Two years ago, after 30 years as the chief executive of a public company, latterly with United Business Media, I crossed over to the world of private equity and became a partner of Kolberg Kravis Roberts & Co (KKR).
I was already well-acquainted with private equity. As an investor in several funds and a member of two advisory boards, I had witnessed consistently good investment returns, seen how investment decisions were made and how companies were managed. There was evidently much more to their success than simply piling on debt and reducing corporate overheads.
The failure of the private equity industry to explain itself and, in the case of many privately owned companies, to provide information beyond the statutory minimum, has unsurprisingly led to a caricatured version of private corporate life where calculating investors sanction unsupportable levels of debt, a squeezed cash flow and a low level of investment.
But private equity specialists do not operate this way. They know it would be a sure-fire recipe for disaster – destroying value and fatally compromising the private equity business model. And research in the US demonstrates this: initial public offerings of private equity-backed firms perform better than IPOs in general.
So what is the private equity specialist’s recipe for success? It is this: first find a good company, add talented management and then implement a bold plan to invest in growth and optimise operating and financial performance.
As with public companies, privately owned companies have to contend with the competitive dynamics of the marketplace and the impact globalisation. But there are some significant benefits to being – or going – private. Free from the short-term perspective of quarterly reporting and the aversion of some institutional shareholders to sensible levels of debt and risk investment in growth, privately owned companies can adopt a long term approach and embrace an entrepreneurial growth culture. Moreover, the governance structure is based upon ownership: all directors have a significant stake in the success of the business and board meetings can concentrate on products, customers, people and performance.
Of course, private equity ownership is not going to be to every executive’s liking. Expectations are high – in line with rewards – and underperformance is not indulged. The chief executive used to quasi-imperial powers and supported by a pliant bureaucracy would be in for a rude awakening. Those self-important chief executives who seek newspaper profiles, the adulation of the gabfest crowd and the unquestioning support of their colleagues should stay put. Executives should leave their ego at the door and prepare to answer tough questions from private equity executives often less than half their age but with formidable intellects.
But if the private equity culture is bracing and challenging, it is also highly supportive.
We are constantly meeting chief executives and chief financial officers who either want to discuss the merits of private ownership for all or part of their business or are looking to move and lead a privately owned company. If you are such a chief executive or chief financial officer, then the first thing to do is to take a leaf out of the private equity investment handbook and conduct extensive due diligence and rigorous benchmarking.
Not all firms offer the same things. A few firms, such as KKR, invest in big companies and operate on a global basis. At the other end of the scale, there are many firms that are highly skilled at start-ups and growing small enterprises. Then there are those that invest in just one country or region or in one or two sectors of the economy such as technology or infrastructure.
Seek out those firms with a deep knowledge and experience of your sector. Many firms are organised on a sector basis and have recruited senior business leaders to help bring the right blend of investment and commercial skills to each company in their portfolio.
While making your choice, ensure that you spend time with the sector teams and probe the depth of their knowledge and experience. Remember, you will be partners with them for the next five or six years, so you need to be satisfied that you can work effectively with them on both a professional and personal level. It is certainly worth seeking the advice of a couple of the former chief executives who have worked with the firm for a number of years.
Once you have chosen the private equity house, you need to develop the business plan. You should propose challenging but realistic targets in order to optimise performance, to grow the company and to focus on the core businesses. Make sure that the proposed capital structure ensures that you have the financial resources to deliver the plan.
The final ingredient is the management equity plan. This should include all key executives – each of whom will be required to make a meaningful investment within the context of their personal financial circumstances.
When I chose a private equity house, I made a judgement on the quality of the people, their integrity, their record of innovation and the depth of their industry knowledge. I have not been disappointed.
Lord Hollick is a partner at KKR
