A question my partners and I at Ideasphere have been getting more frequently by operating executives at our client companies is whether an acquisition by a Private Equity Group (PEG) is a good or a bad thing for them. Based on our experience with many transactions over the last ten years, our answer is, it depends on who the buyer is. Just like assessing Venture Capital (VC) firms who invest in some of our startup clients, the answer depends on the type of money the PEG represents: Green, Gray, or Red. Depending on that, an acquisition can be good, great, or a really bad thing….Green, Gray, or Red Money? Please allow me to elaborate.
· Green Money is just that: A financial buyer who recognizes an opportunity to buy an asset that will grow over time and generate returns with little need for direct involvement by the buyer.
· Gray Money is green money plus brains: A financial buyer who recognizes an opportunity to increase the value of an asset by bringing intellectual capital (their business network and access to management talent) to the table, along with real capital (their money).
· Red Money is like getting in bed with the Devil; No matter what you do, you’ll wake up with horns. Red Money is a financial buyer who recognizes the value of an asset can be increased through non-value-adding financial and operational engineering that consciously cripples the asset in the long term, but generates a short term pop in value that can be exploited for a great return.
So how do you know what kind of buyer you are dealing with? By doing some research on past transactions and their outcomes, you can identify what the “modus operandi” of the PEG generally is and reach your own conclusion. DO NOT BELIEVE THE PRESS RELEASES AND THE MARKETING FLUFF THAT ACCOMPANIES THEM. I am not in the habit of naming names in public, but I can recall a couple of situations where the press releases and the website proclamations about a particular transaction must have escaped from an alternate reality or parallel universe because they had no connection to the world we live in. What follows are some general indicators to look for that can help you identify the type of a buyer you will be dealing with. Find companies that have been acquired or interacted with the buyer and compare what happened there with the archetypes below. Even though I am a believer people and companies can change if they want to, I am also aware that a tiger does not easily change its stripes. In this case, past behavior is a solid indication of future performance.
When a Green money investor completes a transaction in a company, the most visible changes to the operating side of a publicly traded company is the exit from the public markets, the shift of focus from quarterly results and stock price fluctuations to long term consistent returns, changes in the board of directors with directors appointed by the PEG, and sometimes a new CFO or CEO. If the company was private and generally successful, there are usually Board changes to reflect the change of control, but minor changes in senior or operating management. The PEG is generally respectful of the operating expertise of the senior executive team and the operating managers are treated with respect and deference when it comes to operating decisions. The daily life of the operations group changes very little and in some cases gets better. For example, enhancements and infrastructure projects are reviewed more strategically than when the company has to worry about quarterly earnings and can get funded at a faster rate. This is usually a pattern consistent with how they interact with other companies in the PEG portfolio and stays like that as long as the company continues to experience a steady growth and meeting performance benchmarks. From a structural perspective, the debt load on the company is manageable and there are no major cuts or brutal reductions in force. Occasionally the PEG might leverage their investments in other companies to make introductions and help with sales, but that’s more associated with Gray Money. In the end a Green Money PEG is a way to shift a reasonably performing company into the next gear through the infusion of pure capital.
When a Gray Money investor acquires a company, it is generally because they believe they can bring their intellectual capital – Expertise; sometimes operating, but generally financial and market – to the table along with their money for a great return. In addition to the visible changes a Green Money investor would make, other changes may be the addition of a new division, the acquisition of complementary business, the transfer of executives from the “bench” at the PEG to the company, etc. The senior management team is frequently supplemented with more experienced executives, either directly from the PEG or through recruiting efforts the PEG initiates. The daily life of the operators changes in subtle but important, and usually positive, ways. Many PEGs will engage high end consulting companies like Ideasphere to help elevate the thinking and execution capabilities of the executive team. The results are usually a fresh look into the way business is conducted and an infusion of “outside thinking.” Also, PEG analysts are generally more sophisticated than the company in-house staff, if there are any, and they demand a more nuanced reporting with a significant eye on financial performance. If the CFO and the finance team are not up to par, they are usually replaced or supplemented and the operators are expected to understand and be able to describe the financial performance of their operations. “Finance for the Non-Financial Manager” is a most sought-after self study course by the operating executives. Gray Money is a solution to a company stuck in low gear without enough real or intellectual (management) capital to get through the inflection point.
When Red Money comes knocking on your door, be afraid, be very afraid. Just like other sources of capital, Red Money PEGs can show up when a good company is in distress through some unfortunate circumstance, like running out of capital at the wrong time in the liquidity cycle, or can come out of nowhere with an offer. The timing is not important. What is important is to recognize Red Money PEGs and understand the implications. Red Money is focused on short term returns, does not care about sustainability, has no social or ethical boundaries, and generally has no respect for operating executives. It is generally staffed by financial mercenaries, many with impressive degrees from Ivey League Universities who are experts at modeling and financial engineering, but have no operating background and could not manage their way out of a wet paper bag with a running chainsaw. When a company enters the realm of Red Money, everything becomes a short-term solution with the only objective to pretty up a company for a sale, either as a whole or in pieces. On the surface this may look something Gray Money may do, but the devil is in the details, and Hell is a sure destination because of bad intentions. Where Gray Money will strategically add resources to the company, either real or intellectual capital, and push the operations team to streamline costs to increase the value of the enterprise before a sale, Red money will burden the company with high levels of debt and push for indiscriminate cost reductions that will improve the financial metrics in the short term but are not sustainable. Red Money will issue mandates on operating performance targets with no concern for feedback on their feasibility from the operations team. Quality and Safety generally take a back seat and Red Money will generally dismiss capital projects that do not have an immediate payback and often forgo necessary investments in infrastructure maintenance and upgrades. Red Money is not a long term solution for the company and, unless comfo
rtable swimming in murky waters, it’s not a good thing for operating executives.
My partners at Ideasphere partners and I have seen all three types of investments and actively pursue working with Green and Gray Money, but after one really bad experience with Red Money (early on in our life), we have learned to recognize the signs and make it a point to stay away from those transactions. When we see Red Money coming towards existing clients, we help them find alternative capital sources, or if that is not possible, we direct them to our network of recruiters so they can get out as soon as possible.
As usual, feel free to write back with your thoughts to firstname.lastname@example.org