Company culture is a key driver of private equity success
Key Takeaways:
● Private equity partners invest in existing businesses with the goal of improving their value and sustainability.
● Cultural integration is a critical milestone for private equity investment success.
● Private equity investments provide an opportunity to influence and improve business culture, diversity, and inclusion when best practices and effective leadership styles are leveraged.
An increased emphasis on company culture in recent years has been driven by the undeniable links between culture, employee morale, and long-term financial outcomes. Company culture can also be a bellwether of success before and after private equity (PE) investments are completed.
In this blog post, we examine private equity culture and the changes to company values, leadership, communication, and work environment associated with PE investments.
Understanding private equity investment
Private equity firms typically purchase a portion of an existing company with the goal of earning a profit when the business is resold. PE firms are responsible for selecting and managing the companies they purchase on behalf of outsiders who invest in private equity funds. The PE firm then partners with the purchased business to make operational and financial improvements to increase the business’s value. The three broad categories of private equity investors are:
● Angel investors who make relatively small investments in early stage businesses and startups and don’t take a controlling stake.
● Venture capital firms that invest in young businesses and startups further along in their lifecycle, including businesses lacking the resources needed to scale up a proven business model.
● Private equity investors who identify more established (not startup) companies for investment. It is common for PE partners to purchase a controlling stake in the business.
PE firms invest in a broad range of interests, based on the focus and risk tolerance of the fund. The various types of private equity investments available may include:
● Leveraged buyouts that incorporate borrowed funds to increase buying power
● Growth equity investments in successful businesses
● Distressed private equity funds used to restructure businesses in financial peril
● Fund of funds investments that spread dollars across multiple PE funds to enhance diversity
The slow gestation period of private equity investments is sometimes viewed as a disadvantage, along with the high-dollar barrier to entry and inherent risk of failure. Potentially high returns and the ability to influence investment outcomes are among the advantages that offset these risks.
Key players in private equity deals
Successful private equity deals leverage the expertise of seasoned financial analysts and business experts to perform their due diligence and select the right opportunities. Limited partners (LPs) provide capital for investments while general partners (GPs) are responsible for the operational control of acquired assets. Once a PE deal has been completed, consultants and other specialists may help to define the company’s new direction and exit strategy. Pivotal executive leadership roles can span many years and strongly influence company culture.
Impact of private equity investment on business culture
Business culture encompasses many factors that directly impact employee satisfaction, productivity, and profitability. In general, shared values, attitudes, and practices are at the core of a business culture. Private equity investment can introduce changes to leadership, policies, and strategic direction that inevitably reshape company culture.
PE investment can have a positive impact on culture when employee retention and development are emphasized during the transition and valued elements of the existing culture, such as flexible working policies and benefits, are retained. Private equity investment also creates an opportunity to reshape the culture by emphasizing employee contributions as the backbone of company success. New shared goals and objectives established by the PE firm can motivate all employees to leverage their talents and increase productivity.
The role of leadership in cultural integration
Responsibility for cultural integration should be shared by everyone, but successful leaders set the tone by displaying the trust, respect, patience, and collaboration needed to meld the cultures of the acquired business and PE partner. Leadership can facilitate cultural integration by interacting with employees, providing useful feedback, and acknowledging positive progress.
With a positive foundation in place, business leaders can overcome the challenges they may face during cultural integration, including resistance to change, employee anxiety, geographic issues, and differing expectations that must be resolved for the company to remain successful. Open and honest communication is the most important tool leaders can use to keep the culture on a positive footing.
Diversity and inclusion in private equity investments
Private equity firms recognize the value of diverse and inclusive organizations that attract talent from a broader base while benefiting from disparate ideas and experiences. Progress has been made in recent years, with more women and minorities represented at both the investment and operational levels of PE firms, and more institutional investors now include diversity, equity, and inclusion (DEI) in their due diligence practices.
Private equity firms can improve diversity and inclusion by favoring investment in companies that demonstrate diversity at all levels. Once investments are made, these firms can also ensure the redefined culture actively supports and maintains diversity and inclusion through initiatives such as recruitment, training, and promotions.
