Private equity firms provide value to their portfolio companies beyond the initial investment. They offer expertise and, when necessary, governance. But firms are only doing half their job if they don’t mine an untapped asset – their considerable networks – to help their portfolio companies grow and scale. Fully leveraging networks is crucial to successfully managing portfolio companies, closing deals, and hiring top talent.
The Shifting Landscape of the Private Equity Industry
Private equity firms are becoming increasingly involved in business decisions that extend way beyond the moment when funds are being deposited. Firms are now consulted for expertise on expansion, strategy, and governance. For example, a recent survey by BCG found that a majority of private equity professionals see their role in portfolio companies as an expansive one; rather than focusing solely on capital, they expect to have a greater voice in key business decisions in order to boost growth. This may mean drafting or revising business and expansion plans; consulting on strategy; or governance. Portfolio companies seem to be responsive to the attention. In another survey, 90 percent of portfolio company CEOs indicated that their private equity firm had had a positive effect on their company’s performance.
Another important role that private equity firms are being expected to fill is that of bridge builders. Portfolio companies want their firms to give them access and introductions to decision makers and power players. As quoted in a Forbes article, Kevin Hudson, national managing director of Grant Thornton, LLP says, “Our survey of 217 middle-market portfolio companies revealed that just 10 percent of their private equity fund investors have made or are currently making these kinds of valuable introductions for them. At the same time, nearly 85 percent of companies consider these connections to be pivotal to their future success. It’s a disconnect, but one that is easily overcome and can ultimately yield significant upside for everyone involved.”
Becoming involved in key business decisions and depended on for introductions to influential people is all part of the evolving landscape that private equity firms must adapt to. Portfolio managers looking to expand their role and be successful in this landscape without draining all their time and energy should be pulling on one of their most powerful, if underutilized, resources: their relationship capital.
Why Relationship Capital Matters
In its most basic definition, relationship capital is a firm’s network of formal and informal connections, established over years both in and outside the industry. It’s the amount of influence an individual has, measured in terms of the quality of his or her network, and it is a critical tool to be leveraged in developing, growing, and scaling businesses of all sizes. The value of such relationships lies in an individual’s ability to circumvent usual channels and get a warm introduction or shorten a sales cycle.
Building a healthy and efficient network on which you can draw does not mean investing extensive amounts of time and energy in each individual. The most valuable relationship capital is earned when you curate decision makers and influencers across a diverse array of industries, experience levels, and backgrounds, and periodically reach out when you have nothing to ask for.
By tapping their relationship capital, private equity firms can help their portfolio companies grow and succeed in these strategic areas:
Originating Deals
Common “deal signals” – such as a startup acquiring a new investor or a nonprofit receiving a large donation – typically set the origination process in motion. Unfortunately, for most firms, this process is still laborious, time-consuming and requires substantial headcount. As Business Insider notes: “According to data from Teten Advisors, the median investor in private companies reviews over 80 opportunities in order to make 1 investment. The median private equity fund required 3.1 investment team members to close one transaction in one year.”
Do those numbers sound unsustainable to you? They are. Business Insider also notes that 55 percent of funds surveyed reported that they plan to change their origination process over the next three years, a higher percentage than any other fund process. All these signs point to one thing: for most firms, the origination process is clunky at best and, at worst, terminally broken.
Staying on top of the competition means finding a smarter origination process, and that starts with understanding the power of relationship capital. Leveraging your organization’s connections will give you the clearest and most influential path to a company’s leadership. Your deal team can get a warm, trustworthy introduction and be taking its second or third meeting with the execs while other firms are still cold calling.
Driving Growth
As previously mentioned, portfolio managers are being relied upon to inject value into their companies by guiding business expansion, either geographically or through new product development. As manager, your role is not only advisory, but tactical as well. You may draw on your industry experience in planning expansion strategy, but when it comes to actual execution, your network will be a huge asset you shouldn’t overlook. Your primary and secondary contacts can help provide both access and influence in new markets.
Your relationship capital plays a similar role in areas of growth relating to governance and operational engineering. As reported by BCG Perspectives, “CEOs see PE firms as natural partners in finance-related matters such as M&A, exit strategy, and balance-sheet management. In fact, many CEOs expect PE firms to take the lead when such questions arise. One CEO told us, ‘Our PE firm has been able to provide financing and legal expertise that we do not have in-house. We face more complicated issues than we did before the acquisition, and their expertise is welcome.’”
To successfully tackle issues of governance and operational strategy that your firm may not have in-depth knowledge on, look to the web of connections. Your relationship capital is fertile ground for highly qualified board members and advisors who can help lead your portfolio company through the lucrative, but often painful, growth and scaling periods. These might be board members at other portfolio companies, investors with a track record at your firm, former colleagues, and partner contacts. Keep in mind that these individuals are not necessarily your endpoints, but gatekeepers – they could provide you access and introductions to others who will be the expert endpoints.
Building Trust with CEOs
Making the deal is only half the equation. To be seen as a trusted advisor, it’s important to build a relationship not only with the CEOs of your portfolio companies, but also with the people in their professional networks. If the people they already know and trust, trust you, the CEOs will feel more comfortable bringing your firm in on major business decisions.
