losing their whole investment.

One investor using RBF both for restructuring and new investing is Capacity Capital, a new fund investing financial and social capital into small revenue-generating growth businesses, especially the overlooked and underestimated.  For example Capacity Capital recently made an investment in RentSons, a company that helps people link up with “helping hands”. Rent Sons had a mix of existing debt obligations that, as is common in debt structures, did not offer the company the flexibility they needed to manage downturns in the business cycle.  They now have the flexibility they need thanks to Capacity Capital restructuring those old debts and providing new financing in a combined RBF financing.  

Through a new RBF investment they are providing RentSons additional growth capital and restructuring their old debn

For investors and companies that have used traditional debt and are facing likely default, this is a great time to consider restructuring the debt using an RBF structure.  When the timing of cash flows is uncertain but the company’s prospects are still strong, the traditional option is equity. However, the investor has to believe they will one day be able to sell that equity.  By restructuring into an RBF structure, the company can have the flexibility they need to recover, and the investor can have a realistic path to recovery and profit.  

It will take some time before we have enough perspective to look back and draw final conclusions from this experience, but one clear lesson we can learn today is the value of flexibility and we can put that lesson to work today by using Revenue-Based Financing and the other alternative investment structures featured on ImpactTerms.org