By John Grafer
Do private equity firms deserve your distrust? Some do. They invest in your company, strip out costs, pursue short-term results, and flip your company to the next owner as soon as possible to maximize returns for their investors regardless of the consequences for the other stakeholders-;the employees, the customers, the suppliers, the community, and you. Employees may be undercompensated, customers may feel like they didn’t receive what they paid for, suppliers may believe they were taken advantage of, the community may be unhappy with your practices, and you may end up feeling like you work for the man.
Why does this happen? Incentives. Typically, private equity firms raise capital from investors and are required by a written agreement to return remaining capital and any profits in less than 10 years. So if the private equity firm invests in your company in the sixth year of its fund, it usually has to begin the sale process no more than three years later. This artificial time horizon creates pressure for the private equity firm to deliver favorable financial results in the short run. After all, investors likely won’t invest in the private equity firm’s next fund without them.
Would changing the incentives also change the outcome for all stakeholders? We believe the answer is “yes.” By connecting investors’ time horizons with yours, the incentives are aligned and so are the behaviors. So eliminate the artificial 10-year horizon and find a patient source of capital. The first part is easy-;just change the term in the written document.
But what kind of investor is willing to execute that document and potentially wait more than 10 years for a return of capital? A business founder, owner, or operator like you who understands what you understand-;that the evolution of a business and its culture takes years or decades, not months. These investors are often entrepreneurs who’ve also experienced significant liquidity events and want to re-invest in the next generation of entrepreneurs. They think in terms of generations, not Wall Street quarters, and they’re an ideal source of patient capital.
An evergreen fund with an investor base comprised of individuals and family offices seeking long-term value aligns incentives. It allows the private equity firm to think like a partner, not act like your owner. That could mean paying better employees a little more; sharing proprietary customer order information with your suppliers so they can be active and efficient members of your supply chain; educating your customer regarding when NOT to buy your product; and working with a local government to invest in a training facility that provides your business with skilled team members and enables the community to flourish.
These are all seemingly poor decisions if short-term cash flow is the most important metric. But, when the objective is long-term value creation for all stakeholders, decisions like these are the foundation of success.
And the virtuous cycle that ensues is self-fulfilling. For example, when employees believe they are fairly treated, they work smarter to make better products and provide better services. As a result, the customer has a better experience, knows you care about him/her, and becomes unshakably loyal to your business for the long run. Your business becomes a defensible leader that is the envy of the industry. It then attracts better talent, experiences reduced hiring and training costs, provides even better products and services, and so on. Paradoxically, profit turns out to be a reflection of what you give, not a measure of what you get.
But this stakeholder-centric approach isn’t for every founder or CEO. Psychologically, it takes someone capable of recognizing that he or she can’t do it alone. That the leap from scrambling to scaling may require a tedious reconstruction of business processes. That extracting one’s self from the details and daily fire drills to shift from working IN the business to working ON the business may require relinquishing control of decisions that have always been within the leader’s domain. And that the best ideas for transforming an industry may come from a well-orchestrated employee survey or an experienced board member with no experience in that industry.
Practically speaking, it takes defining, articulating, and executing success measures, key performance indicators, a disciplined and strategic hiring practice, strategically aligned compensation plans, dashboards that shed light on paradigm-shifting decisions, and many other seemingly mundane undertakings that professionalize the business.
It’s hard work, and it requires humility and teamwork. But we love helping businesses grow so, for us, it’s good business.
John Grafer is a principal at Satori Capital.
About Satori Capital
Satori Capital is the preferred capital partner for companies building significant long-term value through a sustainable approach. Based in Dallas, Texas, Satori’s team has a long and successful track record as private equity investors and founders and CEOs of privately owned and publicly traded companies. Satori partners with talented management teams to accelerate the growth of companies with at least $3 million of EBITDA that are "built to last" and meet a set of criteria described as “sustainability.” These businesses deliver strong returns by operating with a long-term perspective, committing to their mission or purpose, and focusing on creating value for all stakeholders.
By John Grafer