Take control of the process by going into it with a clear idea of exactly what you want, including the type and size of investment, the ideal exit horizon and the people you need on your board.
Choosing a private equity partner is one of the most important decisions you’ll make during your tenure as a CEO. Choose wisely and it will open new doors and take your company further than you imagined possible. Choose poorly and it can be the beginning of a very frustrating period in your life.
During nearly 20 years of entrepreneurship, I have gone through the process of researching, evaluating and selecting a private equity partner many times. My journey started in 2001, when LLR Partners invested in my first company, Innaphase (subsequently acquired by Thermo Electron) and it continues to this day: I will be raising money for my latest company, Pod, in the very near future and am currently building a shortlist of potential investors.
Along the way, I have served as CEO or board member to several venture capital and private equity backed companies and one public company. As you might suspect I have worked with a range of investors.
Based on this diverse experience, I believe that there are three important steps that every CEO needs to take in order to make a wise choice in a private equity partner.
Figure out what you want from an investment
Always start by clarifying what you need before you begin exploring what a financial partner can offer. Be clear about the amount and type of funding you’ll need, the time you believe it will take to achieve a successful exit and the kind of funding partner you want to take that journey with.
Start with the basics. What is your current growth stage and how much funding do you need to get to some key business markers? You might be looking to fund the company for a shorter term—for example, 1-2 years—and then raise additional funding at a higher valuation. Alternatively, you may be looking for a financial partner to stay with you until the exit. Private equity investors excel in this later stage—that’s their specialty. If you have never exited a company before, you will be working with people who almost certainly have been through many exits.
Be clear about the amount and type of funding you’ll need, the time you believe it will take to achieve a successful exit and the kind of funding partner you want to take that journey with.
Then look at what you’ll need over the longer term. Are you likely to need a follow-on investment to acquire other companies as part of your roadmap? If so, pay close attention to the birth order that an investment will place you with a particular investor. A fund that’s in year one or two is likely to have the runway to provide a follow-on investment further down the line. When it reaches year five, that makes you one of the last investments going in, which means they’re getting to the end of the available capital. If you’re uncertain of the future, you’ll want to look for an opportunity that places you a little bit earlier in somebody’s fund and gives you more flexibility.
And finally, consider your ideal exit horizon. If you think you’ll need time to make a successful exit, you don’t want to place yourself in a situation where the process gets rushed. Look at whether this is the private equity group’s first, second, third or fourth fund for a clue to the expected exit time frame, because initial funds can create undue pressure for a rapid exit. I learned this the hard way when one of my companies became part of a firm’s initial fund. After several years without any exits, they were motivated to create one so that they could move on to raise fund two. It placed a lot of pressure on the company to create liquidity for the investor during the financially difficult period of 2009-2010.
Ask questions about the board of directors
Once you know what you’re looking for, it’s time to talk to your shortlist. Here are some of the questions to ask private equity firms:
Who will the partner appoint to your board? You need to know who that person will be, what their outlook and temperament is and whether they’re someone you can picture working with effectively.
Look for the patterns in previous board appointments: does this person tend to flip on and off boards, or do they stay put?
Will that partner be there for the long haul? I sold one of my companies with the understanding that the partner who did the deal with us—someone I trusted and was excited to work with—would be on the board. A month later, I found out he was being replaced by someone I had a terrible rapport with. I lasted for a few tumultuous months and then left. Look for the patterns in previous board appointments: does this person tend to flip on and off boards, or do they stay put?
What kind of independent board members will they put in place? The ability to run and staff a board is a critical requirement for a private equity partner. Find out who will be placed on your board, what specific value they will bring and what kind of compensation they will receive. Some private equity firms still expect board members to work for free, but the good ones recognize that building an effective and experienced board takes money. Good board members work incredibly hard to push your company forward and help you succeed, and it can make a vital difference to outcomes.
How important is a good board of directors? Here’s a real-life example:
My first company, InnaPhase, was launching a brand-new, 1.0 software product into pharmaceutical companies. The product was exceptional, truly disruptive technology, but the pharmaceutical industry is very conservative. I flew out to meet our incredibly important potential first customer, and they told me flat out that there was no way they could make a deal with a brand new company offering an untested product. In the middle of the meeting, someone came in with a note from their CEO. My board member, who happened to know this person well, had reached out and vouched for me personally. Within a few minutes, the group pivoted from a “hard pass” to getting the deal done. From that first successful deal, we were able to build a client base. It turned out to be the making of our company.
Meet with an investor’s CEO references in person
The last—and most important—step in the process is to talk to people who can speak to the caliber of the partnership from personal experience. CEOs are known for getting to the point quickly and being brutally honest, so these conversations will be invaluable in helping you form an accurate, unvarnished picture of what it will be like to work with this private equity partner.
Don’t rely on the phone to conduct these conversations. I recommend meeting with the CEOs in person, where you can get 15 to 30 minutes of their time without distractions over a cup of coffee. And make sure you’re talking to CEOs who have worked with the individuals you expect to interact with daily. Questions to ask include:
- “How long have you been with this investor? Do you have any other investors?”
- “Is the investor hands-on, or hands-off?”
- “Who do you work with in the firm? Have you always worked with these individuals? Do they always come to your board meetings? How often do you talk to them roughly? How are they to work with?”
- “What’s the firm’s agenda? Are they pushing you to acquire businesses or exit or scale? What are their priorities?”
- “How does the investor react to bad news or tough situations?”
This last one is so important, especially for younger CEOs who tend to feel pressure to always deliver good news. But you need to know that you can be honest and open with your private equity partner so that they can help you through the tough times. If the investor is known for panicking or playing the blame game instead of rolling up their sleeves and finding a solution, move on.
This is true for all challenges, large and small, but the COVID-19 pandemic and resulting economic fallout elevated the needed for strong partnerships to an unprecedented magnitude. CEO references will be very revealing in how committed, thoughtful and creative private equity firms were in supporting their portfolio companies through it.
You need to know that you can be honest and open with your private equity partner so that they can help you through the tough times.
Here’s the bottom line.
The private equity partner you choose is one of the most important decisions you’ll make as a CEO. Take control of the process by going into it with a clear idea of exactly what you want, including the type and size of investment, the ideal exit horizon and the people you need on your board. Then make sure the partner is capable of delivering by asking the right questions and talking—candidly and face to face—with other CEOs who have taken this path before you.