There’s always a relatively high degree of risk for an executive onboarding into a new company. If a private equity firm owns that company, the risk is magnified as those executives must converge into the culture of the company they are joining and into the culture of the private equity firm that owns the portfolio company.
As I’ve said throughout this series, executive onboarding is the key to accelerating success and reducing risk in a new job. People generally fail in new executive roles because of poor fit, poor delivery or poor adjustment to a change down the road. They accelerate success by 1) getting a head start, 2) managing the message, 3) setting direction and building the team and 4) sustaining momentum and delivering results.
Private equity firm leaders suggest executives in their portfolio companies should pay attention to five critical differences versus what they may be used to: context, objectives, strategy, relationships and required impact.
There’s a contextual difference. When you join a private equity portfolio company, understand you are “Walking into someone else’s paradigm – their rules, their language.” You, and everyone else, are ultimately working for the “PE fund’s” investors. Yes. There’s a PE management company advising the fund. Yes. You’re joining a separate, free standing operating company owned by the fund. Decisions need to be made in the best interests of the fund’s investors.
The fund has no feelings. Its objective is to maximize return to its investors. And, as one leader put it, “The fund is a limited time offer.” If, for example, the fund gives its managers five years to invest its money and ten years in total to return its money, that yields an average hold time of five years. Private equity fund managers are short-term stewards of the portfolio company. They must buy, improve and then exit their portfolio company investments in order to realize a return by the end of the fund. The good news is they are less worried about quarterly results. But they are time-bound.
The private equity meta-strategy is to optimize returns with a combination of revenue growth, operating and organizational improvements and financial engineering. As one leader explained, they try to “Buy good companies with good teams” and help them improve their operating strategies, reduce their operating costs, improve their organizations and grow revenue. At the same time, they try to optimize the capital structure, economics and cash flow to maximize valuation and internal rate of return. “Rate” is a key word, encompassing the level of the return and the speed of the return. Better results faster.
In general, there are three types of compensation: base, bonus and long-term incentives. The normal prescription is for people’s base compensation to be enough for them not to have to worry about their day-to-day expenses. Bonuses should focus people on mid-term upside and long-term incentives should focus people on, wait for it, long-term upside. As one leader explained, private equity investors are keen on an “alignment of interests” between the fund’s investors and the portfolio company’s executives. Thus, they prefer to under-weight base and bonus and over-weight equity incentives, so everyone is working in the best interests of the fund.
This tends to drive relationships. New executives must converge into the PE-owned portfolio company operational paradigm and build relationships with the financially-focused deal partners all at the same time.
Private equity firms have a bias to hire people that think, talk and act like “deal executives” over “job seekers.” The more executives focus their decisions, actions and language on what will benefit “the fund”, the better. They should lead strategic, organizational, operating and financial processes that create value for the fund’s investors and which value creation can be realized (for everyone) when the PE firm exits its investment in the portfolio company.
Finally, private equity portfolio companies must think differently about cash.
- Managers of public companies invest to increase shareholder value over time and report earnings on a quarterly basis. They are generally more worried about reported earnings than they are about cash. (Until they need to worry about cash.)
- Managers of family-owned companies invest to create wealth they can pass on to the next generation and don’t have to report anything.
- Managers of private equity portfolio companies are time bound, don’t have quarterly reports, but must pay attention to cash on a continuous basis, making sure they can meet payroll, fund their own investments and “redeploy every dollar of excess cash to pay down debt.”