How high-growth company CEOs tap the power of private equity

Private equity has become a resource for a growing number of founder-led businesses seeking stronger, more sustainable growth.

By all measures, this alternative form of investing has been very successful for PE portfolio companies and their management teams as well as the investors who provide capital. Today, the investing model has become an integral part of the economy — for example; there are nearly 8,000 US PE-owned companies, which contrasts with fewer than 5,000 public companies. With a track record of outperformance, PE continues to attract more and more capital from a broadening array of investors. Globally and across strategies, PE assets under management (AUM) stands at over US$5 trillion, according to Preqin.

What’s behind PE’s ability to accelerate growth and create value? General partners (GPs), limited partnerships (LPs), and portfolio company management teams invest side-by-side, which aligns interests, and creates high-powered incentives for engagement and collaboration. With limited-life funds, there is also a healthy discipline to focus on unlocking potential growth drivers and returning capital to investors. The model is robust: it has proved highly adaptable across nearly every sector and geography, as well as up and down the capital structure and throughout the life cycle of companies.

Why consider private equity?

Partnering with a PE group is especially attractive for founders of lower and middle market companies that aim for transformational, not incremental, growth. As minority or majority investors, GPs invest alongside their portfolio company management teams to create a real culture of partnership that is necessary to drive collaboration and execution on an agreed upon growth plan.

A growing number of private equity groups specialize in taking young, growing companies to the next level and doing so quickly — over a three- to six-year investment window. As active and engaged investors, they bring not only capital, but specialized industry expertise and experience, and generally a large network of specialists, including operating partners who are often ex-CEOs. Management teams collaborating with PE firms gain access to value-add capabilities across functional areas such as business development, M&A, product road-mapping, IT, and recruiting to drive organic and inorganic growth.

Founder-operators who work with PE firms especially appreciate the ability of their PE partners to bring a fresh mindset to evaluating their companies and its growth opportunities. “It is important to have a partner that has a broader view of what is possible for your company, and it really expands the opportunity,” notes Jeff Eastman, CEO of Alchemy Systems, whose firm was angel-backed and then acquired by a PE company. As serial investors of growth companies, PE firms look at thousands of firms every year to become highly experienced builders of businesses.

The importance of finding the right fit

According to seasoned PE-backed CEOs, one of the most critical criteria to look for in a prospective PE partner is alignment of vision, investment thesis, and values to keep everyone rowing in the same direction. This alignment is also critical for stimulating productive collaboration where all the partners are passionate about building the business and can communicate freely and frankly. The right PE partner can also help founders achieve their personal goal – whether it’s a fair financial return, maintaining the legacy of the business, or looking after key stakeholders. Benefits to broader stakeholders can be significant: “One of the things I take most pride in is that we have made about 20 millionaires over that course of Alchemy’s journey,” adds Eastman.

As many PE groups are highly engaged, hands-on investors, they tend to interact frequently with the management team. Consequently, “it is really important that there is a personal fit” between the partners, emphasized by John Fraher, CEO of Adare Pharmaceuticals who has worked three times with PE. Ultimately, owner-operators want to work with those individuals whose judgments they can trust, who they are able to talk with openly and transparently, and who they are able to work with through the inevitable rough patches.

Ultimately, finding the right PE partner involves in-depth due diligence, similar to what GPs practice in evaluating their prospective portfolio company targets. In addition to thorough reference checks, it may be worthwhile to learn how different PE groups think about debt and equity, which may be informative of their investment style and culture. Founders may choose either a negotiated sale or a more formal auction process to broaden the pool of potential PEs. In either case, there are likely to be significant benefits in getting help from experienced investment bankers and legal counsel to assist with due diligence and make sure the sales process runs smoothly.

Lessons and challenges

CEOs of PE portfolio companies who have built successful partnerships and achieved accelerated growth are in agreement that one of the most important lessons is to be clear upfront about your goals and vision for the company. “The most important thing is to start with what is your vision, what are you trying to accomplish, and then look for partners whose vision is aligned with yours,” stressed Joe Fluet, CEO of MAG Aerospace, who has worked with two PE groups.

Early on, one of the biggest challenges founders face is the time commitment in running a full-blown sales process while managing the business. Having a CEO sit through management presentations and due diligence meetings over a four- to six-month period can be highly distracting and potentially paralyze a firm’s operations. Thus, it becomes imperative to prepare early: decide what your goals are, get the right team behind you, and map out the most efficient process.

When a PE partner comes on board, founders may face a challenging transition as they shift from their role as owner-operator to co-owner, CEO. These roles tend to involve different mindsets, skillsets, and responsibilities. A founder who built his or her business on risk-taking may now have an owner that is more risk-averse and will place execution responsibility squarely on the CEO’s shoulders. Navigating these management team-GP dynamics highlights the importance of transparent and candid communications and basing the partnership on mutual trust.

A common regret CEOs have with their relationship with PE firms is not pushing hard enough to get more capital upfront and putting it to work early. And PE investors may agree that this is an opportunity missed. Besides boosting confidence in the management team, making strategic investments earlier may be more likely to lead to growth before the PE holding period ends. Entrepreneurs who have boot-strapped their operations and are worried about dilution, naturally may be hesitant to request capital. This point also highlights the importance in keeping aware of the exit window. In the later stages of a portfolio company’s life a PE firm will be focused more on executing on exit strategies and less on putting more money to work.

Conclusion

There is growing interest by founder-led businesses to partner with PE groups to achieve accelerated and sustainable growth. The co-mingled, limited-life fund investment model is proven and now a mainstream approach that goes beyond investing capital to providing companies a wealth of operational resources, governance, sector expertise, and talent on-demand. PE is indeed a growth business.

The sheer number and variety of PE firms and abundance of capital they have available indicate that the owner-operator is in the driver’s seat. The challenge is selecting the right partner that shares your vision and values. To get there requires obtaining financial and legal help, asking the right questions, and doing your homework. As it is likely to be one of the most important journeys a founder takes, it is never too early to prepare.