Private equity investors play a significant role in the economy and act as active owners of their portfolio companies. They invest in companies with the goal of value creation and can have a considerable influence on the strategic decisions of those companies. Most encourage more daring and greater ambitions. Most, because a lot depends on the directors, their seniority, and the size of their investment in a portfolio company. Put different directors on your board and you’ll get different decisions. This is not surprising, but it is confrontational. And it’s something you can actively work with.
A recent study by a team of researchers, including Veroniek Collewaert and Sophie Manigart from Vlerick Business School, Jeroen Neckebrouck from IESE Business School, Tom Vanacker from Ghent University and the University of Exeter, and Dries Bourgois from KU Leuven, has provided insights into how private equity investors exert their influence.
The research, published in the Strategic Entrepreneurship Journal, found that the influence of a private equity investor on the strategic decisions of a portfolio company depends on three factors:
- The financial involvement of the private equity investor: the larger the investment of a private equity investor, the greater their influence, involvement, or interest. So, if you want significant involvement from your investor, choose a partner that matches your ambitions.
- The experience of the board members: experienced board members can play a significant role in influencing the strategic decisions of a company.
- The performance context of the company. When a company underperforms, a private equity investor is more inclined to implement major changes, especially capital investments within the current organization. Conversely, when a company performs well, exceeding expectations or ambitions, there is a quicker move towards acquisitions and less tinkering with the existing organization.
The research teaches us that growth strategies are performance-driven: internal growth through capital investments in the organization, or growth through mergers and acquisitions (m&a). The study found that private equity investors with substantial interest and experienced board members are most inclined to implement significant changes when a company underperforms. In these cases, they are more likely to focus on short-term measures within the organization to improve performance.
The likelihood of a company undertaking acquisitions depends on the financial involvement of the investor and the performance context of the company. In cases of outstanding performance, this is more likely with large investments, but less likely with experienced board members.
Vlerick studied 51 portfolio companies for five years.
When a company performs well, the effect of the private equity investor is less clear. In some cases, private equity investors might make larger investments and acquisitions to accelerate growth. In other cases, particularly among senior board members, there’s a preference to maintain the status quo to protect the value of their investment. This can lead to a divergence in ambition levels, as the horizon of investors may not always align with that of the management.
Define your performance context and your decision theory
Crucial in all this is to define in advance what good performance is. Otherwise, this becomes subjective during the collaboration. For example, you have an exceptional year, followed by a good year. You want to avoid that all decisions are now based on the exceptional year and that a ‘normal’ year, according to the ambitions, is now perceived as a subpar year, which calls for different decisions (cost savings, investment freeze, etc.). A clear behavioral framework of the organization (‘behavior theory of the firm’: how do we make decisions in function of the performance context) is therefore desirable.
This research offers valuable insights for companies working with private equity investors. It is important to understand the performance context of the company, the financial involvement of the private equity investor, and the experience of the board members to predict the impact of the private equity investor on strategic decisions.
other private equity = other decisions?
According to this research, yes. For companies looking to collaborate with private equity investors, it’s important to choose a strategic partner that aligns with the company’s objectives. It’s also important to set clear expectations regarding the role of the private equity investor in strategic decision-making. Don’t be too quick to be satisfied that private equity firms want to work with you; be selective, check references, talk to entrepreneurs who have worked with them (ideally those who are not currently collaborating, to get real feedback). And this research shows that it’s best to also adjust the seniority of your board members based on the ambitions of the organization.
https://onlinelibrary.wiley.com/doi/epdf/10.1002/sej.1487?domain=author&token=X9D6THKTDGQDS9JNBQDR
