Research shows that diversity at the board level adds meaningful long-term value for companies and their owners. Data from Predicting Long-term Success for Corporations and Investors Worldwide shows that the most diverse boards added 3.3 percent to return on invested capital compared to their least diverse peers. Additional research confirms this trend – a 2015 study from McKinsey & Company found that companies in the top quartile for racial and ethnic diversity are 35 percent more likely to have financial returns above their respective national industry medians, indicating that diversity can be a strong differentiator that shifts market share toward more diverse companies over time.
In addition to improved performance, diverse boards consistently invest more in research and development and demonstrate an increased capacity for innovation, giving their companies a meaningful competitive advantage. A multifaceted team fosters not only creative innovation but resilience, and greater board diversity leads to lower volatility of returns. Diverse perspectives and ideas keep companies flexible and better able to navigate, or rebound from, unexpected obstacles.
While these studies, and others, focused on the benefits of board diversity for public companies, there is no reason to believe that the same value-creation potential would not exist for those that are privately held – and data from The Carlyle Group confirms that view. In a study of its portfolio companies, Carlyle found that firms with two or more diverse board members recorded 12 percent higher annual earnings growth than companies with fewer diverse directors.
Despite the evidence of the benefits of increased diversity, progress at private companies has been slow. A 2019 Crunchbase study of the boardrooms of the most heavily funded private companies revealed that just 7 percent of board seats were held by women, and 60 percent of companies did not have a single woman on their board. There is little reason to believe that the numbers are any better for people of color or those representing other dimensions of diversity.
As private equity-backed companies comprise a significant and growing proportion of the economy, the diversity of their boards is receiving increased attention and provides an opportunity to promote diversity, equity, and inclusion (DEI) alongside long-term value creation.
To improve in each of these areas, FCLTGlobal has convened numerous roundtables over the course of the past year. The outputs of these sessions are the practical guides shown below, that both GPs and LPs can use to evaluate, implement, and report on diversity and inclusion in the boardrooms of their privately held portfolio companies. For some firms, these may be the first steps. For others, they may be a refinement of plans already in motion. Regardless, they are a means to putting leaders in the boardroom of private companies who are representative, forward-looking, and positioned to create long-term value.
In order to make private boardrooms more inclusive, private investors must first assess their current practices and the role they can play in progress. Frank discussions between general partners (GPs) and limited partners (LPs), both in the diligence process and post-investment, can help both sides leverage their positions to enhance diversity and inclusion at the portfolio company level.
Once this initial evaluation has been made, the actual implementation of next steps is critical. Rather than resting on the laurels of loose commitments and vague targets around board diversity, grounding a plan in real-world, practical actions is a more direct way for GPs to play a role in real change, supported by their LPs.
Finally, and some would argue most importantly, accountability and reporting are required to ensure that private equity firms are hitting their portfolio-company diversity-related goals. A framework that tracks the status of current voting and non-voting portfolio company board directors and board chairs, as well as changes resulting from director turnover, can serve as a baseline for creating consistent information sharing between GPs and LPs.
Read The Missing Element of Private Equity: Creating Long-term Value Through Portfolio Company Board Diversity
