Private equity firms are groups of investment professionals who must jointly agree on how to deploy the capital and resources of the firm. What kinds of firms come together to make good, informed decisions?
In the first of a three-part series about investment decisions, three experts discuss the culture of collaborative investing that must be in place at a private equity firm in order for it to thrive. Richard Lawson, Managing Partner and Co-Founder at Huntsman Gay Global Capital, Douglas Londal, Managing Director at New Mountain Capital and Daniel Galante, National Managing Partner of Transaction Advisory Services at Grant Thornton, share their views about the ingredients for deal success. This is required viewing for anyone who wants to better understand key differences between private equity firms.
Topics discussed include how LPs scrutinize investment committee procedures, the innovative ways that leading GPs build consensus and collaboration within the partnership, how disagreements are resolved, how the ideas of younger professionals are integrated into decision making, how to avoid creating “fiefdoms” within the firm, and what compensation model is “so dangerous” for the health of a firm. The segment also includes an expert Q&A With Galante of Grant Thornton, the sponsor of this thought-leadership series.
David Snow, Privcap: Today we're joined by Rich Lawson of Huntsman Gay Global Capital, Doug Londal of New Mountain Capital, and Dan Galante of Grant Thornton. Gentlemen, welcome to Privcap today. Thanks for being here.
We're talking all about the importance of taking a view of the world before you invest and how that tends to lead to better deals. I'm very interested in how a group of very smart but different individuals at a private equity firm might actually be able to arrive at, number one, a thesis of where in the world they want to invest, and number two, on a specific company they want to invest in. I'm going to guess that it's not always the hallelujah chorus or whatever you want to call it, a total majority opinion, so how is it that a culture develops at a private equity firm to that effect?
And maybe starting with Dan, you can give us a bit of a history lesson since you've spent a lot of time in the private equity industry advising clients. How was it generally in the old days of making a group decision, and then how did that evolve to the current status that we have now?
Dan Galante, Grant Thornton: It's really interesting, and I've been working with private equity for almost 20 years now. And I think if we look back into the mid '90s and the level of founder-led, almost dominance, in an industry that was just starting to grow, there was just starting to be some capital in there. There's a lot of investment opportunities, and capital was really the king as far as the ability to make the decision.
And that's completely changed. We've seen probably two different cycles in that period of time, and today where capital is more of a commodity, it's the value add that the private equity firm, as well as the professionals supporting the investment, can add not only an understanding what they're buying, but work with the management team in their ability to help augment them and guide them to really change the growth pattern that an investment had from when they bought it to post-investment as far as the opportunity to return. So, it really has changed a lot to a level of heavy collaboration, heavy debate and challenge, and really getting to a level where there's almost complete agreement within the partners, within the firm, to be able to move forward on a transaction.
Snow: Doug, I know that you're from New Mountain Capital. There is a very egalitarian approach to idea generation. In every case-- it's called deep dive-- the people who submit an idea have their names blotted out, and then the best ideas win. How often is it that your top partner, Steve Klinsky, does not have his idea chosen?
Doug Londal, New Mountain Capital: I don't know about Steve, but I'll tell you that mine is rarely chosen. It is very much a bottoms-up approach, and what we find is the best ideas are often coming from the people who have had the most recent experience. And so oftentimes, it's our associates who have just come in from McKinsey or Bain, or working on a project at Morgan Stanley or Goldman Sachs, where they'll come in and because of that interaction that they've had on that project have a particular idea that's very focused and very timely. And so, we haven't done the math, but I would say if you weigh it, we get more ideas that are ultimately pursued coming from the junior people than we do the senior people.
Snow: And are new employees or new professionals at your firm, and are outside observers of the process, surprised to see that there is this much discussion and debate, as opposed to the top guys who know it all ramming their ideas down the organization?
Londal: Yeah, I think they are early in their careers. It is something where, whether it's the thesis or actually the underwriting decision, you have to have real intellectual honesty and you have to have alignment of incentives to actually get to a good decision. And because of that, if you've got that, I think you can get a healthy process.
But we really require and demand, quite frankly, our junior people to speak up, and often what we'll do is when we go through a transaction and we're underwriting either a thesis or a deal, we'll say, let's start with the junior people, and have them talk first and give their opinion. Because if I give my opinion, or Steve gives his opinion, or one of the senior partners gives their opinion, and then one of the junior people might have had a different opinion, all a sudden they're going to be wrestling with, well, do I say what I think or do I say what that guy said? And so, we really like to have that culture, but it doesn't take long for people to realize that speaking up is important, and actually speaking up even if it's a different point of view will gain you a lot of respect.
Snow: Rich, your firm, Huntsman Gay, is a relatively new firm in private equity. How has your firm sought to develop a culture of collaborating on investment decisions in a way that favors the best ideas winning?
Rich Lawson, Huntsman Gay Global Capital: For lack of a better term, it gave us the opportunity to create private equity 2.0, so we were able to build from the ground up. And I think so often in many years past, we've seen in private equity, in a lot of cases, fiefdoms form within organizations championing certain investment ideas or certain directions, strategic directions, for those firms.
