GOVERNANCE · SERIES B · ARTICLE 06
The Six Governance Gaps That Appear in Almost Every Founder-Owned Business Before Its First PE Investment.
After advising PE funds on what to look for when they acquire, the patterns become clear. The same six gaps appear repeatedly. None of them are fatal. All of them are fixable. The question is whether you fix them before or during the process.
After spending years working inside PE fund operations and advising on acquisitions, I can tell you that the governance assessment of a founder-owned business is rarely surprising. The same gaps appear. Not similar gaps. The same ones. The order varies. The severity varies. But the categories are consistent enough that I can describe them before I have seen a single document.
Understanding them before a PE conversation begins is not a guarantee of a clean process. However, it is the foundation of one.
Every founder-owned business that has been run well operationally has governance gaps. The question a PE buyer is asking is not whether the gaps exist – they always do – but whether the company can evidence that it has addressed them deliberately.
Gap One: Board Minutes That Read as Ratification, Not Deliberation
The most common governance gap in founder-owned businesses is a board that functions as a ratification mechanism rather than a decision-making body. Minutes reflect decisions already made, risk discussions are absent, and independent challenge is absent.
This is the gap that concerns buyers most, not because it indicates fraud or mismanagement, but because it indicates that the business has been run as if governance were a formality. A buyer acquiring a business wants to know that risks were visible and addressed. A minute book that shows no risk discussion suggests either that no risks existed, which is implausible, or that they were not brought to the board, which is a management quality concern.
Gap Two: Related-Party Transactions That Were Never Formally Documented
Founder-owned businesses operate with a level of informality that is entirely rational when the founder owns the company. For example, rent is often paid to a property holding company the founder also owns, or services are provided by a family member’s firm. These arrangements are common, often commercially reasonable, and almost universally under documented.
A PE buyer’s counsel will map every one of these. The question they are asking is not whether the arrangement was fair. They are asking whether it was documented as if it needed to be justified to someone outside the family. If the answer is no, the arrangement becomes a negotiating point regardless of its commercial merit.
Gap Three: Founder Compensation That Has Never Been Independently Reviewed
Founder compensation is one of the most sensitive governance topics in a PE diligence process. A founder who has never had their compensation reviewed by an independent party presents a specific risk: that compensation will need to change materially post-acquisition, and that expectations have not been calibrated against market.
This is also a gap that is entirely preventable. An independent benchmarking exercise, conducted before any PE conversation, removes the question from the diligence agenda. It does not need to result in a change to compensation. It needs to result in documented evidence that the process was independent.
Gap Four: Management Accounts That Tell an Operational Story but Not an Investment Story
Founders typically run their businesses from financial reports that make operational sense. However, a PE principal needs to understand a different set of questions from the same data: unit economics, sector benchmarks, and normalised EBITDA.
Rebuilding management accounts to institutional standard is the governance improvement with the highest return on time in the PE readiness process. It costs relatively little. It takes a few months. And it changes every subsequent conversation, including the ones in the sale process, because management has spent eighteen months thinking about their own business in PE language.
Gap Five: Regulatory Compliance That Is Assumed Rather Than Evidenced
Most founder-owned businesses comply with the regulations that apply to them. Very few have documentation that demonstrates that compliance in a form a PE buyer can read.
The difference between compliant and evidenced-compliant is smaller than it sounds. It is largely a documentation exercise. But it is the difference between a diligence conversation that starts with a clean baseline and one that starts with a buyer’s counsel identifying gaps and pricing them.
Gap Six: An Ownership Structure With Undocumented Arrangements
Cap table complexity represents a specific PE diligence risk. Informal arrangements, verbal understandings about future equity, undocumented loan note conversions, and arrangements with early employees that were never formally resolved, create title risk that affects the structure of any PE transaction.
I have seen deals restructured and timelines extended because of ownership arrangements the founder regarded as settled but that had never been documented in a form a buyer’s legal counsel could rely on. Resolve these before a process begins. Every month you wait is a month during which these arrangements can become more complicated to address.
THE PRACTICAL TAKEAWAY
- Audit your board minute book for evidence of genuine deliberation. If it reads as ratification, begin rebuilding the board process now.
- Map every related-party transaction. Document the commercial rationale and the approval process for each one.
- Commission an independent review of founder compensation against market benchmarks before a PE conversation begins.
- Rebuild management accounts to institutional standard. The exercise also prepares management to speak PE language.
- Complete a regulatory compliance baseline. Present it proactively rather than waiting for the buyer to find gaps.
- Clean up your cap table. Resolve informal arrangements before they become deal-structure complications.
START HERE
Not sure where to begin?
If you are eighteen months from an exit and have not stress-tested your governance posture, this is where to start.