For the CEO of an investee company, a good relationship with its private equity (PE) house is simply prudent: you never know when additional financial support may be required. If the CEO and the PE house can’t strike an accord there may not be an environment for decision-making - which would ultimately damage the business. But how closely should the PE house be involved? And what are the potential pitfalls both for the CEO and for the PE house?
Mark Hunter, CEO of Airclaims Group
, provides four tips to help CEOs ensure a smooth relationship with the PE house:
1. Ensure that your top priority is cash-flow - do not underestimate the amount of management time that will otherwise be taken up by bank covenant management
2. If it does not already exist, create a forum for collecting and formulating ideas for growth
3. Ensure that your finance team are strong and sufficiently technically competent to deliver to the demanding requirements of a demanding post-deal board - do not be afraid to ‘upskill’ in your team at the start of the post-deal relationship
4. Make very good use of the networking opportunities created by your relationship with the PE house
A harmonious relationship may also be critical because, as Francesca Cornelli, Professor of Finance at London Business School
, puts it: “the PE house aims to achieve its returns by improving the operating efficiency of the company”.
Naturally, relationships vary between PE houses: some are less involved while others are very active on the board and have a closer relationship with the CEO. Francesca continues: “PE houses that are most involved and ‘hands-on’ are, however, also the ones that give the CEO a longer horizon. The CEO does not have to worry about interim results, but, rather, can focus on achieving the value increase. That shows a less obvious advantage of a close relationship between a PE house and the CEO: the PE house will not have to rely on interim reports and results to judge whether the CEO is competent and is moving towards the company’s target as, by working alongside him/ her, they can assess first-hand his/ her quality and whether progress is being made.”
Tim Farazmand, MD of Deal Origination at Lloyds Development Capital
agrees that the relationship between the CEO and the PE house is critical. He says: “It underpins the investment strategy and sets the tone for appropriate corporate governance. It should be an intimate relationship based upon trust and transparency. If the right chemistry does not exist at the institutional and personal level from the outset then I would question the merit of proceeding with an investment.”
Ultimately, both parties need to understand and agree how best to engage and respect this. Tim continues: “I still count the vast majority of CEOs that I have backed over the years as personal friends. Each working relationship was different but we always found a way to work together and developed a productive and enjoyable working relationship."
Friction may occur between the PE house and the CEO when the house gets too involved in the operational side of the business. Or, perhaps, too involved for the CEO’s liking? If it’s not the PE house’s job to interfere in the running of the business, what level of involvement should it have? In fact, this was a question that surfaced at a recent Criticaleye Private Equity CEO and NED Breakfast
Experienced CEO, Brian Amey
, stresses the importance of establishing what your PE house is looking for in terms of regular data on the company or market. “Don’t be surprised if you get little feedback on good news,” he says. “Equally, the chairman may expect you to deal with the PE house directly, only adding his input where necessary. But it is always up to the CEO to report on those issues which he and his exec team feel are the ones relevant to the business and the market. It is also vitally important to get engagement with the PE house on the strategic issues and challenges facing the company.”
What happens when the relationship breaks down completely? Kieron Sambrook Smith,
, once led an MBI for a company that took him 18 months to acquire. He selected a venture capitalist to back him, which didn’t know him or his business partner. “They insisted on their choice of non-exec chairman, who had little experience of the profile of business,” says Kieron. “We disagreed on many things immediately and, owing to his attitude and his relationship with the VC, I had to leave three months later. The company has since suffered financially and in terms of its reputation. The PE investor director didn’t attend any related discussions because the chairman didn’t want them to understand how his decisions were being questioned.”
From the CEOs perspective, understanding the PE house’s history and reputation is crucial: it will foster faith and trust in the organisation that is backing you. “Equally important is a clear and shared understanding of the responsibilities that each party has in delivering the strategy”, says John Innes, CEO of Amor Group
. “The CEO is accountable for delivering the business plan; the PE house is there to back him/ her.”
Sam Ferguson, CEO of EDM Group
, goes one further and suggests that the PE house’s involvement in the business would depend on how much autonomy the CEO requires. He says: “Some PE houses have a reputation for wishing to be involved at the operational level; others have a reputation for being good investors. If you are a CEO that likes to do it your way, then working for a PE house that wants to be involved in the operational decisions will not give you the job satisfaction that you would hope to get. Therefore the right balance is dependent on the character and experience of the CEO.”
The PE house needs to have an ongoing dialogue with the CEO to ensure that he/ she is always fully briefed. “If necessary, when the business is under performing their expectations, they need a fallback plan, which may include replacing the CEO or boosting the management team,” says Sam. “It is also important that PE houses understand the sector and the company they have invested in and that they have set an accurate expectation of the performance of the company.”
If you’re a CEO dealing with a PE house for the first time, patience is a virtue, contends Rob Crossland, CEO of Parasol.
“However much time was spent on due diligence in getting under the skin of the business, the CEO must be prepared to continue to educate and inform,” he says. “By the very nature of the PE activity, what’s obvious and critical to the CEO may be less so to the PE Director and, in the early days, the competing pressures of post-deal momentum, 100-day plans and energy can contrive to make questions appear trivial. They are not – the more patience you have in continuing to explain the nuances of the business early-on, the easier things will be in the longer term.”
Equally, says Paul Shaw, CEO of 7city Group Ltd
, PE houses need to keep the CEO’s eye on the ball: “The PE house should keep reminding the CEO of what they are trying to achieve - exit multiples - so the CEO never loses perspective of what he/ she is trying to achieve for the PE house. Listen to the CEO and recognise the pull and pushes that exist in the business from the other stakeholders; the employees, suppliers and clients.”
Darren Cunningham, CEO of Sure Maintenance
, agrees. “Focus on everything that generates the highest enterprise value. Total honesty and transparency is needed between all parties right from the start. Always summarise information with simple, visual, straight-talking headlines. Never assume they know your market and make time to brief them on developments.”
To get the very best out of the relationship, says Warren Murphy, CEO of Sporting Index
, it’s vital to outline clear plans and priorities so that everyone’s role is understood: “A good PE house will know the difference between supporting a management team and controlling it. There can be times when this line becomes blurred and it is important to be alert to this and have the relationship in place to push back if required. It is also important to understand that there will be times when the interests of the management team and PE house may not align and these can make for some tough, but resolvable, situations.”
There is a fine balance between working effectively and closely with management and running the day-to-day operations. “And the latter scenario is unwise,” concludes Mark Hunter. “The right balance will include fully participative board meetings and strategy sessions leading to a sense that the PE house is supporting the CEO and his or her management team in delivering to the plan. An effective CEO will be better aware of the personalities and capabilities within his or her management team and should be allowed the autonomy to extract the best performance from that team.”
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