I think for us, as we built our organization, the first thing we did was we said we are all going to find partners that have known each other on average less than 15 years, So you really knew who your partners were in the trenches with you. When you had to make that difficult decision, you were able to do that. And quite frankly, that also translated to the type of GP governance terms that are really critical. When you're in a situation like that, and you have partners, and you're trying to make decisions, one partner can't veto an investment decision too. That begins to make a difference, but I can tell you just in our experience together as a partnership, we've never been a situation where we didn't do everything by consensus and collaboration.
Londal: Yeah, and that trust is so important. If you don't trust the people around the table who are giving you the information on the investment on which you're trying to make a decision, you'll have a dysfunctional outfit. And then behind that, we really think you have to have an alignment of incentives. And what I mean by that is-- to the point of not having fiefdoms-- it's important that every person around the table is going to be investing equally and participating equally whether it's their deal or not. Because there are cultures out there where you get paid based on what you bring to the table, or you get carry based on what you bring to the table, and the problem with that is there can be a little bit of, I'll tell you what, if you approve my deal, I'll approve your deal.
And that is so dangerous in the investing business. Investing is tough enough. If you think about how we make decisions, every investment decision is generally on the margin. If it was an easy decision, then somebody out there is going to pay more. And so generally, every investment decision we make, reasonable people can say we shouldn't do it or we should do it, and so you really need to know that the people around the table, one, you can trust, two, are going to participate the same way you are whether they're leading the deal or not, and three, that that intellectual honesty is coming out.
Lawson: It's interesting, because as Doug mentioned, if you were to look at and graph against this emerging managers, billion dollar plus type of new funds, what you'll find-- when we raised our most recent vehicle, which was a billion dollars of outside capital, we committed $100 million of our own money against it. So to Doug's point, there's a total alignment of interests. The percentage of our own partnership's net wealth, as well as our employees, is much higher than it has been in previous years, I think, in other fund situations. And so that is a theme that is happening, and you're seeing it increasing.
Snow: Correct me if I'm wrong, but I'm sure it's a little bit more fun when you're trying to make an investment decision and everyone sort of agrees that, yeah, this seems like a good idea. But what happens and how do you work through when either one partner or a number partners vehemently disagree with some aspect of either an investment thesis or a specific opportunity? How do you work through that? Are there formal processes in place? Is it just more of a pow wow? I mean, how do you approach it?
Londal: If you get to the formal processes, you probably know which way it's going to go, which is not get approved. We've never had it where it came to the formal processor vote. We've had lots of very, very long discussions, and I can't think of a person in my firm that I haven't had a strong disagreement with about a particular thesis. That's just how it works.
It generally tends to be a little more energized when it's about pulling the trigger on underwriting a deal as opposed to a thesis, because people can say I agree with the thesis, or, well, I don't quite agree with it, but it makes some sense, let's see if we can find a good opportunity. But when you're underwriting a deal, and you're actually committing firm capital-- and to Rich's point, we're committing our own capital, because we've all got capital in the business-- those conversations get a lot more energized.
And the important thing is you've got to dispense with the senatorial courtesies and just have honesty and respect, and every one of these people who you have the debate with, ultimately you've got to be able to say, we're going to debate vigorously, we're going to either agree to disagree, or we're going to come to a conclusion or modify the deal, and then you walk out of the room and you're working on the next thing together. And if you don't have that kind of environment, it makes it hard for it not to be personal, and you can't have it get personal in these sorts of things.
Lawson: Not too dissimilar from Doug as well is we take a three-phased approach to this. So you give people the opportunity to have numerous chances to actually raise concerns. So the way we look at it is we always have two partners on a deal, so two partners are always championing an opportunity, and we call that phase one. And they'll grab a firm resource. They'll present that to the partnership and say this is why they think this is a compelling investment opportunity.
When we actually can get that to a place where they've signed some form of agreement, an LOI with a business seller, that moves into a phase two where we haven't actually started turning on third party dollars with our accounting team and our lawyers and our advisers, but we're spending an inordinant amount of effort internally with a much larger deal team.
And finally in phase three, which is your last chance to put that out there, you're actually spending real third party dollars. And in all those cases, it gives the organization complete transparency and visibility on what each of those deal teams are doing, because on any given week, we're probably looking at three, four, five, six different transactions, although ultimately at the end of the day, we're probably only doing three to four a year, much like Doug.
Londal: Yeah. That's so smart. And there is a range of different ways that investment committees operate, and the one extreme is what I'll call sort of the Supreme Court model, where nobody hears anything about it. You come, you have your opportunity to present, and everybody's thumbs up or thumbs down.
Our approach is very similar to Rich's, which is starting all the way back in the thesis process, you've got people who are giving views on whether or not they like it. When you actually have a process that starts to come to fruition, you have multiple meetings with people all the way through the process so by the time it comes to the decision, you know what everybody's objections are, and hopefully you've had a chance to go back and answer them.
And that just gets to the collaboration. You want to hear the objections. The objections generally you want to understand, because maybe you missed something. And so it gives you a chance to actually go back and do the research against a particular question, figure out whether or not the valid point was raised, and if so, how do you modify things?
