Why private equity firms and startups are becoming a better match everyday

a conversation with Wendy Herbst

The involvement of private equity (PE) firms in the tech sector has become a growing trend. But what can an early-stage tech company expect when entering into a partnership with a PE firm? For many, there exists an almost cartoonish perception that these partnerships are essentially takeovers, where companies are chopped up, optimized in bits and pieces and eventually sold for maximum profit. In reality, these relationships are far more similar to the traditional VC-founder relationships we’ve discussed at length in this blog – highly collaborative, and for many startups, a viable path to healthy growth and a lucrative exit.?

That said, there are notable differences between VC and private equity, some obvious and others more subtle. To explore these nuances in more depth, I sat down with my friend and thought partner Wendy Herbst, a veteran executive leader at companies that have partnered with private equity firms. We discussed the emerging alignment between startups and private equity, its potential impact for founders, and why we’re seeing it now.?

YK: Tell me a bit about your background. How did you get into the private equity space??

WH: Early in my career, I had joined Sherwin Williams on the sales side, and they gave me the opportunity to not only build a solid foundation to my career but also to complete my MBA while I worked. The experience of grad school really opened my eyes to a world far beyond what I'd been doing, and I became especially fascinated with the world of private equity. Eventually, I made the transition and for the past 16 years I have been working for PE backed firms that had been acquired, guiding these companies in new GTM strategy and helping them to navigate the PE partnership and eventual exit.?

YK: Let’s start by setting some context for startup founders. What does a private equity partnership usually look like?????

WH: Each PE firm will have their own strategy, my experience has been these partnerships are just that, a partnership, with a shared vision for growth. During my time working in private equity I have seen a marked shift in the typical dynamic of these relationships. Firms are moving away from the takeover approach, where a company is purchased and a strong hand is taken in making cuts and putting executives in place. More and more are taking the approach of investing in people, where the operating company continues to be the decision maker, and the PE firm plays a resource and support role. Of course it depends on the firm, but there are increasing opportunities for startup founders that want to stay with their business, but need a shot-in-the-arm to help grow.?

Most of the companies I’ve been involved with have taken this approach, investing in a running business and keeping teams in place, and supplementing that with resources, and they are not alone. That mindset shift has led to a lot more private equity activity, and tremendous opportunities for mutually beneficial partnerships.??

YK: What are the most critical factors to consider for an early-stage company looking to take on PE investment??

WH: If you’re a company looking for PE investment, the name of the game is value creation. What value does the firm bring to the relationship? That should be clearly defined at the outset. Along with that, clear communication. Know how the potential firm operates, and be transparent about not only why you are seeking investment, but what you want your involvement to be. Knowing what you want from the engagement is one of the most important things to consider, and saves either party from wasting their time.?

Once you’re clear on the target, prepare your presentation. Firms are looking for a solid business with a good story. Think about what that story is, and where its potential future lies. That’s really the piece they are buying, that future potential, so show up, be passionate, tell your story in a compelling way, talk about why you’ve had success, why you believe it will continue, and why they can and should also. Know your numbers, they’ll want to be compelled by the story and reassured by the financials.?

The other major piece they’re looking for, and something to think about as you develop the pitch materials, is where they (the PE company) can bring value. They will absolutely do their due diligence, so you need to do as much of that work for them as possible and have it ready. It really comes down to knowing your story, and having your data. I do recommend some sort of consultation or a partner that has done this before that can help develop that offering package, because PE firms will want to understand every element of the business in order to consider investment. They will look at every line of business, back forward and sideways. Presenting that information clearly will help you get to the right investment partner faster.

YK: It seems like companies need to walk a fine line between courting a potential PE investor and vetting them as a partner at the same time. Does that present challenges??

WH: In an ideal scenario, it really shouldn’t. The best private equity firms are going to be looking for a prospective partner to be evaluating them, too. PE is typically intended to lead to an exit, but they want to feel good about what’s going to happen until then, confident that things will go how they anticipated. It comes back to clear communication being the most important tool in the relationship.?

YK: What should that process of evaluation look like from the perspective of the startup? What should they be looking for, and where??

WH: Look at their track records –? their respective websites will show past investments and current portfolio. Do they invest within your industry? Do they have resources to properly add value there? Looking specifically at their past investments, how long did they hold them and what was the change from when they purchased them to when they sold? Look at current portfolios, ask what they’re doing to create value within them, and assess how it matches up with what you’re looking for.?

Another factor is value creation from their side. Are they consistently doing it through financial engineering, operational improvement, new channels to market? It’s all about multiple expansion, growing the multiple on higher earnings in the future, how are they doing that, how have they done it in the past and again, does that match up with your goals?

Finally, know the investment team, and what that dynamic will look like post investment. Who will you be working with, do you feel like it will be a good relationship, does it meet the goals you’ll have as a business? Then agreeing on what an exit looks like– once you are partners and they’ve made the investment, do you see the path forward in the same way??

YK: Do these tend to be delicate relationships? How can a company prepare for eventual roadblocks or divergence in philosophy??

WH: Things happen. It can be things within control, where there was a miscommunication within the company or between the company and PE firm. Things happen in the market, too, that just are out of your control. Macro-environmental situations that will cause a need for a change in strategy, a shift, a pivot, and those things happen all the time. That’s when having those established lines of communication, decision making and up front processes of what to do when there’s a red flag, if you will, to say, “this can’t go the way we originally agreed upon so let’s come together and get back on the same page.”

For this reason, it is important to talk about where you have gaps at the very beginning. Don’t come and say that you’re perfect because one, you’re not, and two, they’re going to make their own judgements. You’re better off identifying and acknowledging them up front, it shows that you’re both realistic and thorough.?

They’re looking for investments where they can bring value, so if you’re talking to the right companies and presenting it correctly, talking about gaps is not going to detract from future value. Rather, they represent an opportunity for a proper partnership between the company and the PE firm, which is exactly what they’re looking for. To have done that work for them, pointing out to them how you see them as a resource that can fill that gap, can create great conversations and partnerships. If a speed bump comes, you want to feel like you’re facing it together.