The Value Add in Private Equity

There’s never-ending conjecture around the value add that private equiteers really bring to investees. Ask a private equiteer and the list is long; ask certain jaded investees and the list is non-existent. The truth is probably somewhere in the middle.

Unlike venture capital, most private equity firms don’t have domain expertise in all of their investees’ industries. But, what private equiteers undoubtedly bring, is a fresh, external and highly-motivated perspective. And, just as a second set of eyes improves most writing (this post is a good example), a second set of minds improves most investees.

So, if we’re not industry gurus, how do we expect to add value through applying a second set of minds? Well, it’s best to start with what we know best… business. Rather than trying to teach aeronautical engineers how to design planes, we should show them how to make money from planes as a business. We should provide the complementary skills to take an ordinary business with great products & services to a great business with amazing products & services. That’s the added value.

It’s all much easier if you start with the most complementary areas first. Back to the aeronautical engineering company, chances are, they aren’t as good at selling planes as they are at making them. And, they probably aren’t as good at negotiating strategic acquisitions as they are at appraising the technologies used in those potential targets. So, know your strengths and start by adding value in the most obvious places first. Consider:

Value Add Sales Generation
Value Add Financial Management
Value Add Business Transactions

Now, I’m not saying these are the only areas in which private equiteers can add value. I’m simply saying that my experience is that private businesses are weakest in these areas.

It’s an interesting exercise to consider your investees right now. Are you doing everything possible for them in the areas in which you have the most complementary skills? Everything possible? Do they have an amazing sales team? Are they aware of the most important financial drivers and do they monitor them very regularly and act on the data? Are they fully aware of acquisitive opportunities and are you doing everything to land them? Conceivably, if you can’t say yes to all of these, then you’d have to ask yourself what you’re really doing.

PeHub reported a somewhat scathing piece in The Economist about the value add of private equity. One of the lines that caught my eye was:

“You are far more likely to achieve billionaire status by running an asset management business than by setting up an operating business”

This may be true by looking at raw statistics; obviously there are many more operating businesses out there with many lesser qualified owners (than those running PE firms). I think the question that’s more relevant (though likely untestable) is whether a suitably qualified person is more likely to achieve billionaire status from an operating or asset management business. Anyway, it’s mostly trivial, though in the same vein, I think the media trivialises how easy it is to do well in private equity. Sure, some people do very well, but in a previous post I showed how financially unrewarding life can be in private equity.

One of the other lines to catch my eye was:

“Aha, I thought, evidence that finance, not good management is at work.”

Private equiteers typically (emphasis on typically) aren’t entrepreneurs. They often aren’t even senior managers from operating businesses. So, would that suggest their greatest value-add is in private business managerial improvement? What would it suggest if we knew most private equiteers were lawyers, accountants, consultants, b-school grads, etc?

When we talk about experiential value add for private equiteers, I tend to think of the following:

Financial and legal engineering – it’s true; most private equiteers have a financial, law or consulting background, and unsurprisingly, they use this background to create value the way they know how
An external eye – you don’t necessarily need a private equiteer for this, but someone with business experience can often find simple and obvious improvements in even the best-run businesses
Value creation experience – by fact of investment in various businesses and involvement in various value creation strategies, private equiteers have experience creating value, and that can be handy.