Why Private Equity Works

When it does.

Some Private Equity firms make purely finance deals where the main value is in the financing, but the frequency of these deals are on the decline.  So what are they counting on, and how do they make it happen?

Before we answer that question, let’s look at a related play that is still operative; breaking up the parts.  Many companies are so large that their public valuation is less than the sum of its parts.  Despite the delicious innuendo of the movie “Wall Street” often buying these companies and splitting them up is a good play in the long run.  If you have ever worked in a subsidiary allowed to languish hidden, unchallenged and unloved within a large corporate umbrella, and you have any aspiration at career development or in pursuing excellence in general, then you know that this is true.

Specialized and top industry knowledge in the sectors in which they operate.   Most Senior management in equity firms are high profile managers with intimate knowledge of the sector, able to bring their decades of experience to the table but also the benefit of an extensive list of industry insiders and vendor and customer contacts.

Especially with all that talent, operational improvement is a good possibility.  If you’re running your company 4-5% over industry cost structures, you can bet the private equity owners are going to be looking to shave that off.

At its best, more active and aware boards of directors.  Too often public company boards border on dysfunctional.  Many members not do not understand the industry in which they are serving, they really don’t have much business experience either.  Private equity firms can bring a very active board to senior management, with measurable, active targets and ongoing project reviews.  In that regard, they act not as some older brother looking over your shoulder; they are an added resource and an ear to discuss strategies, as well as keep senior management focused. 

Imagine a well informed Executive coming into your Senior management’s offices and one at a time, asking what the benchmarks of their jobs are, and the hard, measurable bottom line responsibilities they manage.  It’s quite energizing to the top say, 25 Senior Executives of the firm to realize they must justify the value of their existence, especially when the explicit implication that there be a synergism with the rest of the company.

This type of situation is really all too rare, and at least one of the reasons Enron situations can exist.  Think for a moment of Kenneth Lay’s defense; basically claiming he had no knowledge of the activity that brought the company down and therefore was ‘innocent.’  As CEO, he was implying he didn’t know what his right hand was doing, and also that his Board didn’t care either.  There is a huge fiduciary gap here which is almost ludicrous to ponder, not withstanding that one of the reasons we pay upper management millions of dollars a year is first and foremost to “take care.”  Claiming unawareness is like showing up at bank robbery with your friend and claiming in court that you didn’t realize that’s why you were there.  In my mind, Senior Management must be held accountable just because they were there.  It’s their job.  We’ll have more to say regarding fiduciary duty in other articles.

Incidentally, our example also brings up another aside worthy of a future article; the terrible record of the government deregulating industries.  A look at them, including energy, telecommunications, and the airlines is really a look at under-performing companies, still shackled by culture and regulation decades later, generally holding the entire sector back from stepping into the current century.  More on that later also.

At its best, a high performing Executive not only appreciates this kind of active, measurable accountability, she demands it.  How else can one gauge their and most importantly the firm’s success?  Private Equity brings a much better chance that the Board knows how to put such a process in place, and that the people they send to help have real specialized knowledge and value to the positions they are over seeing.