This was originally published on Medium (March 2016)
Defined simply, Private Equity (PE) helps in matching medium-term capital (in the form of equity) to deserving private companies as those businesses move from one level to the next on their growth curve. In the process, PE helps deliver superior returns to its investors, which range from Pension Funds to High Net Worth Individuals.
I have been working in the Private Equity space for the last eleven years — initially in India, and recently in Australia with my current base being Sydney. During this period, I have analysed a broad spectrum of sectors (from water treatment to diamond jewellery), led different roles (from PE fund–raising to exiting majority holdings to setting up two offices) and invested with wide range of stake-sizes (from growth-minority to buyouts). I have evaluated about 400 investment opportunities, at varying levels of engagement and mostly from disparate sectors. I have closely been involved in 25–30 businesses — negotiating, investing, managing or exiting. Along this journey I have had the privilege to work with, and learn from, some of the best people in this space.
The unique thing about working in PE is the ring-side view it provides to a lot happening in this world. If you work in sector-agnostic space, you meet with some of the best founders and management teams in several industries. You learn to see the way the economic world moves fairly early and fairly repeatedly. The vantage point and view it provides is very different from many other roles in the financial sector. Lenders & bankers have this view, but they do not get to observe closely the intricacies of these companies. Advisors see the same, but they do not participate in as much of the decision-making where one in fifty companies is picked to be funded. The PE space stays one of the best places to appreciate the workings of the financial-economic world.
In some sense, eleven years may not be enough to draw life lessons. However, for me, this is a time for a sabbatical, a pause. And as I take this break, I reflect on the last decade and try to encapsulate some of the themes and undercurrents that have stayed with me over time while working in this fascinating space. This task of drawing the outline is easier done when one is away from the daily rush, from a distance, when you can look back at a longer period in greater depth and sketch out what you see. This is as much a note-to-self for future reference as to share with you what I have picked up along the way.
Lesson #1- The key asset is people. Train yourself to see them in temporal dimensions.
Private Equity sets itself a task of delivering superior value in three to five years (usually) of holding a company. Broken down for simplicity, PE returns are driven mainly by three key numbers — (1) revenue growth (2) profit margin expansion, and (3) valuation multiple improvement/ company’s perception improvement during the holding period. In case of levered deals, a fourth number is the leverage kicker. All these multiplied give you the returns that PE delivers during its holding period.
Given this context, as one evaluates companies for investments, one looks at a lot of quantitative and qualitative details — industry, business, the revenue build, growth opportunities, costs, profit margins, potential savings, cash flow, capacity, working capital, its balance sheet– all the financial and physical capacities and potential.
However, the key asset that colours all in its own shade is the people driving the business. Forced to choose between two companies with similar prospects, and similar assets, the company one would like to back is the one with a better captain of the business. Things do not always go as planned, companies mostly do not meet their projections, and in such scenarios, one is better off with a better team to steer the business forward in choppy weather and make the best of circumstances.
More often than not, in PE, one works as a facilitator and at other times, negotiator. You are often to understand people and evaluate them. But how does one evaluate people? Unlike other variables, or rather, more than other variables, people are highly dynamic variables. They are open to influence.
One thing I have learned over time, is to try to look at people in more dimensions. Not as static flat points, or as what you see when you meet them, but say, vector-like, with more dimensions, lines in space, travelling at their own speed on different paths and planes. Objects coursing their own trajectory — which have come together on the same plane (in this case, the company), intersecting courses for a limited duration of time. And when you look at them, you try to gauge their temporal history, their direction, their speed, and get a sense of their world-view.
Met at a same point in time, two CEO candidates may offer similar capabilities, but what helps to understand is what got them there, their speed, their direction. This then nudges you towards the better decision. For a moment, think of two people you know well, working in a common space, and think of their individual histories, where they are coming from, how much distance they have covered in the same period of time, what experiences they have collected over time, and the direction they are headed in. And you get to appreciate a lot of why they do what they do.
