Mastering Private Equity. Prahl Michael
process. Recognizing, acknowledging and addressing problems up front are part and parcel of the successful ownership model.
This value creation process involves not only understanding a company's balance sheet and financial statements, but also its employees, their impact on the world around them and being good participants in community life. This all contributes to value creation – or destruction.
As an industry, we've learned that we can make a difference by integrating our performance-focused investment philosophy with environmental, social and governance (ESG) initiatives. It is our responsibility – not only to serve our investors through great investor returns – but also to support them by investing in the communities of the corporations in which we invest. Over the years, I think the PE industry has picked up on this quite a bit.
And while that doesn't mean every company we invest in is advancing an ecological solution, I believe PE-backed companies can help solve challenges – economic or otherwise – in their communities. Whether it's improving municipal water treatment facilities, funding sustainable economic initiatives in underprivileged communities or reducing waste and promoting eco-efficiency in plants and factories, incorporating ESG practices has become a focal point throughout the lifecycle of an investment.
As I mentioned earlier, one of the key principles to making this work is the alignment of the interests of all parties – managers, investors and employees alike.
Investing alongside one's investors, or our limited partners (LPs), is the best demonstration of partnership. While the principle of alignment has not changed from four decades ago, it has definitely been emphasized more greatly in recent years. We, and others, have continued to make larger firm and employee commitments to our funds, further incentivizing our employees to do well for our investors.
With the addition of new technologies and important groups like the Institutional Limited Partners Association, there is also a focus on making sure LPs have greater visibility into the underlying details of the companies in which they are invested. This enhanced transparency is not limited to the PE industry alone, and our world is better off for it. Information is at our fingertips. This is a good thing and promotes efficiency, integrity, and accountability. In my opinion, these are the mainstays to being a trusted partner in private equity, not just to LPs but to all of our stakeholders.
Today, success in PE involves many more facets and many more faces related to a deal. Our constituents include our limited partners and their beneficiaries but also the employees of our portfolio companies, stockholders, regulators and government officials as well as the media. As the collection of stakeholders has evolved quite significantly, so has the industry's approach to engaging with them.
To succeed in PE, communication and transparency are key. As we work to build strong relationships with our stakeholders, we remember: people do business with people they like and trust.
As far as the mainstays to being a good investor? I'd say curiosity and a sense of history. To me, people who are curious are going to be far better stewards of others' money. Why? If there's no curiosity, you're basically doing something that's already been done by someone else. Moreover, being knowledgeable of the past means you can learn from past mistakes and, hopefully, not repeat them. Without these two attributes, one will miss out on opportunities, or experience slip-ups, by not seeing the whole picture.
Now I know this has been a long answer to what is private equity? In my mind, at the forefront of this lengthy explanation has been one of my favorite quotes from General Eric Shinseki: “If you don't like change, you will like irrelevance even less.” The industry has gone through many changes, but by doing so, private equity continues to attract some of the most sophisticated investors in the world.
While we will have to wait and see how the asset class continues to evolve, I anticipate that private equity of the future will need to prioritize diversity to remain germane.
Too many of the same people means too much of the same thinking – an element of today's industry that I feel greatly needs to be addressed. As we discussed earlier, more of the same is a stepping stone to irrelevance. We need to value having more diverse groups of people – diversity of gender, race and ethnicity, and especially diversity of experiences and thinking. There is no doubt that diverse groups drive better outcomes – it has been proven time and again – it creates a better work environment, more creative ideas and is a critical focus area of our investors. I think this is a lesson we are in the middle of and hope the industry will heed this important message in order to succeed in the future.
So what is private equity?
You will hear many answers to this question from industry leaders in the chapters ahead, but what I hope I've made clear is that private equity is so much more than its literal definition. For me, private equity always has been and always will be about building value over the long-term.
PREFACE
Gone are the days when “being in PE”1 meant buying assets with steady cash flows in heavily leveraged transactions and riding the investments out to a successful exit. Despite the evolution, growth and increasing diversity of PE, this dated image persists, but no longer does the industry justice.
So, what does modern PE look like? The main difference from the activities of the '70s and '80s is that PE firms have developed into transformation agents that impact businesses at critical junctures of their development. PE funds are no longer just hands-off financial investors seeking to profit through changes to the capital structure or by selling off parts of a business; as the industry has matured, PE firms increasingly engage via active ownership to drive value creation in their portfolio companies. Indeed, a partnership with PE can provide portfolio companies with the edge to remain relevant in the hypercompetitive age of globalized markets.
Although PE has become synonymous with exceptional growth and wealth generation, the industry has endured its share of challenges. In particular, each financial crisis has opened the door to controversy. The spotlight focused on the performance of leveraged buyouts in times of highly visible defaults and then switched to venture investors' ambitious start-up valuations when valuations slipped and follow-on transactions took on a distinct pass-the-parcel flavour. There are ongoing debates about the fairness of profit-sharing between limited partners and general partners (and taxation of the latter) as well as the industry's impact on its investee companies and on the economy at large.
Will the value-added focus of the PE industry become a model for the financial markets of tomorrow? Will the limited partnership model itself require dramatic changes to survive? How can we better communicate the benefits professional PE can bring to companies and not only to investors? These are some of the relevant questions being asked by senior industry players as we set out to write this book.
As PE works its way into the economies of the 21st century, board members, senior executives, finance professionals and entrepreneurs are well advised to follow the industry's development carefully. After all, whether venture funds, super angels, growth equity funds, turnaround investors or buyout funds, we are talking about gatekeepers and agents who are entrusted with the capital of their investors to find the best entrepreneurial opportunities possible, whether in developed, emerging or frontier markets.
As for students of the industry and junior PE professionals, developing a solid understanding of the overall business model of PE will enable them to develop new ways to differentiate their firms in the eyes of investors. Attractive target companies in search of funding can choose from more than 8,000 professional PE firms worldwide to find those who meet their expectations and can deliver worthwhile partnerships.
A NOTE FROM CLAUDIA ZEISBERGER
As a professor at INSEAD, one of the leading global business schools, I am fortunate to be part of a diverse, young, dynamic and entrepreneurial community. As the academic director of the school's Global Private Equity Initiative, I am often the first port of call for students, alumni, senior executives and entrepreneurs for a multitude of PE related issues, including career transitions, start-up ideas, fundraising and access to industry professionals.
For years I have been asked for a resource that would enable them to deepen their knowledge on a specific topic
In the context of this book, PE is defined broadly and includes venture capital (VC), growth equity and buyout funds. More about this later in the book.