The psychology of enterprise value

Enterprise value is arguably the ‘biggest’ number in private equity. It represents the sum total of everything that is known, thought and felt about a business at a particular point in time. As such it reflects a basket of hopes and fears that transcend financial analysis. It is also the basis on which ‘success’ or ‘failure’ are gauged so, as well as being driven by emotion, it is itself a strong emotional trigger.

Gut feel influences many major decisions in PE, none more than those relating to EV, but the standard PE toolkit is dominated by ‘rational’ quantitative analysis. This tends to marginalise or try to eliminate psychology and emotion, pushing them below the surface where they may distort perceptions of EV. Expanding the analytical toolkit to embrace insights from psychology enables PE practitioners to gain a richer, deeper and more accurate understanding of EV, leading to better results.

Beyond the numbers

Attachment, doubt, trust, cognitive diversity and intuition are all psychological and emotional factors relevant to EV. The following examples show how an understanding of these can give a richer view of EV than numbers alone.

The future is unpredictable, so avoid over-attachment to any one future scenario for growth. Look beyond the historical path to value creation and connect with the underlying
‘intangible’ drivers of EV, such as skills, knowledge, practices and relationships. Showing how these can be deployed to engage with emergent threats and opportunities will alleviate doubts about the sustainability of the business and potentially boost the multiple.

Embrace doubt rather than try to eliminate it. Both uncertainty and conviction are emotions and attempting to avoid the former and crave the latter can distort judgment. Techniques such as ‘active open-mindedness’ can give practitioners a more dynamic understanding of how EV changes over time by tracking assumptions behind key decisions.

Focus on how to build trust on the part of a potential acquirer. Here, the accuracy of the numbers is only the first step. The kind of deeper trust that will boost the multiple depends on the coherence and credibility of the underlying ‘story’ of the enterprise and its capacity to reliably hone its value proposition and brand over time.

Recognise that the individual and collective psychology of the leaders of the enterprise are key drivers of value creation and destruction. Diversity of thought at leadership level is fundamental in ensuring the resilience and adaptability of the enterprise and this can materially affect EV.

Cultivate psychological self-awareness and develop instinct and intuition as core competences. PE practitioners pride themselves on their gut feel but there is often limited understanding of what influences this and how it can be improved. Systematically tracking emotional reactions during negotiations can provide an edge when it comes to the final decision about EV.

The financial view will always dominate the world of PE but this ‘lens’ can make practitioners sceptical about embracing non-quantifiable, psychological factors. Because EV will never be an entirely ‘rational’ number, embracing the underlying psychology will produce better outcomes both in terms of the lived experience of practitioners and the returns they achieve.

Dr David Cooper is a recognised authority, international speaker and media commentator on the psychology of private equity. Through his firm, Cooper Limon, he advises GPs, portfolio leaders and LPs on the application of behavioural insights as a basis for creating value