Galante: I think what's really interesting that we're hearing here is the level of sophistication that has really been built into the private equity industry as it's matured over the years. And the two processes that both Rich and Doug has explained is very similar to what we're seeing with a lot of clients that we work with, where we're just working with them earlier in the process, but the level of openness, the level of collaboration, and the decision making process is much different today. And it's really essential to be able to effectively pick that right opportunity and how you're going to deploy that capital in today's market, which is changing, is much more competitive than ever it's been.
Snow: How much of this process, the final crunch time decision making, are LPs interested in? In performing due diligence on the next fund, do they want to see these logs? Do they want to understand what the investment committee process is like?
Londal: They do. And similar to the conversation we just had, the questions around an investment are usually pretty apparent. It's the data that really drives the judgment that is the harder thing to really come up with.
So we will similarly lay out all of the questions, and usually early on in the process, and say here the 9 or 10 things that are the very important questions we need to answer about this investment to come to a judgment of whether or not it makes sense to do. And then in each progressive meeting, we'll lay those questions out and give a little bit of a green, yellow, red as to whether it's trending positive or negative, and if so, why.
And so, just that progression of making the decision through the process is something that we do document. We don't document it for the formality of it. We document it more for the organization of letting everyone who's not on the team understand and really be up to speed with how we're thinking about these sorts of things. But when it comes to fund raising time, the LPs want to see, really all the way from the beginning of the process, let's understand how you thought about the theses, let's understand how you laid it out, what research you did against it. We'll talk through generally what the process was for getting deal flow, but then ultimately, when it comes to an underwriting deck, they'll want to see all of the decks and all of the paperwork around that as well.
Lawson: We'll actually do breakout sessions with our larger LPs, our advisory board. So in addition to the annual meeting, we will bring folks in and put each of our various portfolio companies in separate rooms, and allow them to rotate through and meet the actual investment team, from the analyst associate all the way up to the partner, the team that made that decision on behalf of the firm, and really talk about what the investment thesis was, how it's gone so far, and quite frankly, what is the plan? And we've found that that's been very, very helpful in educating. Again, introducing even more transparency in private equity.
Snow: All of the firms here are the very pictures of excellence within private equity, but I want to ask if you could identify some telltale signs of a team of GPs that is not fully functional, or maybe it shows signs of dysfunction, what would those signs be as far as trying to make group decisions? Without naming names?
Galante: Tough question. I think it goes back to what Doug said earlier as far as the ability to re-attract capital. And the limited partners in today's market is much more competitive as far as where they're going to place their capital, and they're doing much more thorough and comprehensive due diligence. And where there's not consensus and where the partners don't trust each other, that really comes out in the field when you talk to people, and it comes to the table right away. So I think we'll see, as we're replenishing essentially the capital that's been invested over the last five or six years in a delayed cycle, how certain funds are able to and how certain funds aren't able to re-raise
Londal: And I think if you've got to the benefit of actually being in the four walls and being a fly on the wall in the partnership, I think you can tell just by whether there's second guessing that goes on. Because generally, through this entire process, once the decision's made, then it's everybody going forward, and there's not any, well, gee, you missed plan this week, and so you shouldn't have done that deal.
So I think a sign of dysfunction could be that second guessing. If you don't have the luxury of actually being in the four walls, I think an external factor to look at-- and I think LPs look at this-- is retention. Which is if you've got a partnership group that's been cohesive and has worked together and stayed together for a long period of time-- this gets back to Rich's point earlier-- you generally have a level of trust and a level of functionality within the decision making process that allows people to continue to be very comfortable investing their own capital in that process. If you don't, you tend to see turnover in the partnership.
Expert Q&A With Dan Galante, National Managing Partner, Transaction Advisory Services, Grant Thornton
Privcap: How does Grant Thornton help its private equity clients make better-informed investment decisions?
Galante: It starts in a number of different ways. First if we think about the identification of the investment thesis and the help that we could provide with our 800 partners and managing directors and 6,000 professionals and the knowledge that we have into not only industry sectors but deep into different sub-sectors of companies they may be looking at and areas they want to focus on, and bringing data points together to be able to help challenge their investment thesis and corroborate some of the things that they're looking to move forward.
And we take that into the valuation of a company from a diligent standpoint-- a blend of both commercial diligence-- how the company's positioned in the market-- financial and business diligence-- the actual performance that the company is doing today-- blend in operational diligence-- the capabilities of based on what they're doing today-- how sustainable is it, but more importantly, what opportunities are there to be able to grow at post acquisition, and then of course, including tax from a structuring as well as diligence standpoint.
Privcap: How does your firm help add value after the deal is done?
Galante: We're able to leverage that knowledge and those insights into helping co-develop with the management team and the private equity investor or the board post transaction, a 100-day plan. And that 100-day plan is going to be how do we then help transform the company, and augment management, and augment the capabilities from a functional standpoint that the private equity firm really has in-house to accelerate the value creation process.
Privcap: Talk about how you build relationships with GPs via a _single point of contact.
Galante: A single point of contact is going to be able to provide access to all of Grant Thornton's solutions and ideas across the firm and across the country.