Private Equity Deal Making: The Psychology Behind the Deal

There’s no question there are certain predictors in any deal making process that can either enhance or erode the success of a deal. Generally speaking, that’s why the due diligence process is key — both for investors as well as the portfolio companies that they’re acquiring or investing in.

And while the due diligence process is largely a positive experience (wherein evaluations and background checks have been proved to be highly predictive of a team’s future success), not all deals pan out. Some fall apart before they happen, primarily because of red flags that may come up during this process.

That’s why an increasing number of private equity investors are taking a more nuanced approach to investing — they’re finding companies with strong management teams to better ensure there’s a seamless fit between their own firm’s working style and approach to business. Instead of focusing primarily on financial and operational due diligence, investors are interested in getting a sense of the people behind the company they’re investing in.

All in all, it’s about ensuring both the investor and its investee are making the most of their relationship and maximizing their partnership throughout the entire lifecycle of the deal.

That’s where the folks at Kilberry Leadership Advisors step in. As a team of industry leadership experts, they regularly work alongside investors to assess management teams to help their clients evaluate what type of people they’re investing in, from a psychological standpoint. Essentially, Kilberry steps in at the due diligence stage for two general purposes. First, to identify any red flags such as a lack of motivation, wherein the management team’s company thesis or growth plan appears great on paper but does not reflect the team’s spark or ability to execute in the way the PE firm needs them to. Or second, to better help the investor work with their portfolio company’s team, depending on what their dynamic is like.

Kilberry recently published a study which takes an in-depth look at the psychological aspects behind private equity deal making, to understand the view from both sides of a deal and the perceptions of both the buyer and seller to see where they’re working well and where there are gaps. The study emerged from a demand to identify the discrepancy between what buyers and sellers are looking for in a deal.

The study interviewed 50 private equity industry executives – 25 managing directors at PE firms and 25 members of management teams at portfolio companies – to learn about their methods of assessing and partnering with each other. Here’s what we learned:

Finding #1: Due Diligence

Both private equity investors as well as portfolio companies find the due diligence process to be effective.

PE: Investors Are Looking For Big Thinkers

Data suggests that investors place equal emphasis on the operating model and the product or service offering as they do in evaluating the management team, which indicates that investors find all three of these facets of due diligence equally important. They’re looking for CEOs who are open to input — a highly important quality of a successful leader.

In evaluating management teams, investors are also looking for CFOs and COOs to have strategic experience, not just controller skills. In many cases, CFOs or COOs of portfolio companies have been with the company from inception but don’t necessarily have the strategic skillsets investors are looking for. Investors are looking for executives who are the ​“big thinkers”, and not just the doers.

Portfolio: Execs Enjoy Getting to Know Their Investor

Sellers are also doing their due diligence and it’s not just the investors who’re executing on this process. In fact, a primary consideration for the portfolio company is to get an understanding of the investor’s sales and networking aptitude — a criteria sellers evaluate as high on the totem pole of needs.

In addition, portfolio execs are also heavily invested in the process their investors take in getting to know them. What’s interesting is the enjoyment the management team gets from this experience. They don’t view it as scary or intimidating, but instead very much appreciate the effort from their investor to get to know their management team on a personal level.

Finding #2: Walking Away from Deals

According to data from Kilberry, while PE investors are more likely to walk away from a deal (44%), a similar number of portfolio companies are likely to do the same (36%) if they feel the due diligence process uncovers any misalignments between both parties.

PE: Management Team Lacking Certain Characteristics

In cases where investors have walked away from the deal, it’s almost primarily a result of the portfolio company’s management team missing certain characteristics and skills: leadership skills, motivation, and/​or both.

Often investors end up leaving a deal because they felt the management team don’t have what it takes to lead the company through the level of growth that they’re keen on seeing. The company may have a good growth strategy on paper but are missing the unique personality traits required to execute on said strategy.

Portfolio: Misalignment of Values

On the portfolio company side, a similar number of CEOs have walked away from a deal for a few reasons — all of which direct back to the investor’s way of doing business.

Some portfolio companies say it’s a simple misalignment between their own team personalities and values to that of the PE firm’s. In addition, the deal team often wants to maintain a high level of control over the day-to-day management responsibilities (i.e. hiring and firing of staff, etc.), and many execs aren’t prepared to let investors have that level of involvement. Many portfolio companies want to maintain a high level of independence and autonomy.

Thirdly, many portfolio execs want to ensure their investors have experience in their industry, and often times walk away from a deal as a result of the industry being unfamiliar grounds to the investor.

Finding #3: Post Deal Relationships – What Works Best, What Doesn’t

Understanding the psychological aspects in both sides of deal can help investors and portfolio executives make informed, proper choices in an effort to eliminate future pain points.

PE: Deal Flow Opportunities and Connections to Synergistic Businesses

If a deal with a portfolio company is a success, many investors say they benefit from the deal flow opportunities that follow, and the connections that are made with business opportunities in similar areas.

Portfolio: Improved Management Techniques

Some portfolio companies have struggled with the level of involvement that investors like to have in the day-to-day company operations, whether it be working with the company to help them scale, cutting down costs to reduce the bottom line, or the degree of rigour around reporting. Both investors and portfolio execs have indicated ​“cost cutting” as a pain-point in the relationship.

But most portfolio execs say they’re happy with the level of support their getting in terms of input on personnel issues and other day-to-day management and operations. Many portfolio companies enjoy and appreciate this level of involvement and benefit immensely in terms of improving their own management tactics and techniques.

In some instances, portfolio companies indicate the need and desire for more involvement in two areas: assisting in the development of the company strategy and support in regards to sourcing potential partnership opportunities.

To read the full report titled A View From Both Sides: How PE Firms and Sellers Can Form Wise Partnerships, click here.

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