Strategies for managing the impact of private equity investment
Over 65% of business leaders believe culture is more vital to success than the business strategy or operating model. To ensure a positive outcome, private equity partners must provide the leaders of their newly acquired assets with the time, tools, and resources necessary to:
● Identify and assess cultural gaps
● Develop a cultural integration plan
● Communicate changes and expectations to employees
● Engage employees in the cultural integration process
Employee engagement can be fostered through focus groups, town hall meetings, training, and one-to-one communication with leadership. Throughout the transition, leaders should develop metrics to monitor engagement as they fine tune the integration strategy.
Case studies of private equity investment and business culture
Not surprisingly, many well-known private equity culture success stories included an emphasis on cultural alignment and improvement that mirrored the positive financial outcome.
Case study 1: Blue Buffalo
The Blue Buffalo pet food company was founded in 2003 based on an unwavering commitment to pet nutrition. This core value was one of many cultural traits shared by the Invus Group private equity firm that purchased a $59 million stake in Blue Buffalo in 2006. Customer education and strategic marketing campaigns were among the initiatives that bolstered employee engagement and sales simultaneously, leading to an $8 billion exit event in 2020.
Case study 2: Treasure Valley Foods
The Treasure Valley Foods (TVF) private equity investment in 2008 was an example of a leveraged management buyout orchestrated by the existing management team. This continuity of leadership and vision, coupled with an ingrained passion for food, led to further refinement and expansion of the TVF brand, along with a two-fold increase in revenue shortly after the deal was finalized.
Case study 3: Payless Shoes
Private equity deals don’t always end with a kumbaya moment. Payless Shoes was once a mainstay of malls across America, but a series of private equity firm leadership decisions that clashed with existing company values ultimately led to bankruptcy proceedings in 2017. Lessons learned revealed that an overemphasis on profits had undermined the marketing and supply chain prowess that had made the brand successful.
Private equity culture FAQs
What is the role of leadership in cultural integration after private equity investment?
Business leaders are responsible for studying the company culture and implementing changes resulting from PE investment. They are also responsible for ensuring the cultural integration reinforces teamwork, collaboration, and a shared company vision.
How long does cultural integration take after private equity investment?
Cultural integration can span from several months to years. The duration depends on factors that include company size, level of employee buy-in, and the initial degree of misalignment between the culture and values of the PE firm and acquired company.
How can we measure the success of cultural integration after private equity investment?
There are many trailing indicators, such as employee retention rates, exit interviews, and profit margins, that can be used to measure the success or failure of cultural integration. Best practice is to also evaluate leading indicators, including proactive customer and employee surveys.
Can private equity investment help improve company diversity and inclusion efforts?
Private equity firms directly influence the diversity and inclusion efforts of their portfolio companies, since hiring practices, company policies, and the diversity of company leadership teams can be upgraded to establish a more inclusive work environment.
How can we prepare for the cultural changes that come with private equity investment?
The best way to prepare for inevitable cultural changes is through well-planned and executed management actions, followed by thorough communication to employees. Of these actions, the first and most essential is a cultural gap analysis to determine where resources should be expended to prevent culture shock.
References
https://www.shopify.com/blog/general-vs-limited-partnership
https://www.forbes.com/advisor/business/company-culture/
https://hbr.org/2023/05/employees-are-losing-patience-with-change-initiatives
https://www.pwc.com/gx/en/issues/upskilling/global-culture-survey-2021.html
https://technicali.com/cultural-integration-in-mergers-and-acquisitions/
https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/the-state-of-diversity-in-global-private-markets-2023
https://romeromentoring.com/how-a-private-equity-firm-helped-blue-buffalo-become-a-billion-dollar-brand/
https://www.genequityco.com/insights/management-buyout-success-story
https://www.nytimes.com/2020/01/31/upshot/payless-private-equity-capitalism.html
https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/the-state-of-diversity-in-global-private-markets-2023