A Conversation with Private Equity Leader John Schweig
“I’m pleased to announce that Mario Brothers Capital has just invested in our company,” the CEO announced. “We’re delighted that Mario Brothers recognizes our long track record of success, and we’re looking forward to working with them to drive the next phase of growth and profitability.”
Any ownership change can strike fear into the hearts of distribution employees. Selling to a PE group, however, often brings with it a unique set of assumptions:
- We just got sold to some strange new type of investment firm I don’t understand.
- The CEO and management team will soon be fired.
- Our new owners will care only about short-term profits and not people.
- The new CEO will slash and burn through our P&L.
- We’ll be sold again within three years.
- This place will never be the same as it was in The Good Ole Days.
Private equity isn’t new – even if it’s new to you. Arguably, PE as an investment method has been around for more than 100 years. If you want a great overview of its history and how it works, check out this Wikipedia article (Private Equity) but if you want the straight scoop based on experience, keep reading.
Having worked with several PE groups and companies within distribution, I can report that these fears aren’t my experience.However, I’ve never been part of a PE group, so I checked in with my long-time friend, John Schweig, to get his feedback on some of these concerns.
I worked for John 30 years ago at Grainger when he was the Vice President of Marketing there. After a long tenure as President of Grainger International and Grainger’s Chief Strategy Officer, John joined PE firm Snow Phipps and has served as the chairman of three large distribution companies for them. He is also on the board of two other distributors.
What to Expect When Private Equity Takes Over
PE firms sometimes replace CEOs; often, they don’t. John says: “Changing out the CEO is expensive and disruptive. Rather than investing with the thought of making a change, we look at the quality of the executive team (including the CEO) as a major factor in deciding whether to invest in the first place.”
I like it when an owner holds senior executives accountable. A poorly performing CEO in a PE-backed company can’t hang in there, delivering year after year of bad results, and face no consequences.
John notes that some PE firms partner with executives who are looking to run companies and then look for businesses to acquire. In those situations, John points out, “the current CEO is likely on the way out.”
In any case, if your firm is bought by a PE group, you can expect increasing accountability across the organization – including in the C-Suite. “PE firms are more likely to take action quickly if things just aren’t working out,” John says.
I’ve seen this, and it is a good thing. Most of us want to be on a championship team – which, in business, means you win in the marketplace, taking share and improving profitability. I have never seen a company act too quickly on low performers, even though no one benefits from delaying inevitable tough decisions about individuals who just aren’t effective in their jobs.
Finally, if there is turnover at the top, remember that exiting senior executives – and in particular – incumbent CEOs – usually get generous severance packages or in some cases, significant equity buyouts. Pirates didn’t jump over the gunwales with cutlasses between their teeth; the new owners bought the ship and have a right to name their own crew.
Will the Private Equity Group Gut Our P&L?
This is probably one of the most curious misperceptions distributors have about PE ownership. I asked John about it. Here is his detailed reply:
“It’s important to understand how PE firms sell companies they own in order to understand what’s likely to happen. Companies are sold as a multiple of EBITDA, a measure of cash flow driven mostly by profits and working capital. The multiple that others will be willing to pay is driven mostly by size and growth. So the PE owner is riveted on the profitability and growth rate several years after they purchase the business. The last thing they can afford to do is leave the business gutted and without growth prospects when it’s time to sell.
“With that in mind, they will reduce excess costs in areas that aren’t helping to produce growth, and invest in initiatives that will drive future growth (e.g., salespeople, e-commerce, customer service, new products, new locations). Most good owners would do the same. The difference is that PE owners are not afraid to invest capital and they have a limited time window to get results. So, areas of inefficiency that the previous owner wasn’t dealing with will get early attention. Growth opportunities the previous owner didn’t see or couldn’t muster up the conviction or cash to go after will get quickly funded.
“Savvy PE firms will invest in a handful of growth opportunities at the outset, since the early EBITDA hit is far less important than making sure that one or more initiatives pays off in future growth. These initiatives will inevitably require new skills and/or increased management capacity, and so augmenting the executive team is almost always part of the process.”
This is consistent with my experience. I once worked for a $2 billion distributor owned by multiple PE groups that were planning to take us public. Just a couple of years before our planned IPO, the PE owners approved an ERP replacement for the company. This was a significant risk (ERP implementations often go south, and, in any case, they burn up a lot of cash), but it was the right thing to do for the business.
How You Should React When Your Company is Bought by a Private Equity Firm
Your PE owners are going to look for people who support the new direction (whatever it is) and sign up to help achieve ambitious goals. So, I recommend you welcome the new owners and help the business achieve its goals. If you do that, I bet that you’ll learn a lot about how to build a better company and drive more profits. And that’s a skill that’s helpful in any company you’ll ever work for, no matter who owns it.
Of course, there are poorly run PE firms just like there are poorly run distributors. It’s possible that the PE firm that buys your company really does decimate the P&L or extract too much in management fees and dividends, thus starving the company of cash.
However, that’s not what employees should expect. When a PE firm buys a distributor, employees often win in the long run – especially high performers who often wind up with more responsibility and recognition because PE groups tend to run firms as meritocracies. Some leaders earn such a strong reputation that they wind up working for multiple companies with the portfolio of a single PE firm.
John adds: “The vast majority of distributors are family-owned. Even very generous owners seldom share equity, so the opportunity for wealth creation for the rest of the senior team is limited. When we buy a business, the rewards for a wider pool of executives and managers can be truly significant. And that’s as it should be.”