No portfolio company is the same
While most PE investors are no vampires like in the quote from Warren, they are still people. That means they are limited in what they can spend their time and attention on.
As a result of the carried interest incentive scheme PE investors rely on for their compensation, they are particularly incentivised to monitor and add value to their relatively larger investments because those have a disproportionate impact on their overall portfolio return and their personal compensation. Therefore, they will spend more of their time and effort on their relatively larger investments.
Additionally, while PE investors generally have board seats, having a seat does not equal having influence or being listened to. Typically, more experienced board members can weigh more on a conversation and can hence more easily influence the decisions taken compared with more junior board members. Our research shows that both aspects, incentives and influence, matter in terms of how PE investors steer the growth strategies of their portfolio firms.
Specifically, when a PE portfolio company is underperforming, its investors are especially more likely to push for capital investments, and against acquisitions when the PE has invested more money and has more experienced non-executive directors.
On the other hand, when a company is over-performing, we found that investors push for acquisitions and against capital investments when they have put in more money and when they have less experienced people on the board. This latter might come as a surprise to many PE investment managers — as it did to us.
Overall, PE investors should be aware that their impact is constrained by their willingness to exert effort, as well as by their influence.
Getting more influence is something they can achieve through appointing board members with sufficient experience; appointing too junior investment managers may harm influence, especially in underperforming portfolio companies.
However, senior investment managers may become somewhat risk-averse or complacent when portfolio firms perform above aspirations, and as such this might deter acquisitions. This may therefore be another factor to be considered.
A buyout puts a PE investor in the driving seat; management typically takes a minority stake. As such, managers might have to accept decisions they would not have taken themselves. Nevertheless, these decisions can enhance value creation in their company as this active involvement is also what entails the added value of PE investors.
