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In more than 21 years of experience as CEO, Adam built three national service companies for nine private equity sponsors. During this period, he completed 58 acquisitions; and, on average, the companies he ran delivered a five-times return on invested capital at exit. He brings diverse expertise from commercial and industrial service businesses, alongside being a published author, licensed general contractor, pilot, former GE executive, and US Army veteran. He sat down with AlixPartners to discuss the outlook for private equity in 2024, and how portfolio company management can best partner with their investors and operators.
Adam, thanks again for taking the time to connect virtually. In your second book “The Exit Strategy Playbook,” you mentioned that during the past 30 years, private equity as an asset class has delivered over 2x the average stock market return. But PE sponsors are as exposed as anyone to recessionary headwinds, rising interest rates, and global turmoil market forces. What's your outlook for private equity in 2024?
After a slow first half in 2023, deal volume started to pick up in the second half. I ultimately expect a more normal deal flow in 2024. Why? Because, at the end of the day, the one unforgivable cardinal sin of PE is not to put limited partners' money to work. When LPs commit capital to you, that’s money other funds don’t get. If you the GP don’t use the capital, then your LPs miss out on not just an opportunity to potentially 2x the S&P returns, but also on making other investment choices.
Remember: PE funds are rated against funds of the same vintage year; returns may be lower one year than another, but it will be a level playing field. You won’t be penalized for something that affects everyone equally. Don’t put the money to work though, and a PE firm will struggle to find investors for its next fund. There is well over a trillion in dry powder out there; it must be put to work.
As a CEO, how would you prefer to structure your relationship with your PE sponsor? Are there any notable pros/cons that you can share about a particular relationship?
Incentive alignment is critical. Up front, I do not like it when PE firms charge a preferred yield or management fees. These fees disproportionately hurt management whose majority of returns comes from incentive equity that is paid after the preferred yield.
Operationally, I’ve frequently observed that value creation plans are not in place on Day One of the hold period. There may be a rough model, but the majority of value creation planning is done post-close. I think sometimes investors have unrealistic expectations about how quickly plans can be developed and how easy it is to get alignment between the sponsor and management on the value creation plan. I have 21 years of experience working with 9 PE firms and that isn’t always the case.
The good news is that I generally expect the value creation levers to be almost identical everywhere:
- Organic (price, volume, pivots)
- Margin improvement (cost efficiency, process efficiency, technology investments to drive productivity)
- Inorganic (buy companies, integrate, harness synergies).
If the PE firm's deal thesis was well thought out, an experienced management team can put some form and shape to it pretty quickly.
What should a CEO do at the beginning to get off on the right foot with their PE sponsor?
Engage your partners early, ask for help, and make sure to align on the value creation plan. Ensure governance is clear on decision-making. Establish your transparency by communicating good news fast and bad news faster! Hit your numbers.
How do you like to maintain the relationship during the holding period? I assume you want a “just enough” partner—not too hands-on, not too hands-off. Are there ways to get that balance?
PE firms run the gamut on interaction models. I have seen firms that were overly hands-on and others that were too hands-off.
I have what I call a “Hands-On versus Hands-Off” meter. If a founder is selling a business, it's very important to understand how hands-on a PE firm intends to be. If a founder is seeking autonomy and his or her sponsor is a very hands-on partner – the relationship won’t go well. This is like a marriage. In the world of transitioning founders to now working with PE, there is a 73% failure rate that the founder turned CEO of a portfolio company won’t make it over a typical 5-year hold period. Founders focus too much on money, and not enough on the personality of the firm they are going to bed with. Ideally, I’d establish an understanding of this before selling the company, or before taking the CEO job. I’d learn about this by interviewing other CEOs who were once married to the PE firm. I might also ask to speak to some who were fired to understand how they were treated when the marriage didn’t work out.
How does that translate into governance once the deal is done?
I like to see a mid-level cadence that has regular rhythms of interaction on multiple levels. PE partners need to have a monthly check-in with CEOs at a minimum. Mid-level PE folks who own the day-to-day investment should have weekly or bi-weekly check-ins. PE associates should be plugged in with lower levels of the company, primarily in finance and accounting.
Board governance should be monthly business reviews done remotely and quarterly board meetings in person. PE guy: Stop making leadership teams come to you in NYC (or wherever). You need to come to the company and have some level of visibility inside it—and some opportunity to get a feel for what’s happening beyond what you can see in PowerPoint.
Should a CEO err on the side of telling too much or too little? You don’t want to be the boy who cried wolf, but you don’t want to be too late—with good news or bad…
I’d rather err on over-communicating versus under-communicating, but both can be irritants to the PE partner or CEO. You need to establish what rhythm is expected and what level of detail is expected, then meet those expectations. Understanding governance is important:
- When does your partner need to be involved in decision-making?
- What level of reporting makes sense given what they need to report to their investment committees and for their internal portfolio reviews?
CEOs should remember that the operating partners all have peers and bosses who hold them accountable. They backed the investment and need to be fluent in performance matters.
As you get toward the end, how should you work with the PE sponsor to maximize return?
Open discussion with your current partner about what constitutes a good “next partner” for the company is important. Market-clearing prices and terms are important too – but if there is a choice, exploring what the best fit of sponsor for the company's next evolution has to be flushed out early.
There is more to picking a partner than just the economic issue.
You have talked about how “Data is the Great Multiplier” which I loved and has never been more topical than right now – can you expand on it?
We must be data-driven in all that we do. Remove emotion and horse-whisperer tendencies and let data guide decision-making. The more data we have, the more we learn, and the better questions we ask next. Becoming data-driven is an iterative process. Once we start the journey never stops. There is no destination in continuous improvement. Old questions answered beget new questions asked. In today’s world, don’t forget to monetize data too! Nothing better than creating a revenue stream based on creating value-add for customers that leverage the enterprise data you collect on them and their competitors!
Lastly, as a seasoned portco CEO, operating partner, and now an advisor & coach to CEOs - what advice would you pass on to up-and-coming managers who might be exploring a role at a PE-backed company?
Learn as much as you can about what PE is, how it operates, and what its needs are to better serve as a portco CEO. There is a tremendous opportunity to generate serious wealth as a CEO in a PE-backed environment. I wrote my first book “The Private Equity Playbook” to educate a generation, yet every time I give a room a basic 10-question multiple choice quiz on PE, 90% of the room fails miserably! People know the term, but little else about its internal machinations. When you truly know how $6 trillion in AUM works – you can feed it what it needs (returns for LPs) and take from it what you want (wealth)!
Adam, this has been terrific, thank you so much for the time and wisdom you've shared today. Here's to 2024!
Thanks, Connor, great to connect and share some of my experience. Go Army!
Adam Coffey is the published author of three books:
- The Private Equity Playbook: Management's Guide to Working with Private Equity
- The Exit Strategy Playbook: The Definitive Guide to Selling Your Business
- Empire Builder: The Road to a Billion
He can be reached at https://adamecoffey.com/
