After introducing this series of posts where I shared the reasons behind it and offered some insights into my approach to product management from basic principles, today’s entry aims to delve into the company’s context and share my initial impressions. Let’s dive in!
As I mentioned in the previous post, this company had been acquired by a private equity fund (PE for short) before I joined. They were also the ones who proposed hiring a CPO, which ultimately sparked this entire adventure.
I will attempt to describe my understanding of private equity funds since this knowledge is crucial for grasping the company’s dynamics. The true aficionados of private equity might forgive me, but this has been my understanding after just over a year of working with them.
For this, I will start with an analogy and then delve deeper. The business of private equity is akin to investing in the real estate industry, it involves finding a property (such as a flat, apartment, or similar) that is well-priced, in a reasonably good location, but has potential. What does this mean? Well, that you can make a few fixes in a reasonable timeframe and sell it for much more than it cost you. This image is quite representative:
With this concept in mind, we replace homes with companies and voilà, you have a private equity fund. In essence, they purchase somewhat dysfunctional companies at a relatively low price but believe can be fixed to sell for a profit. The acquired companies are generally stable, have achieved product-market fit, and with a bit of help, can be significantly improved. This approach is quite sensible when we consider the expected returns; PE funds typically seek returns that are 2-4 times their initial investment, thus the level of risk is lower compared to venture capital (VC), which looks for much higher returns as many of their investments yield zero.
Moreover, when a PE fund acquires a company, they likely already have a good idea of which company they will sell it to later, creating a ‘big fish eats little fish’ scenario that continues in a cycle that could end well, poorly, or somewhere in between.
Here, I’d like to pause and note that not all PE funds are the same; each has what is known as an investment thesis, which is essentially the criteria that companies must meet for them to consider an acquisition. For instance, a PE fund might focus on buying companies that are major competitors to incumbents in the healthcare industry with a technological component and a turnover below 25 million euros.
The typical timeline for a private equity cycle on a purchase spans around 5 years, which could be longer depending on the size, or if things go particularly well and the objectives are met, they might sell earlier. In this cycle, it is usual for the first half of the time (2-3 years) to be a period of investment, fixing the small issues and growing the company, and then in the second part of the cycle (the next 2-3 years), they streamline it to make it look attractive for sale. This is akin to bodybuilding at the gym where you need to bulk up first and then sculpt the muscles to look strong for the summer. Here, the muscle is EBITDA, as these companies are typically sold for a multiple of EBITDA, i.e., X times the EBITDA of the company.
Thus, a relatively aggressive growth is sought, hence the importance of inorganic growth through acquisitions (M&A, Merge & Acquisitions), as organic growth, the kind you achieve with your own resources and initiatives, is the hardest and most resource-intensive. Note that integrating companies is also not a minor issue, but that’s a topic for another post.
As for the income part of the profit and loss statement, if we look at the expenses side, a similar process occurs: maximum efficiency is sought by improving processes or incorporating technologies from the most Taylorist perspective, trimming as much fat from expenses as possible. And guess what a major expense item in companies is? Correct, the payroll of employees and collaborators, which leads to real social dramas in companies participated by PE funds. It’s worth noting that it’s not just expenses that are touched; there is also an influence on working capital, collections management, and much more.
It is, as my good friend José María from Tuio puts it, the game of painting the curve, hence they invest the first years so that by the time of the sale event, the charts of the main performance indicators show favorable trends.
This method of operation certainly has its advantages and drawbacks. I hope these words are not misconstrued because I am not saying they are outright diabolical (well, maybe a little bit 😈); at least the people I’ve had the pleasure of working with have seemed like incredible professionals, from whom I’ve learned a lot and hold in high regard. Another matter is how it affects the product management function and the people, which I’ll discuss in another post because I believe this approach tends to destroy product cultures. Essentially, the core idea is that everything is very short-term because the CFO is king and whispers in the CEO’s ear, so forget about extensive discovery processes and experimental tinkering in a company owned by a PE fund—you better know how to use a telescopic sight because you become a sniper. Check out this thread (in Spanish) by Javier G. Recuenco, which is quite illustrative on the topic.
I haven’t delved deeply into what aspects PE funds seek to remodel and reform in the companies they buy, as it greatly depends on the fund, the company, the industry, and its competitive dynamics. However, there is a common pattern: they apply a hot patch to the management layer of the company, conduct a management upgrade, and often make high-profile signings with a good incentive plan for managers (for example, 10 years’ worth of a manager’s salary in a good case) after the company’s sale. This ensures that the executive committee has a lot of skin in the game to guarantee the success of the operation and significantly influences the interpersonal dynamics within the organization, especially from the top down among various departments.
For all those wondering, yes, my salary was reasonably good (not spectacular, but I consider myself privileged), my incentive plan was also quite favorable, and no, I am not wealthy, as I did not stay long enough for the vesting to complete, which means you start with 0% incentives and as time passes (or other conditions are met), you convert those incentives, 10% every six months, for example. But let me tell you, I left before any of those incentives materialized because, as the saying goes, if your principles don’t cost you money, they are merely opinions.
This management upgrade is what led me from being CTO and Head of Product at Goxo, a story I will share another day, to being CPO at Nalanda Global, a company owned by a private equity fund, whose adventures I will continue to share in upcoming entries of this series.
In summary, working in a company owned by a PE fund has been an eye-opening and enriching experience that has allowed me to appreciate both the efficiencies that these dynamics can introduce and the challenges that can emerge, particularly regarding product culture and short-term management. While PE funds aim to optimize and enhance the value of companies for significant returns, it is also crucial to consider the human and cultural impacts of these interventions.
This experience has taught me about financial structures and strategies and also about the importance of balanced management that weighs financial needs against human needs. This duality is something all professionals should consider.
Have you had experiences with private equity funds? Does your vision align with what I’ve described, or has it been different? I am very eager to hear your perspective and learn from your experiences. Would you consider working in a company owned by a PE fund? What factors would encourage or discourage you from doing so?
I invite you to share your thoughts and experiences with me to help shape a more complete understanding of what the involvement of private equity funds means in our industries.