It takes tenacity and stolid determination to push a private equity deal all the way to completion. From originating the deal to negotiating terms, it’s thankless work (Ha! 20% carry is thanks enough).
But as a private equity pro, you sell yourself as a master of value creation, not a master of closing deals. So, when a deal closes, you really haven’t even begun to prove yourself. It may feel like the end of the journey, but it’s only just the beginning.
People will make up their minds about you in these first few weeks. They’ll be watching and analyzing your every thought, every word and every action. They’ll use this to decide whether they’ll work for you or against you. It may sound unjust of them, but you probably close deals by promising the world. So now it’s showtime; it’s time to deliver.
Here are a few other thoughts to consider once you make a new investment selection:
- There may be lingering bad blood from the negotiation phase, so make sure you reconnect with everyone who’s still involved in the business; change the focus from the transaction to the future
- Make sure you act on the findings from due diligence; it wasn’t just for show, it was commissioned to better understand the business and better understand the next steps to strengthen the business
- Communicate with management and visit them often to show your support; again, you need to transcend the adversarial relationship that developed during deal negotiations
- Minimise the annoyance of implementing new systems by making changes fast; this applies especially to new financial reporting processes, which often require a lot of effort upfront
- Offer your services and your firm’s services over and over and over again, and act quickly on any promises; you will gain respect and credibility by showing you don’t mind rolling up your sleeves
- Focus on tasks that businesses often neglect, for example, contacting acquisition targets, renegotiating bank terms, gathering intelligence from competitors, collecting customer feedback, etc.
- Most of all, keep acutely aware of the culture, people and politics and adjust quickly and ask for explicit feedback; you need the support of the people, without it you’re doomed from the outset
As you can imagine, your performance early on sets the stage. It feeds back to others and especially onto other entrepreneurs who may be looking for investors now or far into the future. Think of that extra effort now as what it takes to future proof your firm and ensure a good return on investment selection.
Good Return on Investment
This may sound a little strange, but whenever I look around a private equity shop, including my shop, I think to myself what on Earth are we all doing? I don’t mean this in an existential sense (although that begs answering too), but more in a productive sense. We seem to spend way too much time in perfunctory meetings or way too much time analysing the past to predict the future. And, it disturbs me that this is the life of the average private equiteer.
Now, I know it’s human nature to lament our long working hours and to celebrate our stoic commitment, but let’s spare a moment to be honest with ourselves. Success in private equity is partly making good investment selections and partly making good investments better. Success isn’t a PowerPoint presentation, it isn’t a founder’s mistake in 1943, and it certainly isn’t a rhetorical discussion where we lionise ourselves for great work (that we haven’t really done).
If we are looking to make great investment selections, then we should discuss great companies, call them, visit them, sell our wares and make investments happen. If we are looking to make existing investments better, we need to visit them, understand them, distill their drivers, talk to the market, model initiatives and make improvements happen.
The problem is that most people would read those steps and exclaim that’s exactly what we do!. But, I don’t see it. I see meetings that disrupt discussions without tangible results. I see analysis that is so technical that you’d think we were exploring permutations of DNA pairs in the human genome. I see hubris attached to accoutrements, guest lists, gated estates and public appearances. I see inefficiency.
What I’d expect to see in my private equity returns on investment Elysium, is a truly cooperative team, a team completely open to sharing opinions, a team with humility, thoughtfulness, self-honesty and a focus on those oh so simple objectives. A team that is so opposed to conventional wisdom that it doesn’t even know what constitutes conventional wisdom. A team that spends most of its time either in thoughtful discussion or out discovering the world, not sitting at a computer or in box-ticking meetings. In this fantasy world, my team would kick ass.
Private Equity Returns
Especially in the current market, it pays to be discerning with potential investees. The current under-performance of many funds has been attributed to over-gearing, high purchase multiples and poor fundamentals, so we don’t want to become caught in the same trap when it’s clearly a better time to be buying (in a sense of Private Equity Returns). The following list outlines a few characteristics of potential investees that I believe are important to look out for:
- Potential market size: depending on the size of the fund and the size of the potential investee, the market for that investee needs to be a certain size to mitigate a range of risks. A larger market means you need less of a share to achieve target returns. It also means that competitors have less of an influence when they get aggressive. For a lower-mid-market fund, I look for markets with a current size of at least $0.5-$1b and with growth rates that are at least positive (not as common in our current economic climate).
- Customer/Supplier Fragmentation: the last thing you want in this market (when it’s already tough to grow) is to invest in a business with high customer concentration. If a major customer is lost, you could lose a significant part of your business. All of those great strategic plans you had to grow the business will now only bring the business back to its former glory. The same goes with the supply side, although there’s often less of an impact (unless you are licensing someone else’s brand).
- Counter-cyclical offering: most of the highly defensive industries make for bad investment selections. They either don’t have the growth prospects or are too risky. I’m thinking agricultural commodities, certain financial services, natural resources, etc. But, you can benefit from counter-cyclicality in other industries too by finding sub-industries that businesses visit in tougher economic conditions due to cost savings. There’s no point going into something like motor yachts with the expectation that next year’s sales will grow upon last year’s sales; common sense in this area will go a long way in saving face (and no, I don’t buy that old money argument).
- Invested management team: we’re seeing many business owners looking to sell out completely while telling us that their businesses would make great investment selections even in a downturn. One would think that a mass exodus would indicate something quite different to a great opportunity. So, beware of business owners jumping ship, especially if they’re not on their deathbeds and are sufficiently able to continue their businesses. They know more about their business than you do, so take notice of their behaviour. Also, don’t let earnouts that seem to lock management in fool you; they’ve often done their numbers and have accounted for the risk of losing the earnout.
- Low gearing: a seemingly low risk business with high gearing can become high risk and virtually non-existent if revenue softens or a refinancing event strikes. A lowly geared business also gives you room, should you need it, if things turn sour. We are seeing businesses file for insolvency every second day due to gearing, so it should serve as a powerful warning to private equity investors looking to buy in this market. Again, common sense and looking at deals objectively will save face.
There are many other characteristics to look for in potential investees, but these are the most prescient for the current economic climate. I say, forget about being a contrarian investor when you can just use some common sense; look for fundamentally good businesses, purchase them at reasonable prices, and use private equity value creation principles to exceed target returns. Why make it more complicated than it needs to be?
Investment Selection (Investees)
If I personally purchased a business as an investment selection, for wealth creation and as some sort of plan to create passive income, I would want to know it inside-out. I would hope to have access to every scintilla of data available, and even the data unavailable. I would expect to know the people personally, to know the advisors (finance, legal, etc) and be able to recite the key drivers of the business and their latest metrics. This isn’t an obsession, it’s just par for the course considering the obvious consequences of relinquishing control of such an important asset.
I attended a private equity returns on investment conference recently and spoke with a number of general partners, mostly just idle chatter, but also a tête-à-tête or two on the topic of investees. I was somewhat startled to hear GPs forgetting the name of their investee’s CFO, or not knowing whether revenue last year was $300m or $400m, or not being sure whether an investee has an online e-commerce presence. There could be many reasons for this; I just hope it’s not a sign of what’s to come. By this, I mean private equity continuing the trend along financial engineering and not doing much for the long-term value of companies with a lot of potential.