Private Capital

“Debt is a sword. Equity is a pillow!” asserted an investment banker to a senior leadership team intent on growing their business through acquisition.

At the time he was promoting the virtues of a highly leveraged, management buy-out structure. His point being that the right capital structure complete with high debt, creates an environment where management have an incentive to make better decisions, faster, sooner and smarter. For the past 5 to 10 years the corporate sector has seen the advent of private equity as a mainstream force in the economy. Much of the activity has been fuelled by the ‘debt sword’ advocated by many in the finance sector. The appeal and seeming simplicity of the model has meant that very few executives have not been tempted by the appeal of private equity. Indeed, as a senior search consultant, there have been many conversations with senior executives who have insisted they would never work under any other structure than private equity. That is of course until the Global Financial Crisis.

The Global Financial Crisis has brought home that too much of a good thing, ie debt, may well set the foundations of future decay. This change in the orthodoxy of the day has exposed the myth that commercial success is largely about how the numbers are cut. Indeed several executives that have taken the private equity path have come back and shared that the pressure created by too much debt, led to short-term decisions at the expense of customers, corporate culture and employees. Indeed the fullness of time has seen the capital structure and myopic focus on numbers creating untold damage to shareholder value.

Many years ago the “Oracle from Omaha”, Warren Buffet in his Berkshire Hathaway shareholder letter shared that in his experience acquiring companies often are populated by executives who regard themselves as ‘princesses looking for a ‘frog of a company’ to kiss and turn into a prince.’ However in his experience, ‘if you kiss frogs, you end up with a bad taste in your mouth!’ The moral to the story is that when selecting a company to either acquire or join, irrespective of the ownership model, it is best to choose a prince!

So, if contemplating a career change into the world of private equity, the underlying fundamentals for making a good career selection remain true. What is the reputation of the team you are joining? How strong are the customer relations? What is broken and needs to be repaired? Where are the risks? What is the nature of competition in the sector? After all these questions can be answered and the risks assessed, should an executive then consider the reward and the targets being set. Private equity, indeed most ownership structures, while being a component of your consideration, is not a panacea, nor is it a guarantee of success. Indeed, the chances of career success are possibly less than in other ownership structures.

Inevitably some executives are better suited to high risk environments than the more stable, established blue chip or multinational companies. Sometimes stage of career is a large determinant, as will be person financial position. However the fundamentals for selecting that next career move require a thoughtful analysis of the market position of the company. Of less concern is whether a company is global or local. Rather, “What is it that is special about the business? What macro-trend will create the opportunities moving forward? What is it that is compelling to customers? or “How intact and strong are the distribution channels?

Another important factor is the relationship with the Board and/or stakeholders. If you do not have trust from the beginning and understand the track record of the Board in working with management, you may find that you unwittingly inherit a poisoned chalice from day one.

Another key factor is the quality of the team. If the leadership team is not up to scratch, do you have the mandate and support from the Board to make the changes necessary to put the business on track as required?

The Global Financial Crisis has created a large shake-out in private equity and shown that there is no special magic ingredient that a private equity holding versus public listed versus multinational brings to guarantee career success. What is important are much deeper commercial factors and how they align to your own values.

First published for the CEO Forum Group at http://www.ceoforum.com.au