While the rest of the business and financial world frets, private equity has been surprisingly sound over the last year. Even though the big deals that dominated headlines in 2006 and 2007 are now rare and financing capital is tight, private-equity managers have remained calm, and few of those big deals have unraveled.
Increasingly, public companies are examining the private-equity model for lessons that they can apply to their own businesses, including how to take a longer-term focus, improve compensation structures, and perfect portfolio management and capital allocation.
Directorship recently assembled a panel of corporate directors and private-equity managers and experts to discuss changes in capital markets and what public companies can take from private equity in terms of strategies for better performance.
“We do believe that public company directors can learn a great deal from the private-equity markets, including the way incentive plans are set for management and governance, certainly,” said Charles Weinstein, managing partner of Eisner LLP, an accounting firm that represents a number of private-equity clients, including Clayton Dubilier and Apax Partners.
Christopher Loiacono, a partner at Eisner, said that a limited number of private-equity firms are still managing to form new funds and raise capital. “In terms of new fund formation, the brands that are still highly valued and going on their sixth and seventh funds are the ones that go back to market right now and raise traditional private-equity funds. We’re seeing a shift in private equity towards infrastructure funds and we are seeing structured finance professionals coming out of traditional finance backgrounds now forming funds in the infrastructure space.”
So, how are private-equity firms managing their portfolio companies in this uncertain period? “We’re probably doing everything the public companies either can’t or don’t do in this current environment,” said Drew Lipscher, a partner at private-equity firm Greycroft Partners. “While that’s a sweeping generalization, I think there are a couple of core points that underpin that logic: One is, especially at the early-stage level, we take risk. Another aspect involves how we can shift strategies and respond quickly to market conditions, customer needs, or other changes that public companies just can’t execute.”
Some of the panelists said that public companies need to do a better job of moving quickly to take advantage of opportunities. “Public company CEOs should be more nimble so they are able to respond to market conditions that have been so volatile as of late,” said Jonathan Urfrig, CEO and limited partner of U Capital Group. “We also need CEOs that are focused on allocating capital properly.”
One of the questions the panel addressed is: Are some CEOs better for public companies than for private companies? “From my experience—and there certainly are exceptions—private-equity managers are most interested in an exit strategy, so they are primarily interested in increasing the enterprise value of the business,” said Alan Gelband, founder of Gelband & Co., a boutique investment bank. “A public company is more interested in market cap and shareholder value. So, consequently, there are different CEO styles that accomplish these goals differently.”
Sarah Eames, a director at Allied Health and Global Med Technology agreed. “A public company CEO is an individual who sets the strategy and understands what the objectives of the company are. I don’t think there are many public company CEOs who can make the transition very well to a private company CEO.”
IPOs on Hold
While the market for initial public offerings (IPOs) is essentially on hold, many of the companies that went private during the booming buyout period will begin preparing to get themselves in shape for a public offering at sometime in the future.
“The IPO market, unfortunately, is absolutely closed for the moment, but it will open back up. And what we’ve seen prior to this recent phenomenon is a number of smaller IPOs. You had $10 million, $20 million, and $25 million IPOs, and the management teams of those companies tended to be very inexperienced, and not to have a lot of guidance from a board of directors,” said Eisner’s Weinstein. “When that trend changed to private-equity funded companies using the IPO as an exit strategy, the entrepreneurial management team of these smaller companies had the benefit of a very experienced board.”
The experience of the CEO is a key concern of companies looking to go public. “The process of filling out the management team can be a difficult one. You have to make sure that you have a CEO who can survive the road show, be credible, and, preferably, has been battle-tested in a prior job,” said Robert McCooey, senior vice president, Capital Markets Group, at Nasdaq OMX.
In preparation for going public, many private companies, especially those controlled by private-equity firms, will build a top-notch board and practice good corporate governance. “We have executive sessions at all the board meetings that I’m involved in. And we go through the same process of evaluating the CEO. What are the positives? What are the negatives? As a board, it is incumbent on us to turn it into something positive. We bring the CEO back into the room and say, ‘here are the actionable items,’” said Lipscher.
Many of the panelists pointed out that private-company boards tend to be less divisive and more focused around the business model. Parag Shah, a senior managing director at Hercules Technology, said that, by nature, private-company boards are different: “You’re also much more invested in the company compared to independent directors on public boards and you have the issue of greater liability on public boards than you do on private boards, not that there isn’t liability on private boards, but if you’re facing liability issues then you’ll just be that much more likely to engage in second-guessing the CEO.”
Differences aside, when the market improves private companies will be lining up to access the public- capital markets and Weinstein says they will need to be more prepared than ever: “Even though there is not an IPO window right now, companies that may eventually go that route are putting in place the corporate-governance systems and dealing with Sarbanes- Oxley, even as a private company. Putting in place an internal control structure will allow a more natural transition when they do become a public company.”