Private equity investment in North America continues to grow, with increasing numbers of investors looking to realize above-average growth returns. But the pre-acquisition stage can be extremely challenging, especially for general partners who will be actively involved in growing the company to achieve the expected returns.
As a CEO who grows businesses for a private equity group, I’ve worked with a number of general partners and family investment groups during the pre-acquisition stage. I’ve seen how challenging it is for owners and senior management to effectively communicate the realities, risks and opportunities of the business to general partners and other investors.
The good news is that general partners have an opportunity to actively manage the process. By combining strategic and financial analysis with a host of soft skills, you can build trust with owners through the due diligence period to get to closing.
From the CEO’s point of view, here are the top five areas where general partners can take the lead at the earliest stage to create a successful acquisition:
Close due diligence gaps. General partners often have a superficial understanding of owner-client relationships, concentration risks, repeat clients and competitive positioning. To remedy this:
- Go two layers deep in understanding the people in the business. General partners often will interview and assess senior leadership but not the people who are more engaged in direct client relations, daily operations and execution logistics.
“By combining strategic and financial analysis with a host of soft skills, you can build trust with owners through the due diligence period to get to closing.”
- Research the sales cycle of the prime competitors. Understanding the experience you have as a general partner with the prime competitor can tell you a lot about your target company.
- Interview suppliers and partners. This gives you an opportunity to assess the culture, market position and execution capabilities of your target company through the eyes of a third party.
Understand the business fundamentals and execution. Going beyond the strategy and numbers to really understand the business is critical in building trust with ownership. To gain in-depth understanding:
- Go on a sales presentation. Seeing the pitch, interaction with the prospect and how leadership overcomes obstacles or gaps will significantly help you when assessing and evaluating sales data.
- Attend an operating meeting. Observe the process of delegation and interaction of the attendees. Are actions linked to key strategic goals? Is there clear delegation and accountability? Are problems discussed and corrective measures assigned?
- Review business plans from the past three years. Learn how the team has assessed its performance compared with the plan and made adjustments to drive better overall performance.
Determine the strength of the management team. The existing owner will likely leave the business within months. As a general partner, your investment will rest on the next level of leadership, so it’s wise to get to know them well, and to deal with people, competencies and productivity early in the process. Questions to ask include:
- Who are the up-and-comers in the company?
- Are there any skill deficiencies and are there plans to address them?
- How are innovation and new ideas introduced into the company?
- How does the company deal with challenging employees?
- Is the business operating with proper employment standards?
“For both the owner and the general partner, lack of clarity and transparency on objectives, involvement, timeframes and payments to the investment party are major challenges.”
Get clear on investment objectives, timeframes, and payments. For both the owner and the general partner, lack of clarity and transparency on objectives, involvement, timeframes and payments to the investment party are major challenges. More often than not, misunderstandings in this area lead to failure. As the general partner, you can manage this by doing the following:
- Clearly describe your objectives and what will occur after closing. There should be no surprises.
- Provide the CEO and senior leadership with a possible timeline if things go to plan. This allows them to line up execution with expectations.
- Explain your expectations for information, reporting and frequency of involvement. This allows senior leadership to determine if additional resources will be needed to meet reporting requirements and to anticipate additional costs.
- If taking a fee, be transparent about it. Outline the “why” and what value that ownership gets for this fee.
Ensure a proper fit. Ensuring the investment style of the private equity group aligns with that of the owner-operator is key to a successful transaction. Nothing erodes trust at this early stage more than having the investment approach change, so:
- Be clear about your intentions for the future of the business. Be up front about whether you intend to run the company separately, combine it with another similar entity in your portfolio, or strip out pieces and sell unprofitable divisions.
- Get to know the ownership team well. You may need to get to know their families as well. (On one occasion, I went through a courting process with a general partner who did not take the time to meet the owners’ significant others. Because the general partner did not build trust with all family members, the owners’ partners ultimately did not agree to the general partner’s involvement.)
- Assess the culture and ownership’s investment style, and be consistent. Many business owners have built their companies by being very frugal and highly strategic, spending money where and when they need to based on lessons learned. Carefully assess where you can truly add value and build trust based on your assessment of the ownership’s competencies.
- Be clear on the owner’s role going forward. Explain the duration, upside, and expectations for all members of ownership. If roles will change after closing, clearly outline your expectations.
Actively managing these five key areas can significantly improve the pre-acquisition process for the general partner and for those operating the target company. From my perspective as a CEO, a general partner who pays attention to the soft assessment and people-related aspects of the business helps everyone start off on the right foot and sets the stage for a successful investment.