Thursday, January 25, 2007

Cognitive Dissonance

Yoo hooo... Mr. CEOPrivate equity is a tough racket.

Oh sure, everybody on the planet is simultaneously bemoaning the fact that PE is taking over the world and desperately trying to get a piece of the action, but still, it’s a tough racket. Unless you can swan your way through the World Economic Forum at Davos like one of the private equity plutocrats, your day-to-day life is no cakewalk. Yes, yes, we know that your firm No-Name-Middle-Market-Commodity Fund LLC has posted compound annual returns in excess of 98% since Noah crash-landed the Ark, but it’s hard to get the respect and attention you deserve with so many players on the field. More private equity deals are being done than ever before, yet it’s difficult to find good companies to invest in.

So, what do you do? You market yourself.

Now, as apparent punishment for my many sins, one of my jobs as an M&A intermediary is to periodically visit private equity shops to press the flesh and learn about their investment interests, styles, and preferences, so I am on the receiving end of a lot of this marketing. Let me make a small observation: most of you are doing it all wrong.

Mistake number one: In my experience, when it comes to investing in companies, most financial sponsors talk like girls but act like guys.

Most of the financial sponsors I talk to give highly specific criteria for the kinds of companies they are willing to invest in: minimum revenues, earnings, industry verticals, growth opportunities, etc., etc. When I sit in their richly paneled conference rooms listening to their pitch, it usually sounds exactly like the kind of comprehensive checklist some women use to screen potential husbands. You know: tall, handsome, rich, charming, exciting, good in bed, understanding, likes kids, etc. And just as unrealistic.1

On the other hand, when it comes to the mating game, men are famous for being far less discriminating. Likewise, notwithstanding their stated criteria, a lot of private equity firms end up investing in almost any company they can persuade to say yes. This is not a bad thing—it supports me and myriad other middlemen—but it does show up the gap between what financial sponsors say and what they do.

Mistake number two: The part of the conversation with a financial sponsor that I dread the most is when they start talking about how they “differentiate” themselves. Apparently, they all received the same PE trade group memo explaining that financial sponsors are no longer just financial engineers. Now, they “add value” by improving operations at their portfolio companies. They airlift a star-spangled SWAT team of The 25 Best Corporate Managers in America into each and every due diligence session and Board meeting. They employ a crack brigade of ex-GE Vice Presidents and former Navy Seals to scour expense reports for surplus paper clips. It’s not just about leverage anymore: “[Your private equity firm name here] makes companies better.”

The first time I heard this, I was suitably impressed. Now, when the 547th financial sponsor I have met trots out the same damn story, I find I struggle to suppress a yawn or a belly laugh. This is true even though I know I should feel intimidated by the 23-year old Associate with a net worth greater than the GDP of Botswana sitting across the table from me.

Now the average public company executive with undamaged temporal lobes can figure this out just as well as I can. As someone who works with corporate managers on a regular basis, let me give the three PE guys still reading this a clue as to how potential future portfolio company managers really view financial sponsors: They think most of them are assholes, and a few (maybe you?) are not.

This is the real secret of getting attractive companies to sell to you: it’s all about chemistry. Personal chemistry between the target company’s managers and the financial sponsor deal guys. If they like you, they’ll bend over backward to make a deal happen with your firm, and if they don’t, they won’t. It’s as simple as that.

Of course, ex-post facto corporate managers will always justify their decision with some flimsy rationalization like “Those guys at Skinem, Ripem and Rapem LLC really understand our company / industry / need for six corporate jets,” but don’t you believe it. They just like you. (Well, you and your money.)

The beauty of all this, of course, is that being an asshole is completely in the eyes of the beholder. The PE guy who seems like Typhoid Mary to one management team will look like Mother Theresa to another. In part, this is because—News Flash!—corporate America is full of assholes, too. Like you, they come in all different shapes and sizes, and I can guarantee you that somewhere out there is a public company CEO who thinks you look exactly like Gisele Bündchen.

So, do not despair, Dear Private Equity Reader: one day, your Prince will come.


1 Fortunately for the continuance of the human race, when it comes right down to it most women end up settling for some relatively average guy with a slight paunch, cute dimples, and a nascent bald spot, not Leonardo DiCaprio. Which is just fine, since not too many women qualify as Gisele Bündchen, either. (Besides, even Leo and Gisele couldn’t keep it together.)

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