For example, imagine that the CEO of a startup spent years building a successful product from the ground up and is still very involved and emotionally invested in the company. If the CEO is undecided about whether your firm is in it for a short-term gain or truly playing the long game to benefit them, how are you going to bring her around?
One way is by using the clout of the connection who introduced you to her in the first place. Another is by tapping your relationship capital to see which other connections she’s most likely to be influenced by. You can leverage your network to gain access to these professionals, bringing them on as an advisory panel. With the right tools in place, building trust with CEOs and gaining access to their proverbial inner circles is only a matter of a little research and some effective outreach.
Recruiting Top Talent
Firms interested in the growth of their portfolio companies (and that’s all firms) should be mining their considerable relationship capital for highly talented and similarly well-connected individuals for C-suite, executive, and staff positions at their investments. It’s a free-for-all scramble to hire the best talent, and your top candidates are likely being courted by others, which means you need access. While most firms still engage in an old-fashioned hiring process, firms can take a more patient, more strategic approach to organizational growth and get this much-needed access by leveraging their networks and relationship capital.
Consider this: In a survey of mid-market portfolio companies, the vast majority of those who reported receiving staffing assistance from private equity firms found it to be very useful. Problem is, only one in five of the companies surveyed had received this kind of help. Traditionally, this sort of assistance, when it does occur, happens at the C-suite level. But increasingly, firms are becoming aware of the value of their recruitment efforts up and down the hierarchy. Now, it’s just a matter of more firms stepping up to the plate.
One way you can provide this kind of value to – and thereby increase the value of – your portfolio companies is by reaching out to your network for referrals and introductions. This not only provides a built-in screening protocol, but, once you’ve identified a potential candidate, smooths out the courting process. As an example from the startup field, when Warby Parker was courting Anjali Kumar, then senior counsel at Google, the company leveraged one of its investors, David Lee, who was also a former Google exec. Kumar states that Lee’s praise for the fast-growing startup helped persuade her to join the startup.
As Chris Redding, director of talent management at SK Capital Partners, notes over at Privcap, establishing relationships within his firm’s investment areas has allowed SK Capital Partners to “build human capital as a core competency and leverage a talent pipeline rich with individuals who possess the right skill sets and experiences.”
This is another area in which your firm-wide relationship capital is key. Look to secondary and tertiary connections, like those within your other portfolio companies. Private Equity firm LRR Partners, for example, hosts a CEO summit for the leadership of its portfolio companies, allowing members of an otherwise far-flung network to connect and potentially aid each other in the hiring process. There’s no reason this couldn’t be replicated for CTOs looking to build an engineering corps.
There’s a significant caveat here: poaching. Connections among portfolio companies could potentially lead to talent being poached from one to another. So it helps to have a clear policy established prior to major networking or recruiting initiatives. For example, while the Foundry Group, which holds more than 40 companies in its portfolio, has no formal policy in place, Managing Director Seth Levine explains that “a few of the CEOs in the portfolio have a ‘no poaching’ policy when it comes to friendly companies. That may include companies backed by the same investors (Foundry or others), or it may just apply to a few companies where the businesses have a tight relationship and the CEO feels that actively recruiting from that company would be detrimental to that relationship.”
Using Relationship Capital Software
To make the most of their organizations’ relationship capital, many PE firms are turning to online “network mapping” platforms. More commonly known as relationship capital software, these tools use advanced data analytics to visualize connections between individuals and organizations, offering users the ability to see who knows whom. These platforms are designed to help companies find, build, and cultivate connections using complex algorithms that create a very dense universe of relationship pathways. Most simply, think of it as a real-time graph of how you and your firm are connected to the entire world.
For PE firms, this means understanding the depth and breadth of the firm’s network, ranking connections by influence, and performing the kind of informed outreach that can streamline everyday processes. Specifically, firms can take advantage of relationship mapping tools that offer:
- Tremendously detailed information sets on individuals and companies
- Flexible queries within proprietary databases that can be run by individual, company, role, city, industry, educational institution, political or charitable cause, etc.
- Clear relationship pathways that map to your target(s) and reveal all connections, whether you were aware of them or not
Do private equity firms really need this type of robust software to map their relationship capital? In short: Yes. The manual, DIY process of network mapping can be incredibly convoluted and time consuming, and is never done with complete thoroughness. As this Forbes article accurately states, “One of the most effective types of strategic support a private equity firm can provide its portfolio companies can be characterized as connectivity, or facilitating relationships with key partners and experts. This is especially important for small- and mid-sized companies that do not yet have the extensive networks and relationships that larger and more mature companies have. Unfortunately, according to recent research with executives at middle-market PE-backed firms, this type of purposeful network expansion is not especially prevalent or implemented as effectively as it could be.”
Private equity firms can easily and effectively implement and leverage their networks with relationship capital software.
For private equity firms, maintaining a competitive edge is about more than fundraising and analytics; it’s also a matter of relationship capital, or the strength of their professional relationships and connections. Every advantage counts and that’s why the smart money is on firms that invest in relationship capital solutions. These tools can help firms access decision makers, build solid relationships with portfolio companies, and recruit the most sought-after candidates.