In most cases private equity companies don’t bring in much value on operational matters. But this is normal since this is not their business but mine. They contribute a generic input: value creation strategies and know-how with regards to financing and M&A.
The main downsides of private equity compared to a corporate owner is two gaps: a knowledge gap with regards to operations and a cultural gap.
The cultural gap becomes visible in different attitudes. Private equity people are used to living on the comfortable side of business life: top class hotels instead of the three-star hotel I use; first class flights instead of coach or business class; limo service instead of a yellow cab. This difference in lifestyle, though, cannot be hidden. Their expenses end up in my accounting department because we have to pay them, and I have to explain to my organisation why the permanent preaching for thriftiness does not apply to them. I – as many other portfolio managers – know that this luxury attitude is very badly received by the organisation.
The pressure for performance in a private equity-owned business is permanent and significant. If you are good at what you do as a private equity manager you make sure that your organisation feels a permanent sense of urgency and cost awareness. This makes it all the more difficult to explain this blatant difference in behaviour. I call this the “OPM” attitude of PE owners. They spend Other People’s Money, so they do not care, but they expect me to care for their money. Obviously, this observation applies more to small and mid-size businesses and less to large caps.
On the upside, private equity people bring in a broad – although generic – package of ideas, concepts and experience. They also contribute to a professional working climate. Analysis, discussions and problem solving is handled very professionally, in my experience. For smaller businesses this can be an important educational process with a positive long-term impact. As a manager I always felt I was treated well by PE partners and respected as a peer. This is not necessarily the case in a family-owned business where I have experienced more of a two-level-hierarchy.
PEI: Is there often friction between the private equity firm and the CEO?
I don’t know if this can be answered in a general way, but yes, unavoidably there are frictions, in particular when financial engineering starts to supersede daily operational necessities. Take this example: I used to work in an industry where the raw material made up 70 percent of our revenues. That is a lot of money and the raw material price had an important impact on the profitability. A corporate owner would say, ‘If we have a period of low material prices, let’s fill our reserves, silos and tanks full of material, so we can benefit in the months to come from the low material prices.’ Not so with private equity. The year-end window dressing of your financial statements was more important than the savings for the ‘real’ business.
In 2006, 2007 the financial world went crazy and many people believed that private equity was a game one could not lose. My business was leveraged so high (despite management’s objections) that the slightest irritation in the market – such as raw material price increases – created a severe financial bottleneck. In such a situation private equity creates suffering because you can’t run your business the way you should. All of a sudden financial trouble-shooting distracts you from focusing on the real business.
PEI: How do you view operating partners?
The management team – with the CEO at its top – is responsible for operations and the shareholders are responsible for setting the targets and controlling the performance of the CEO in reaching those targets. Other things like strategy, financing and M&A have to be handled jointly. It is important that the borderlines between these areas of responsibility – operations versus control and guidance – are respected and not breached.
An operating partner who dedicates most of his time to one business, who takes an executive function, who even has an office in the portfolio company, is a cross-border commuter. He steps over the line by definition because he starts hanging around in your sphere of responsibility. Everybody in the company will interpret this as a sign of mistrust. I have always been able to avoid such a construct, but I would have found it unacceptable.
Having said that, I don’t dispute the value of an operating partner if he acts as a sounding board and a coach to the CEO. But this means that he takes a staff function and not an executive role. An operating partner in this form still has to be intimately involved in the business and has to spend a sufficient number of days with management, but as a staff member and not in a ‘Big-Brother-is-watching-you’ role. The private equity owner should either have confidence that their management team is up to the task or they should replace it.
PEI: How do you view the PE industry’s capabilities in operational value creation?
There are three major contributions. Firstly, the total focus of a private equity owner on value creation. As a manager you get permanently distracted by daily problems. PE guys do not suffer from this due to their distance, and they help you to refocus on the real targets.
Secondly, a good PE firm comes in with a broad toolkit, a great deal of experience from other industries and M&A know-how. With these fresh ideas they help you to break through your own paradigm. Making use of this input, though, means that both sides have to overcome their egos. As CEO I have a tendency to believe that their idea is ‘not applicable to my business because things are completely different’. As a private equity partner I should be open to the possibility that a rejection is not an excuse but indeed based on good reasons.
Finally, I believe that most individuals – me included – need a certain sense of urgency. Private equity is great in squeezing out a bit more from management just by keeping a permanent high level of expectation. This is the difference to most corporations. I think this alone adds value.