By trying to understand the world-view of all the people you meet, you develop an understanding of their reasons, their drives and objectives, their fears, and you empathise better. Then, as you meet at the table — the board table while managing a company or the negotiating table while making a deal (buying/selling/ raising money), you are more likely to arrive at a win-win outcome.
This is as much about being aware. If one can force oneself to think like this, to see people with temporal dimension, as a compilation of their individual experiences, one is more open, more empathetic, and negotiations can be better, and encounters enriching.
Lesson #2 — Choose deep over shallow. Long-term over short-term.
One of the things about most choices, decisions and investments in private equity is that you live with them for a longer period compared to other roles. Returns in private equity are heavily weighted on the exit of an investment, which can easily be three to five years from the decision point of investing. In other roles and jobs, where people work on specific projects, or the day to day, the work can be assessed annually, or from project to project. But in PE, the average decision or investment takes longer to bear fruit. It changes some of the scale perspective, and you get a true appreciation of the longer term (longer than a year). Not at the cost of the short term, but long term over short term.
Those managing, or tracking listed companies know how much focus and attention the C-suite can have on the short term — their world can sometimes move from quarter to quarter, and the day to day news cycle can affect fortunes. In such environment, big steps which might have a negative short-term impact require a lot of explaining and perception management, and a lot of boldness, and still, the market may unfairly penalise those decisions.
On the other hand, most of private equity action happens out of the public eye. One is spared the pressure of mark-to-market. Since the investments are held privately for three to five years, irrespective of one bad quarter or one bad year, you try to make choices and take actions that secure a positive long-term outcome. This guides the decisions and actions during the first 100 days or as long as you hold the investment. These actions are akin to sowing fruit-bearing seeds which you harvest as you exit. And you keep sowing seeds until you exit. The reason to do that is that when you exit, you need to show the future value to next round of investors, be it the public markets or a strategic investor or another PE fund. You sow even though you are not the one reaping. Because you are guided by the long term and not the short term.
Sometimes, this can be at odds between management and owners if the time-period they each consider is different. Part of this conflict is addressed by building healthy long-term incentives for the management team, to align everyone towards building value over the longer term.
Once you embrace the long-term perspective, it is easier to cut out a lot of noise. And there is a lot of data and noise when one evaluates investment. When you look through the longer-term lens, you read and follow deeper currents rather than fire-fight or try to gauge sense of shallow, muddy waters.
This one is a takeaway for decision-making. Do not sweat the small stuff, but think centre, think calm, and you’ll do justice to yourself and those around you. A quarter does not amount to much when you consider a life-time, for yourself or for a company, so choose wisely.
Lesson #3 — Be a Student of the Game.
David Foster Wallace wrote an inspiring piece on tennis in his Infinite Jest. He advised relentless practice, learning from all that is unfair in life, and to be a student of the game. I am quoting some of my favourite lines here:
“Be a Student of the Game. Like most clichés of sport, this is profound. You can be shaped, or you can be broken. There is not much in between. Try to learn. Be coachable. Try to learn from everybody, especially those who fail. This is hard. Peers who fizzle or blow up or fall down, run away, disappear from the monthly rankings, drop off the circuit. … Opponents. It’s all educational. How promising you are as a Student of the Game is a function of what you can pay attention to without running away. Nets and fences can be mirrors. And between the nets and fences, opponents are also mirrors. This is why the whole thing is scary. This is why all opponents are scary and weaker opponents are especially scary.”
In PE, one is expected to be a perpetual student of the game. You constantly deal with new businesses, new industries, new people. Even if you have seen a similar transaction or industry earlier, a similar stake earlier, or a similar founder earlier; each transaction and its sub-texts are different. It is always new. You might be an expert in the footwear industry, but you meet a new team in a new market, changing the way things are traditionally done, and you find yourself in a new territory. It is akin to seeing all the same chess pieces but always in a new game. You need to get in, understand the situation and play your next move.
