3 Drivers of Success in Minority Private Equity Investments

Who doesn’t want to be in control? After all, it is a defining feature of many private equity firms’ investment strategy.

Too many firms have decided that only a control position is an acceptable entry point for investment, often paired with the use of leverage to complete the transaction. But in an investment climate like today’s, in which investors and entrepreneurs face economic uncertainty, expensive and limited debt financing and potentially muted valuations, a majority transaction may be less attractive.

With Stride Consumer Partners, all our investments have been minority stakes with little-to-no leverage used. A minority investment may be the most interesting route to create liquidity and bring on a highly qualified investor that should help create meaningful, incremental value in the entrepreneur’s ongoing control stake upon exit.

So, what are the dynamics that determine a successful minority investment?

A minority investment may be the most interesting route to create liquidity and bring on a highly qualified investor that should help create meaningful, incremental value in the entrepreneur’s ongoing control stake upon exit.

1. Trust

The single most important determinant of a successful minority investment is trust.

More than 90% of our investments have been partnerships with founder-led and -owned companies, so establishing a healthy and honest relationship with the person with the most control is paramount.

This is especially true in branded consumer companies, where the founder is often responsible for the vision, culture, brand DNA and product innovation. Building and maintaining a functional relationship truly matters.

Trust often begins with the credibility that a private equity firm has established in the industry and can be corroborated through extensive reference calls with prior CEOs and founders with whom the PE firm has worked. Trust is further built after the deal when a PE firm delivers value to the business across various operational initiatives: collaborating to develop a powerful strategic plan, building out a balanced senior management team or delivering breakthrough performance marketing results.

But it is often built in more subtle ways: effectively navigating the evolution of the founder’s role in the company’s changing operating structure as it scales and expands into one of their choosing that most benefits the business and matches their strengths.

Often, this trust has been built over many months and years prior to the investment, and can result in a proprietary deal opportunity, or at least a real advantage in a traditional process. Its importance grows over the life of the investment and often is a determining factor in when and how successfully a firm exits an investment.

The old saying goes that trust is “earned in drops and lost in buckets,” and those drops are often simple but key behaviors by a PE firm: being accountable, being transparent and direct, doing what they say they are going to do. We like making minority investments for many reasons, one of the main ones being that some of the best companies aren’t for sale. Building competence in creating these healthy, trusted relationships leads to a wealth of high-quality investment opportunities for PE firms.

2. Alignment

Another critical determinant of success in a minority investment is alignment. This alignment involves the vision for the business, the strategic plan to get there and the team that needs to be built to execute that plan. It must be clear, and it must be established before the investment is made.

We have won a few recent deals, and lost a few as well, by pushing hard during diligence to ensure this alignment, going so far as to collaborate on a detailed five-year strategic plan creating a roadmap to a successful exit for all investors. This process was highly successful in a recent deal where the founders had launched a process to sell the entire company. In diligence, we spent a significant amount of time sharing our strategy to partner with them to crystallize the brand, significantly broaden their distribution, drive velocity and increase gross margins. After lengthy discussions, they chose to nix the full sale and partner with us on a deal that eventually created significant incremental value on their remaining equity.

Control investing brings with it key powers (mainly: deciding who runs the business and when the business gets sold), but it also can be illusory. If the investor has misalignment with the senior management team, it is likely to create significant issues in the business. And when investors have a minority position, ensuring that the entire team is on the same page is that much more critical. Ensuring that that they remain aligned, day-by-day and quarter to quarter, is one of the most important focus areas for an investor.

3. Governance

Creating trust and alignment is critical to the founder and company relationship, but it is also important for minority investors to negotiate specific protections and rights.

Because a minority investor lacks the unilateral ability to change management or sell the company, they have a right to insist on certain protective provisions. These are mainly aimed at protecting the value of our security, and they often serve to set up more of a “50/50” governance dynamic. It means that we cannot force any other investor or owner to do anything, and that we cannot be forced into certain things, either.

Some examples include approval rights over issuance of equity or debt, significant change in business strategy and sale of the business at certain values. We can count on a few fingers the amount of formal Board votes we have been involved in over a contentious issue, but a minority investor must still protect themselves and their investment.

A private equity firm’s job is to invest in great companies and provide compelling returns to their Limited Partners. We believe that being inflexible on several aspects of an investment (stage, product differentiation, unit economic model, etc.) drives outsized returns but also allows us to be flexible in the types of structure we use at Stride Consumer Partners.

We have found that minority investments are an important diversification tool and can be a core piece of an extremely attractive portfolio. When considering a minority investment, it is critical that trust is established, alignment achieved and appropriate governance utilized.

Tim Burke is a Partner at Stride Consumer Partners in Boston, where he works with founders of growing branded consumer companies in the Food & Beverage, Beauty, Active Lifestyle and Multi-Unit Services sectors.

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