My colleague Andy Thomas recently wrote an insightful piece on the myriad funding routes available to entrepreneurs and the key factors to making a successful private equity investment. In the years after that investment has been made, there are many reasons for success but two stand out – a partnership approach and structural evolution.
A good private equity investor will look to partner with the management teams they have backed. They will put in place the building blocks for growth but recognise that management teams and investors bring different, complementary skills and experience. Management teams bring entrepreneurial zeal, deep knowledge of their market, operational excellence and strategic vision. Good investors bring a wealth of experience of supporting small fast-growing businesses, the issues they will face and the ways they can create value, as well as an extensive network of experts who can support the executive team as they grow.
The above combination can be a powerful one for growth but needs to be underpinned by alignment, both economic and strategic. Equity participation brings economic alignment and it is crucial to take time getting this right – to recognise who is creating value in the business today and who will do so in the future. Getting this right (or wrong) can make a significant difference to motivations and to the ultimate outcome. Strategic alignment comes through taking the time to understand management’s wider growth ambitions for the business and their personal aspirations and then making sure these match the aims, ambition and timescales of the investors.
At YFM we have funds which cover both growth and buy-out capital, so the businesses we invest in will naturally be of different shapes, sizes and stages of their journey. Quite often we back a management team with great ideas and skills but who haven’t had the time, resources or the need to build out a wider operational, financial and governance framework that the business will require as it grows. An important part of the value we can add is through helping the management team to put this framework in place so that the business is not held back by having outgrown its way of working.
For a business to evolve it needs to take that step forward – to look at itself and where it wants to be in say five years’ time. We have built a network of non-executives who have “been there, done that”, bringing extensive sector knowledge and, crucially, experience of scaling up and selling businesses and of working with new investors. They can help advise teams how to build the right teams and decision-making processes to keep one step ahead of the growth of the business.
One of the most important areas for this structural evolution is the finance function which in smaller businesses can often be seen as administrative but which we see as crucial to the value creation strategies of the business. There are no hard and fast rules on the optimal set-up but when it works well, finance permeates every level of the business, capturing performance and articulating it via a clear set of KPIs and providing timely and accurate information, but more importantly informing board level debate and ensuring implementation of its strategic decisions.
Our investment in Waterfall Services is a good example. We first invested in 2007 and then supported two acquisitions prior to our exit in 2014.
There was plenty of scope for misalignment amongst the shareholder base with three institutional investors, a group of private shareholders and management. And along the way we had to overcome the sad passing of an important team member and the appointment of a new Finance Director, who became a key member of the senior team.
This mix of stakeholders, coupled with the inherent conflicts of interest of the ultimate exit path (a secondary buy-out) meant the potential for misalignment was ripe. However, the strong relationship built up over the preceding years meant we collectively had the ability to navigate this complexity resulting in a successful exit for the institutions (a 5x return) and some director shareholders, while other directors achieved their aspirations of remaining with the business alongside a new investor.
Completion of an investment is the first step on an exciting journey. Thereafter the factors to create value are multiple – but we’ve found that if you stay focused on alignment between investors and management, and ensure the management team put in place the right skills and processes to manage the business as it grows, then you’re heading in the right direction.