WHAT PRIVATE EQUITY CAN LEARN FROM ENTREPRENEURS
Wanted to share my latest article on Forbes. I'm reversing the equation from my typical perspective. Loved working through this with the AM&AA.
What Private Equity Can Learn from Entrepreneurs
I live at the intersection of entrepreneurship and private investments. Typically, I approach it from the perspective of an entrepreneur. Most of what I write about — including my book — focuses on what entrepreneurs can learn from the private equity business model. That said, as I recently prepared to speak at the Alliance of Merger & Acquisition Advisors Summer Conference , I found my perspective flipped.
Given my audience, I thought about what private equity could learn from entrepreneurship, and I realized that private investors can learn quite a lot from entrepreneurs.
Let’s start with an overlooked similarity between these two groups. As I’ve written about before, most potential business buyers begin their search the wrong way. They focus on size and industry instead of the important factors that matter. Private equity is no different.
Private investors typically describe their targets in terms of size and industry. But value is driven largely by earnings and growth, with growth weighed twice as heavily as any other factor. Every investor knows growth is the number one creator of value in private equity. However, there’s a disconnect between this known truth and how most private equity firms behave.
In my experience, their behavior is defined by deploying capital as quickly as possible in investments analyzed largely for past performance. Instead, these investors should start with the end in mind and look for companies they can grow the fastest, as entrepreneurs do.
The best entrepreneurs in the world all possess a common trait. It’s what Carol Dweck calls a growth mindset. It’s what allowed Elon Musk to send a SpaceX rocket to the International Space Station after his first three rockets crashed and what propelled Thomas Edison to eventually create the lightbulb after failing over a thousand times. With a growth mindset, you understand that the world is malleable, success is achieved through effort and you embrace challenge because you know anything can be improved upon.
Now imagine if private equity firms worked to cultivate a collective growth mindset in their firms. I would argue they’d achieve the same results that the most successful entrepreneurs do: increased empowerment, commitment, collaboration and innovation.
Success in private equity does not end with an acquisition. Success is measured after the acquisition is grown and eventually exited. The seeds of success are planted during the acquisition process, when a PE firm looks at potential businesses to buy. Like an entrepreneur, they must remember that the future is not just the company they’re buying — it’s the company plus them.
That begs the question: What does a private equity firm bring to the table aside from capital?
I think the reason you see so many promising businesses fail to reach their full potential after being acquired is that few private equity firms are answering this question.
I’d argue that developing a collective growth mindset within the firm would cultivate a strong differentiator. There are great private equity firms, but it’s extremely rare for companies under private equity ownership to become great.
Practically, that starts with building a bench of capable leaders and then matching them with the right growth opportunities. Finding an opportunity and then picking a competent manager is standard practice, but I believe it’s a suboptimal, backward approach.
A leader-first approach — not a deal-first approach — allows private equity firms to unlock the true growth potential of an acquisition. Capital alone can’t do that, but the right leaders can.
Private equity firms also need to zoom out. “Industry” shouldn’t be defined so specifically because, at the end of the day, there are essentially four: services, manufacturing, distribution and online. The fundamentals of running a business in each of those industries are the same. The skills used to drive growth in a health care company would also help you grow a CPA firm. Leaders in private equity firms don’t need to overspecialize. That’s an artificial limiting factor that should ultimately be removed.
Instead, firms need to focus on matching their leaders to the macro industries in which they would excel. Just as the strongest entrepreneurs build the best companies, private equity could leverage the strongest leaders to create a portfolio of thriving, innovative companies, as well as above-average returns.
Finally, in the private markets, size doesn’t matter. The $1.2 trillion in liquid cash that’s ready to be invested should be aimed toward the best growth opportunity regardless of the business size. So, why are the private markets defining their targets by size? It’s to deploy capital faster, rather than do the hard work of optimal matchmaker. The large volume of deals under $2 million in EBITDA is where the acquisition entrepreneur can thrive because the private equity industry largely ignores it, despite the massive growth opportunities there.
As a private investor, what value do you bring to the deal besides capital? Entrepreneurship starts with a leader-first approach, then defines the opportunity. This is backward from the typical private investment, but perhaps this is the secret to unlocking true adolescent-market growth among PE-owned firms.