Communication is Key: Telling Your Firm’s Evolution Story

Private equity is no exception to the old adage: the path to success is paved with failure. In fact, any seasoned GP will attest to the fact that establishing a successful private equity firm, or any business for that matter, is rarely a smooth or linear process. From their infancy, the best private equity firms remain in a continuous state of flux: growing, adapting and most importantly evolving.  Over the course of this development, the partnership constantly makes assessments and modifies elements of their business plan. The maturation of any firm is reliant on making mistakes and then implementing the learnings from those mistakes to enhance the business moving forward. LP’s refer to these educational mistakes as “lessons learned” and see them as the hallmarks of thoughtful leadership teams.

Addressing these issues internally is a key first step in the process, but knowing how to discuss these miscues and the steps taken to rectify them with third parties can be equally as important to the long-term success of the firm. Fundraising tends to be a critical test of whether a GP has adequately addressed these challenges and if they can speak to changes implemented because LPs vote with their dollars. The best way to manage lessons learned is to provide full transparency. While no sponsor enjoys speaking about the problems that they’ve experienced, any attempts to gloss over changes to key elements of the business and the mistakes that precipitated those changes will leave LPs feeling unsatisfied and confused.

Among the most frequent issues that private equity firms need to address are (1) team turnover, (2) performance issues and (3) strategy drift. Each of these topics touches on a core element of the business, so careful navigation of them is essential. First, team turnover can take on different forms – acrimonious force-outs, amicable succession, spin-outs – but there are some tried and true approaches to the issue that will serve GPs well in fundraising. First, it’s critical to provide a breakdown of roles, responsibilities and attribution for LPs. Investors want to make sure that the current team has a successful track record of executing deals together and that none of the departing investment professionals possessed skills or functions that haven’t been compensated for. Often LPs will ask whether the departed professionals had a sector expertise or sourcing network that will be difficult to replicate. Second, providing extensive references to substantiate the roles and involvement of the remaining team is very important for LPs to verify which senior partner led which deal, etc. Finally, an account of how the departure was handled can be valuable for LPs as they assess the sponsor as a partner. This account may involve speaking with the departed individuals or may simply be addressed through a detailed breakdown of the negotiation of this separation including economics, etc.

Second, track record or performance challenges can be even more complex. There can be a number of reasons for why an investment didn’t perform as expected and a thorough analysis of what drove down returns is a baseline expectation. The additional piece that is important to discuss are the changes to the investment process that were made as a result of those “lessons learned.” Chalking up poor performance to macroeconomic conditions, commodity exposure, customer concentration issues or other elements doesn’t answer the LP’s key question, which is: what have you, as a firm, done to ensure that this type of mistake isn’t going to be made again in a future portfolio? The best firms learn from each mistake and use the lessons from those underperforming assets to augment and enhance their investment process in a meaningful and verifiable way. They will include steps in diligence or additional approval requirements that can be reviewed by LPs as part of their diligence.

Investors aren’t looking for perfect private equity firms or spotless returns because those don’t exist. They are looking for thoughtful groups that continue to grow and evolve over time, so that when they deploy the next fund, they are a little wiser and a little savvier when they invest the capital. There are no assurances that assets won’t underperform or new mistakes won’t be made, but that’s OK. Partnership is about understanding that private equity investing is about an ever-evolving process of improvement.

Next week, we’ll delve deeper into the third lesson learned: style and strategy drift and the difference between an intentional shift versus an unintended drift.

Next on 60 Seconds with Sixpoint: Strategy Drift vs Style Shift: The risks and opportunity surrounding your evolving investment strategy

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