Five Reasons to Adopt a PE State of Mind

This past week, I came across the infamous clip in the movie “Wall Street” where Michael Douglas’ character, Gordon Gekko, makes his “Greed is Good” speech.  It’s one of those scenes that makes your skin crawl.  He evokes all that’s dark and twisted in Hollywood’s Wall Street, exclaiming “I’m not a destroyer of companies.  I’m a liberator!”  Cue the eye rolls and cynicism, right?

Not too long ago, I was working with a business owner that was assessing their options for a sale.  We started talking about private equity (PE) as a viable option.  For their situation, PE had the potential to be a fantastic option for them.  My client, John, had a business partner that was a handful or more years older than he was.  The partner wanted to retire yet John still had plenty of gas in the tank.  He also saw continued growth opportunities for their company. Private equity offered a path for allowing the partner to exit while giving John the support and financial backing to take the company to the next level.  It could offer the win-win-win.

John’s reaction was intense.  “Naw.  We don’t like those guys.”

Yet John had never met any other “those guys.”  All he knew was the stories he had heard or read about and visions of Gordon Gekko.  I convinced him to allow me to introduce him to some PE folks so he could learn more about the PE business model of partnering with business owners to help them take the company to a new level.  I also wanted him to meet these people face-to-face and see that many of the players in PE have a genuine and caring interest in seeing teams succeed in business.  John appreciated the experience, which gave him more confidence as he sorted through their sale options.  He was introduced to the PE mindset to drive value in the company.  John continues to leverage this mindset in his leadership today, even though they ultimately chose a different path for exit.

The truth of the matter is that we can learn a lot, as business leaders and owners, from a private equity mindset.  Most private equity professionals I know have a keen interest in growing companies that in turn grow valuable companies.  There’s a degree of financial awareness and acumen that provides for flexibility and agility. As the market changes, as it has 24/7 over the last 25 months, they’re able to pivot faster and make data-driven decisions.  There’s a culture of “Let’s go!” type of energy, bolstered with business discipline and accountability. 

There are six characteristics that distinguish PE-owned portfolio companies from their peers:

Financial Discipline:       There is a strong sense of financial discipline instilled into PE run portfolio companies.  Strong accounting systems are paired with accounting and financial talent to stay on top of the numbers.  Decisions are data driven, leveraging strategic and operational plans and budgets.

Cash is King:    Exceptional cash management distinguishes these companies, building upon the financial discipline.  Not only do they maintain solid 13-week rolling cash forecasts, but they also hone their accuracy, comparing their projections to actual and factoring in what they learn into the next update.  This is often critical as the company leverages their balance sheet.

Effective Use of Debt:    Debt is a delicate tool in business.  Too much and it can kill you.  Too little and you’re underutilizing your assets for growth.  PE environments are skilled and knowledgeable when it comes to the effective use of debt and cash.

Incentive to Perform:    It’s quite common for key managers within a portfolio company to have skin in the game through equity positions or other deferred or incentive compensation systems.  Why?  Because it drives performance and aligns efforts around a shared goal.

Play to Your Strengths: PE, at its core, is an ownership model, not an operating model.  Traditionally, PE firms invest in the portfolio companies.  They are not involved in the day-to-day operations.  Their involvement is twofold – have a seat on the Board of Directors to ensure the stewardship of their investment and serve as a resource to management as they drive the growth.  The PE professionals’ strengths lie in their financial and strategic thinking capabilities.  They stick to their lane and rely on a kick-tail management team to run the company.  When and if operational needs arise, they lean on their vast networks of resources to bring support.

Hold Only as Long As:    PE funds, by contract, have to exit the investments in portfolio companies in order to return capital to the investors in the fund.  Unlike private companies, there is not an option to hold the company ownership for forever.  This create a mindset of “we’re going to hold this asset for only as long as we are able to add significant, meaningful value to it.  Once the value growth tapers to lower levels, we will dispose of the asset.”   The mindset recognizes when their best work is done and the future of the company, its next “next level,” will come under a different ownership model.

Each one of these characteristics offers a mindset shift we can bring into our own companies, regardless of whether private equity is ever a potential exit option.  This is the mindset for building and growing a strong, sustainable company.  It doesn’t matter what size you are, industry you’re in, or ownership horizon you have.  There are good reasons to adopt a PE state of mind, including:

1. Having a robust focus on your financial information and performance drives better decision making, strategic motivation, and results. Understand the importance of focusing on value, not merely revenue and profits.
2. By leaning on a strong management team to run the operations of the company, owners are freed up to do what they do best – think about and orchestrate the strategic future of the company and its role as an asset in the portfolio. And have more fun doing it.
3. Ownership is lonely. It’s easy to find yourself in an echo chamber where you miss key trends and opportunities outside your four walls.  Having an independent Board of Directors or Advisors provides owners and management with a go-to resource for ideas, sounding boards, and feedback. It brings broader and more creative thinking to the table while challenging you and your team out of your comfort zones.
4. Incentives are persuasive motivators. Design them to drive the behaviors you seek.
5. Maximizing the return on your assets. Hold them only as long as you are adding value.  You and your team do your best when focused on what’s moving the needle.  Remove what’s.  Whether its converting underperforming inventory to cash or selling a division that you aren’t adding value to anymore, eliminate the distractions and harvest its value at its peak.

You don’t have to become one of “those guys” to generate the kind of growth and results that PE-owned portfolio companies do.  Trust in yourself and your team that you can do this.  Bring in help if you’re not sure where to start.  Liberate your company to become its best self.