Investment Firm Pushes Collaborative Activism

As investor pressure to diversify corporate boards intensifies and the emphasis on board adoption of ESG trends grows, a small investment firm is advocating changes that could re-ignite the debate over whether adding members of private equity firms to a corporate board enhances the investor-board relationship.

Mill Road Capital, a $900 million investment firm that primarily invests in micro-cap companies, says it will begin using a “Sponsoring Investor” concept that it claims will “improve the functioning of boards by adding directors with the ability to drive long-term value creation, while also enhancing the culture of boards by bringing in more diverse viewpoints and committing that at least 50 percent of its director nominees will be women or people of color.” The company says it will launch the Mill Road Progressive Governance Fund based on the concept during the second quarter this year.

“When we invest in a company we want to send a signal that we are sponsoring what they are doing,” says Thomas Lynch, senior managing director and founder of Mill Road. “What we are sponsoring is that this board has private equity skills to drive operating value, it has a long term perspective and it has a commitment to build a diversity-inclusive community.”

While investment firms seeking to add directors to corporate boards is not new, Mill Road Capital wants to do this while distancing itself from the adversarial nature of shareholder activism. The company says they will be taking a more collaborative approach to adding board members by seeking consensus and clearly stating what the new directors are specifically charged to do so that the investment community and the capital markets can have confidence in their involvement with the board. In fact, through constructive engagement with companies, Mill Road hopes to be invited to join the boards of investment targets.  Additionally, Mill Road’s directive—to have 50 percent of directors on boards it invests in be women or people of color—breaks new ground.

Why should this be of interest to corporate boards? If Mill Road Capital’s “Sponsoring Investor” approach works for the micro-cap companies it invests in, the potential for similar attempts by investment firms that focus on mid-cap and large-cap companies may follow.

Mill Road Capital is suggesting that it can get companies to deliver what many investors are asking for – improved long-term performance with a commitment ESG and diversity principles in governance – but it has to add board members to do it. The suggestion that boards might need to replace or add directors to improve performance is a sensitive subject and will likely be rejected by many companies. However, companies of any size that recognize they need help driving long-term value and/or finding diverse board candidates might be receptive.

As forecasts for the economy look increasingly bright, boards are going to have to demonstrate to shareholders that they have positioned their companies to benefit from an economic boom as the country emerges from the COVID-19 pandemic. Corporate boards that have not positioned their organizations for growth as the country emerges from the pandemic will no doubt be targeted by activists, especially if their CEO’s salary has increased during what was a down year for most companies. What Mill Road is suggesting is that activism can be collaborative and supportive instead of combative and destructive. That has not always been the case, so it remains to be seen if the type of investor-board relationship Mill Road envisions can be successfully sustained on a large scale.

The concern for directors is that no matter how well intentioned this new approach appears, it is another swipe at the ability of corporate boards to oversee their companies effectively. Institutional investors that want to influence boards are paying attention. The pressure on boards to improve returns, diversify their boards and create more social equity for customers is only going to increase. This shows that if directors don’t move toward these investor focused issues, or at least explain the reasons why they won’t, shareholders will invent new ways to move them.

As for Lynch, he explains his company’s approach this way: “We go to companies and we say we have this broad set of resources, we have operational skills we can help you with, we have financial relationships we can help you with, we have an understanding of the importance of diversity and inclusion…. And since we have a long term focus, we can protect you from conventional activists.” He believes that companies that agree with their analysis regarding unlocking future growth will welcome them onto their board.

James D. White, Mill Road’s managing director and the head of board governance and diversity initiatives, suggests that “This sponsorship model represents the future of this ESG oriented world that we’re moving to.”

Only time will tell if he’s right.