For those who enjoy it, the ‘newness’ of the business is also its best part. One day you may know nothing about gold mining. Then you start looking at a potential investment, and in a week you have a much deeper understanding of the trade. You learn as you go. You get to hear from the founders, who are some of the best people to talk about their business and the sector, about what they have set themselves to achieve, and why. You work with experts and you learn from them. That is part of the job. You need to gain a very high understanding in fairly limited time. In such situations, what is valued is this ability to scale the curve swiftly.
Many people are expected to become experts quickly in their daily jobs. Bankers, consultant, advisors dealing with new clients all the time. It becomes critical skill in PE given that one learns from the founders and the management and then one negotiates with the very same people to buy their companies or become their partners. One is to then take decisions that set the course of the company for the future. To fare well in such scenarios, it becomes crucial that you bring your humble self to the table to ask questions and learn from the experts, from their achievements as well as their mistakes.
Another way to consider this, is that not everything always goes as planned. Despite all effort, one might end up with a bad investment. The ability to deal with it and find your own answers — whether persistence will pay off in that particular case or whether you are better off cutting your losses, is a call you take, and you learn as you educate yourself on the potential scenarios. The ability to begin anew often, holds one in good stead.
In current times, where world order changes quickly and three to five years sometimes get qualified to be called long term, what helps is having on your side people who can respond with the same pace to such changes. No one knows everything, but people have varied abilities of catching up. Value those highly, who bring with them the right attitude to deal with new situations, the ones with rigour and high intellectually curiosity.
This stays a pursuit. Training oneself and the people around to be a student of the game. Appreciating that there is a universe out there and the more you learn, the more you realise your own ignorance. This thinking helps when you build your team. This helps when you evaluate company cultures for investment. And this stays as a lesson you would like to pass on to your kid.
Lesson #4 — Ask often, “What is the Objective?”
Recently, while teaching our son to catch a ball every time it comes towards him, we struggled, trying sometimes to show him how to position his hands in ready pose; how to maintain a particular stance; how to keep his eyes glued to the ball; ultimately realising that so many instructions were not really working. Until we said, you know what, let us just step back and think for a moment what is it that we are doing here? What is the point of it all? The objective is to catch the ball. So, just catch it, and forget everything else. Work with only that in mind, and you’ll fare better.
It worked. Our son still learns and improves, as we all do, but it helped simplify and prioritise the key action. A clear focus on the point of everything that was happening.
What is the point of everything in private equity? I am glad that I got to see this first-hand early in the day. During my first year in private equity, I worked in the team which was raising what was then India’s largest private equity fund. This was in 2005. Private Equity was relatively new in India, and I was working with some of the best and most experienced in the industry. Those who have raised funds know what it entails. If you are still learning the craft (the craft of PE or investing other people’s money), there is perhaps no better place to begin your career. You begin from the very inside and you begin from the position of understanding and firmly etching in your mind that you are managing other people’s money. You raise money by explaining why you are the best people to do so and what edge your ideas have. You meet hundreds and hundreds of investors, look at their questions list, write answers to each of those questions and get an education in why exactly investors let PE earn 2% every year and 20% of the profits. You negotiate with the investors and understand what is critical to them. You learn the best practices, you witness the mistakes, and even though it is demanding, it is one of the best places to get to know what one is getting into. To understand what is the objective of it all. To this day, I advise people beginning their careers in PE to get a stint in the fundraising team where directly understand the investor expectations before they begin doing deals.
The primary objective for investors putting in money in PE stays the pursuit of superior returns by allowing capital to be matched with deserving private companies.
You evaluate hundreds of opportunities and pick a few for investment. Each company is wonderful in its own way, but one is looking for the best match — companies that can deliver returns in the available time frame. The more businesses one evaluates, one learns that even though similar on surface, companies can be vastly different in terms of growth opportunities. Imagine them charting a line graph. Though finance and models talk about perpetual growth, everything happening in the world points otherwise. So you try to understand where on the growth path the company currently is, and whether you can expect the next seven to ten years to have a reasonable growth (this period includes the future you sell to the next set of investors as well).
