Private equity ownership? Sharpen your pencil, Mr. Executive!

Most corporate executives will at some point in their working life, experience a change of employer ownership structure. While the executive may function well in one ownership context, he/she may fail miserably in another – often within months.

In my experience, failure in these contexts can often be attributed to either a simple lack of understanding how to navigate the new shareholder and ownership structures, or to poor due diligence performed by the executive in reference to the new board of directors and their collective and individual roles, priorities, mandates and personalities.

In the early 2000s—as part of the Group Management in a 100M USD Life Science company—I took part in a leveraged management buy-out with a private equity fund as the majority shareholder. Prior to executing the deal, I spent hours on end in data rooms together with my Group Management colleagues being vetted by numerous consultants with different specialties as part of the due diligence process performed by the Private Equity fund. Caught up in the excitement of becoming a sweet equity shareholder, I only spent a moderate amount of time and energy on making my own due diligence and within this time, I was clearly focused on the opportunities associated with imminent co-ownership rather than the risks. Questions I should have asked in my due diligence should have included among others: Who are the key influencing stakeholders and what are their roles, priorities, mandates and personalities (e.g., board members, banks, private equity staff)? What kind of management reporting would be required of me - i.e. would I end up spending an exorbitant amount of time turning my face to the board/owners and my ass to the customer? What was the boards role in relation to the actual owners (majority shareholders)? Would I have a clear mandate in my new role in the new company/ownership set-up? How would resources be allocated the various functional and business areas of the company?

As it showed, the board would consist of people with absolutely no previous experience within the life science industry, making it difficult to perform genuine sparring dialogs. Additionally, the mandate and resources in relation to my role and the roles of several others were unclear and insufficiently negotiated. Who could I blame for this situation? Only myself! It was clear that when it came to making a proper due diligence – hereunder performing the necessary personal, role and organisational risk assessments, I didn’t do a proper job.

When taking part in an MBO with a private equity fund as the major shareholder, Group Management is often asked (or even required) to “put their hands on the cooking plate.” This implies making a sizable investment in the company that will hurt you severely, but not bankrupt you, if the company does not deliver on its revenue, EBITDA, cash flow or other key targets. When entering such a setup, obviously, you are taking a personal risk. However, often—and certainly in my case—the due diligence of the participating executives is not sufficient and focus seems to be more on opportunities than on risks. In fact, I was almost entirely preoccupied with making the deal/MBO come true, meaning working loyally for the current shareholders in the sales process while pursuing the opportunity of taking part in the new ownership. I simply went into “hunters mode” and basically forgot to make my own thorough due diligence. Envisage the image of a hunter tracking his prey and being within shooting range. Now, imagine how focused the hunter is – often leaving out any and all distractions in order not to make a wrong step that may scare off the “prey.” It is at this juncture that the hunter must remember to make a broader and more detailed assessment—his/her due diligence—and not get carried away and take the first shot possible. Rather than risking taking a shot that may end up only wounding the animal, the hunter must keep calm, and assess the terrain, distance, conditions and suitability before deciding to take or not take a shot. Keeping one’s cool and allowing oneself to make a proper assessment in the midst of the excitement is critical.

If it is your first time moving into a new ownership structure, you are probably a bit lost. Often, your judgment is clouded from lack of experience and you struggle with understanding what questions are important to ask and what critical processes you need to be a part of in order to reduce your personal risk. In relation to my case, Group Management, including me, was not invited to take part in the negotiations with the banks and had no insights into how the covenant connected to the bank loan that financed the acquisition was structured. It was negotiated solely between the private equity fund and the bank. What a mistake – by all parties. Of course, the banks and private equity funds cannot have too many stakeholders involved in such a process. However, valuable input on the cycles and risk variables of the company was – in this particular case - never reflected in the covenants. Later, I learned how the focus of a business could change dramatically from delivering on its medium- and long-term goals to focusing almost entirely on short-term initiatives designed to satisfy ill-conceived covenants. Leaving critical covenant negotiations only to people with great theoretical understanding of your business, but with very little knowledge of the inner workings of the company and on what actually takes place in the “machine room” is simply not a good strategy – for you, the company or the new owners.

When assessing organizational, role and personal risks – culture is also key. In my case, the cultural match between the Anglo-Saxon leadership style, enacted by the British-led board, and the Scandinavian leadership style, enacted by Group Management, was not optimal. The Scandinavian leadership style was often viewed as inconsequential and ineffective by the board and combined with the fact that certain parts of the business needed realignment, mistrust and tension started to appear in the collaboration between the board and Group Management. Making your due diligence with the objective of understanding the new ownership culture and taking this into consideration in your strategic, tactical and operational leadership is absolutely key.

In many aspects, moving into a private equity ownership structure also offered a lot of opportunities and newfound insights. First and foremost, it professionalized the financial tools employed by group management (e.g., it significantly enhanced our focus on improving the working capital and cash flow base [improving creditor conditions, debtor conditions, stock turnover, lead time and other areas]). Nonetheless, numerous unaddressed concerns should have entered into my due diligence of the role and the organisation, including ensuring a better understanding of how to navigate among the many new stakeholders in a completely new ownership structure.

This article is the third article in a series of articles from our most recent book: “Executive Onboarding: The Key To Successfully Onboarding Your New Position.”