How the best private equity investors diligence a management team and the board

One thing that Private Equity has agreed on for sometime is that quality management is the key to successful investments. Boards are a key part of that. Some investors already spend considerable time on team and Board selection and the following article will be second nature. Sadly that is not true of all private equity. That said, the best Private Equity Houses are now seriously investing the time and resources into understanding the team they have and supplementing it where appropriate.

A number of small actions can be taken to reduce the risk of backing the wrong team relatively inexpensively:

• Reference the target team informally, before spending considerable resource looking at the opportunity. In some instances, it shows that the right decision for investor is to decline the investment opportunity, but more often it shows the house at the outset certain areas where they should focus, or where the team may need to be supplemented, or indeed where there may be opportunities for the business. Management team informal referencing is becoming more common at this stage in the process.
• Reference other stakeholders. Informal discussions with customers can be difficult at this stage but it is often possible, to speak to potential customers, again in my experience, offering considerable insight.
• Review the team in the context of what is known about the business. Private Equity due diligence looks at the risks and opportunities, and considerable time is spent on the strategy of the business regardless, but the most sophisticated investors are now genuinely looking at their existing team in the context of what is needed, individually, and as a group, and stress testing appropriately.
• Make sure the assessment work that is done can be used in the future. The information learnt from diligence and past processes are no longer being placed in a drawer and forgotten, but are being put on investment review checklists in case the business moves into territory where action on the team is required.
• Get the right Chairman. Selecting the right Chairman is not risk free but the reduction in risk can be extensive with a few inexpensive calls. Quality Chairmen are critical friends. They keep the CEO and management sane and save private equity portfolio managers considerable time, as well as contributing significantly to the value of the business. The key to really understanding what people have done previously, where they really add value and where they do not, what their values and style are really like, is time and quality referencing. Referencing can be quick and inexpensive and is absolutely key. Referencing from people you know is amazingly powerful and there are ways to “know” more people.
• Know what the common traits shared by the top Chairmen are. The quality Chairmen not only have impressive executive careers, but are at the point in their career where they are confident and do not require the limelight. The quality Chairmen, which are a small percentage, are selective about the Boards they join, are passionate about the companies and what they can bring and put the time in that is required. That does not mean stepping on management’s toes. It does mean putting the time in upfront to really understand the business, the risks, opportunities, strategy, competitive positioning, regulatory environment where appropriate etc. and, perhaps more importantly, building a relationship with management and gaining their respect so the Chairman is in a position to influence.
• Ensure the Chairman has capacity to be available when required. It will be the day the Chairman thinks that all is going smoothly in his portfolio, when a CEO becomes ill, one of his other portfolio gets an offer from an acquirer and another breaches bank covenants. The more we really understand the Chairman and not just his experience but how he approaches a company at the outset, from a financial, a marketing, an operational perspective, how quickly he moves to the other disciplines, whether he builds a relationship predominantly with the CEO, or the whole of the board, with second tier management, what his style is like, whether he alters his style for certain people, situations etc. the less risk there will be in the appointment. Quality Chairmen are worth their weight in gold and while I have used masculine terms throughout, it is all obviously equally true for quality Chairwomen.
• A cross section of the team should spend time with the Chairman, not least eating with him - you may be wondering if I am sane at this point - but it can be enlightening.
• Where possible, involve the Chairman as early as possible in the due diligence process. You will benefit from his view, will get to know him better, he will have bought into the same strategy and projections as you but equally importantly, he will have built a relationship with management and will hit the ground running at completion.

Having worked in private equity for more years than I care to admit to here, I have over the last few years increased my involvement with corporates generally, in recruiting and referencing, and not unsurprisingly, the above holds equally true regardless of corporate ownership. Great management teams makes everyone’s lives easier.

Hazel Cameron is a chartered accountant, who worked in corporate finance before joining 3i in 1993. She worked there for seven years making investments, selling and floating businesses. Hazel then opened a London office for $6bn hedge fund, Bowman Capital, that had $1bn in private equity making pre IPO investments throughout Europe. She later headed up the UK for Cross Atlantic Capital Partners, a Philadelphia based private equity house. From 2000, she has been sitting on boards as a Non-Executive Director for private equity and independently. For over 10 years, she has been building networks for private equity firms and helping build top class boards in the context of the company and its strategy. She now works independently, taking on advisory work and helping private equity companies and corporates build top quality teams.