Private equity firms generally have more cash on hand than they do portfolio companies. Seems odd. But the primary reason for this and why private equity groups don’t invest more frequently is because they can’t find leadership teams that they’re willing to invest in. Like a bank, if you can’t make money, you’re not going to put your cash there. Private equity fund investors (partners) who contribute money want returns. And it’s almost always the reason why private equity groups are not jumping in head first–because they don’t have trust in the leadership.
Maintaining Organizational Stability
When private equity groups do approach operating companies and they’re headed into the investing process, the very last thing they ever want to do is replace the CEO. It’s incredibly disruptive and it puts a black eye on the private equity firm with a lot of employees in the company. Ironically, it’s the easiest thing to do from a process standpoint, but should seldom be part of the strategy as it affects the stability and therefore the success of the organization.
Competence and Then Some
Great CEOs come in a variety of shapes and sizes, but when competence and stability work together, it’s a win-win. Competent CEOs bring with them an organization that’s not only stable and effective, but also one that will marshal behind them in support of the private equity firm’s direction for improvements. When a CEO can sit in front of a private equity team and say “I can see where we’re going, I can do this and my team is going to follow me,” his worth is nearly immeasurable. Successful CEOs provide private equity companies more value than anyone in the chain, even more than the investors (after funds are established, of course). The CEOs are the ones who make it work.
The bottom line? Simply put, a portfolio company without an effective CEO is going to struggle. Remember, private equity firms buy companies with an exit strategy in mind. They walk into it saying “We’d like it to work with existing leadership, but if it doesn’t, we’ll make it work with others in charge.” The typical portfolio company is only part of a private equity fund for 3 to 5 years. That’s the timeframe they have to focus on making needed improvements and growth. But they can’t get there at reasonable multiples (where all involved win) without a successful, high achieving CEO to pull it off.