Many private equity firms live by the axiom, “I would rather have a C product and an A management team than an A product and a C management team.”
The quality of a management team is essential in both investment and buyout situations. In the former, the management team’s experience and abilities are greatly scrutinized and can heavily influence an investment group’s decision to invest or not.
The investment group will base its judgment on a number of factors, including management’s ability to formulate and execute the company’s strategic plan –establishing internal controls and financial functions, researching, developing products or services, maintaining margins and overseeing operations. The management team also has to be open to new ideas and working with an outside group that has influence and input into macro decisions and strategic direction.
Regarding a sale or buyout situation, the management team is important because the buyout group may want to keep key members of management or ownership with the company for a certain period. That period could be as little one year or as long as the person wants to stay. Sometimes these management agreements are referred to as golden handcuffs.
Some buyout funds are opportunistic and look for distressed situations in which a poorly managed company has an underlying strength. And there are private equity firms that build their business models around management team buyouts or investments. These firms have a stable of senior executives (or know where they can find them) on the sidelines that have specialties in certain industries. The private equity firm will seek out transaction opportunities that fit its management team’s core specialty, then buy or invest in those targeted companies.
At young companies, many executive teams are creative and entrepreneurial but lack operational expertise. In this case, it is important to round out the team to become more attractive to an investor or buyer.
A good example can be found in the academic world. Many colleges and universities have research departments that are constantly creating new technologies and ideas in all fields. These new inventions and ideas are great, but these departments also need a team to commercialize the idea and capitalize on market opportunities.
This area in universities is called technology transfer. Some of America’s finest institutions, including Stanford, MIT, Harvard and Michigan State, have sophisticated practices in place that allow investors the opportunity to identify and capitalize on such opportunities. Once opportunities are identified and seeded, the management team becomes critical. It is important to not just have creative people who formulate and create ideas but also to have executives who can carry out and execute a plan.
For early stage companies, the management team must be able to multitask and have the ability to do many jobs. Due to budget constraints, new management team members may not be added until capital is raised or cash flow becomes positive. Angel investors or internal funding may be needed before a company is positioned to be attractive to an outside institutional investor. Often, the institutional investor will have human capital (besides equity capital) to offer, as well.
The management team is one of the most important factors that determines whether or not a company receives investment capital. If you’re having trouble finding investors, take a look at your management team and see if it needs improvement.
John Bintz is founder and president of Apple Tree Investments Inc., an investment bank dedicated to middle market transactions. The firm raises growth equity capital, sells middle market businesses and assists entities with strategic business planning. Reach him at (312) 243-9694 or [email protected].
