At the smaller end of town (say under $200m of capital), there are a plethora of private equity firms that are individually owned. Often these owners come from larger firms where they didn’t get along with others or preferred the idea of running their own show (for a larger portion of carry). This isn’t such an unconscionable act in isolation, it’s actually quite industrious, but there are fundamental flaws to single-owner private equity firms.
Private equity firms must have a deep and thorough understanding of deal-making, financial instruments, legal structure, business strategy, and of course, debt management. It’s hard for a single private equiteer to have a deep understanding in all of these areas, which is why it pays to have a range of senior partners/owners whom do in aggregate. Conversely, most single-owner firms are bottom-heavy and don’t have this diversity and therefore contain much more risk for every stakeholder in the firm.
In addition, here are a number of other important considerations regarding single-owner private equity firms:
- They’re a textbook example of a dictatorship – one person, with all of their emotions, persuasions and biases has carte blanche over every major decision; decisions such as selecting investees, hiring new staff and leading due diligence. In private equity, two, three and four heads are definitely better than one.
- Key-man risk is a repellent - investors (limited partners), investees, staff, media, bankers and advisers tend to steer clear of single-owner firms for various reasons. LPs will give a wide berth because there’s increased risk borne by having only one decision maker. Investees will do the same because there is often less value-add from a less experienced team. And staff, if they know better, will steer clear because a dictatorship is not the best place to learn.
- There is fundamental risk to the fund – as previously noted, most of these single-owner firms are bottom-heavy. If something unpleasant affects the owner, the fund is left with a phalanx of fledglings whom may be versed in the daily ruminations of the private equity firm, but lack the critical relationships to run the fund.
- They circumvent necessary checks and balances - even otherworldly businesspeople need checks and balances in cases where they aren’t thinking straight, aren’t completely objective, aren’t available or are simply too stubborn or clueless. Companies have boards of directors, Presidents have senior advisers, but single-owner private equity firms only have LPs, whom most of the time are oblivious to what’s really going on (sorry LPs, but it’s true at mid-market level due to a lack of transparency).
- The arrangement is often a sign of the owner’s character – in most cases private equity firms benefit from multiple owners with complementary qualities. My experience is that single-owner private equity firms are single-owner for a reason: the owner finds it hard to compromise and deal (closely) with other people. Additionally, it gives LPs and others comfort to know three or four top equiteers can work productively (even if at times with tension) using their complementary skills for the greater good.
- Management fees are squandered to profit the owner - with a single owner, there is a real conflict regarding management fees. “Do I spend $x on business tools or tell staff to make do and save the money for dividend time?” Of course this could happen in multi-owner private equity firms, but chances are they’ll keep each other honest. And, having multiple people with a financial interest in the management company will increase the chances that fees are put to good use.
To reiterate, I think it’s industrious and quite brave for a private equiteer to open up their own PE shop. But especially in private equity, it’s best to have a number of owners/partners with complementary contacts, skills, personas and experience. Multiple-owner private equity firms are generally better investors, have better contacts, are better places to learn, are more enjoyable to work within and have more overall success.
You may be thinking that people like Buffett and Branson didn’t need others when they started their ventures, but we’re talking about private equity firms run by relatively average earthlings (plus think of Gates and Jobs… and how Buffett fared with Munger). So, whether we talk about investment performance, esprit de corps (team morale), or access to capital, I really believe that multi-owner funds reign supreme.