Decisions by various central banks to raise interest rates have dominated column inches in recent months, from recession and recovery predictions, to rising mortgage repayments and debt servicing costs. But something about looking back at the extraordinary period of near-zero interest rates has captured my attention, and the knock-on effects affects across the world of business. One such effect that has been thrown into focus is governance, where it fell short and how this greatly contributed to catastrophic losses. To paraphrase Warren Buffet, I believe it is only when rates go up that we see who has been growing without proper governance.
There has been a pattern of similar stories over the last few years that have grabbed headlines, and most have had the same type of company at their heart; a rapid growth disruptor. These companies have tended to progress through infancy to achieving unicorn status in a miraculously short time period, often bypassing the necessary steps needed to sustainably build and run a company of this size. The main reason for this is simple; a near-zero interest rate environment has led to investors valuing growth as the most important metric, and cheap money inflating the valuation of anything demonstrating growth.
Granted, this day-trader investment style has awarded investors significant returns over the last two decades. However, in some cases the fear of missing out prevented robust oversight by forgoing the proper due diligence, leading to the implosion of some of the investor community’s favourite businesses.
Growth vs Governance
Due diligence has always been a cornerstone of the financial industry. Handling other peoples’ money comes with the fiduciary responsibility to ensure the risk profile matches that of your investment criteria, including ensuring there are solid corporate governance structures.
The problem with due diligence is that it is time intensive, and can be seen as an impediment to those chasing momentum in a bull market. However, it is a necessity in the identifying and protecting of long-term successes. Set against my own living memory (which is admittedly reasonably short), when it comes to companies which claim to have the ability to change entire industries, to lose time has been to lose growth opportunity.
These companies in question were founded on disruptive ideas coupled with engaging stories that convinced those they were pitching of fast and furious growth. This lethal combination meant investors were willing to cut corners to get a piece of the action, resulting in not enough attention being paid to the devils in the detail, neglecting oversight of corporate governance and risk. A quirky founder with a strong personality and an idea became a new form of tradeable currency.
When the tide goes out
Examples of this are abundant, just look at the failings of WeWork and Bulb. Or perhaps think of Elizabeth Holmes and Theranos, a company built on empty promises and non-existent medical technology which investors failed to uncover for years.
FTX is arguably the ultimate culmination of this investor approach, so much so that John Ray III, the new CEO of FTX hired to manage the company through bankruptcy proceedings, commented he had never “seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information”. Having dominated headlines in recent weeks, rehashing its failings seem redundant. However, one anecdote worth mentioning is when an investor asked FTX to consider a two page list of recommendations as part of their due diligence, the response they received was a simple: “Go f*** yourself”.
So, what safeguards can we put in place to prevent this risk, even when it is incentivised by economic factors?
It would be fair to argue that investors should take more responsibility to understand the financial risks of their investments, including from a corporate governance perspective, rather than jumping on a popular bandwagon backed by other recognisable names.
However, it also highlights the necessity of external consultants. Issues such as these could have been prevented by having a strong bench of independent and experienced advisers in place.
Advisers provide balance
Focus on growth at all costs has a tendency to centralise power around charismatic founders and create blind spots around unit economics. This ultimately creates long-tail risk for high-growth companies.
Advisers should be more than just enablers of growth stories: they need to provide counsel that grounds companies in the real world. Investors need to be responsible stewards for their clients as well as generating returns. Advisers need to consider the long-term health of companies they work with, not just chase short-term fees.
Governance is essential and advisers who don’t give adequate advice on this can and should be held accountable. They should support boards and management teams to ensure companies are governed by a comprehensive system of checks and balances. Most importantly, these advisers bring a wealth of sector specific knowledge and experience: their function is to call out the risks before anyone external has a chance to.
To steal another Buffet quote, we know how long it takes to build a reputation and how quickly it can be ruined. As strategic communications consultant, we see the consequences of poor governance and the far-reaching reputational impacts it can have. We exist to elevate profile and performance through a clear, consistent narrative and ask the uncomfortable questions before others do. Stories about these rapid growth disruptors built on shaky foundations show how imperative it is to weigh reputational risk in equal measure against investment risk in order to achieve long-term success.
Written by George Peele