Choosing one from scores of opportunities is difficult. And it is easy to get pulled into deal fervour. Especially when you have spent last six months looking at some twenty companies and eventually said no to each one of them for some reason or another. May be, you actually admired one of the companies and wished to get a deal closed but were beaten significantly on value by an upstart PE fund in the market and you clearly cannot justify the proposed deal value. Eventually, the feeling starts building up that one should be closing deals and investing the un-deployed funds. Saying no all the time and getting no deal done clearly does not have the closure that a closed deal brings. Often then, people start mistaking getting a deal done as the objective. But it is not. Deal frenzy happens because people ignore the core objective.
The objective is to deliver superior returns, and you do so by picking superior companies, not just by doing deals. Getting this objective built in the filter allows you to prioritise and guides decision making. You learn to say no. You do not get pulled in doing deals for the sake of deals. You learn to hang in there even when you do not find the right deal after looking at some fifty companies over a year. You learn to think of exit before investment. And the objective becomes the guiding principle.
Lesson #5– Learn to see the wood and the trees in the same frame.
They say that what one sees is a construction of reality by the brain. Eyes see something and then brain fills in the rest on the patchwork of images to give you a consistent, continuous image of the world. It constructs reality with the available materials. Can we then say that if you could feed it more, views from multiple perspectives and vantage points, then what you see can be drawn, redrawn and coloured better and more accurately? Think of parallax here, and how astronomers use it to understand the universe around us. By using two different points, you can triangulate the third.
Most roles in PE, from analyst to partner, require one core repetitive action — the eventual build-up to a call to be taken on any opportunity. One is to evaluate companies, opportunities and try to arrive at their long term projections and potential paths while keeping one eye on the detail and build-up of every small number forming the whole. You do that daily, for each new company that walks your way and for all the businesses that you are managing & exiting from the portfolio.
There are a lot of approaches, a lot of numbers to be pondered over. Lots of assumptions about future of different things to be taken. It is easy to get bogged down by detail. But by allowing yourself the ability to zoom out, and get a bird’s eye view of the landscape, you can dive back in at the right spot. And you bring objectivity to the analysis. The flexibility is valuable, of being able to shift gears, and to keep changing the depth of perception. Seeing more intensely might be seeing more.
As T.S. Eliot says beautifully in Four Quartets,
“In order to arrive at what you do not know
You must go by a way which is the way of ignorance. …
And what you do not know is the only thing you know”
To know what you do not know. To accept contrasting viewpoints. To play with conflicting ideas in your head. Sometimes, it is about understanding that things can have two states at the same time. To look at both sides of the coin in the same view. Another way to think of this is to try to see the forest and trees in the same frame. Depth and detail, both, with the big picture.
As in PE, so in life. Training yourself to look for better perspectives, while appreciating the depth of field with a clear understanding of details allows you to perceive a more accurate reality.
To sum up,
All these are a few lessons or takeaways as I can see today. In no way comprehensive. As Nadine Gordimer in her Nobel Lecture noted about her profession, that to analyse writing while doing so would be like looking down while crossing a canyon on a tightrope. It is extremely difficult to do. I am away from the tightrope right now, and admiring the landscape. Time to stop and stare. And this is what I see.
In some sense, these life-lessons are lifelong pursuits as well, a way of thinking to train oneself in. A framework to make it simpler to take better decisions by focussing on the essentials. By seeing better and more intensely by seeing both, the forest and the trees in the same frame. By remembering the objective, point of it all, and to focus on the long term — to operate from the deep centre and not the shallow waters. There are a lot of forking paths in this life, and a lot of could-haves, but if one is able to define life’s objectives clearly and then funnel all the decisions through these filters of long term and what is the objective, one will hopefully take better decisions and be more at peace.
And then, all those wonderful people in your life — each one is a book to be read. Look at them in more dimensions. A temporal history you need to understand. Train your vision to see beyond what you really see. Value the attitude, the positive force of can-do, can-learn, can-grow they bring, and train yourself and people around you, to be a Student of the Game, always.