What no one tells CEOs about private equity – top tips from ECI Partners

The world of private equity (PE) can be confusing, even for CEOs that have been through the PE deal cycle before, so, ECI Partners, the leading mid-market private equity firm, has decoded rules, incentives and common terms to provide clear explanations of how the PE world works.

Here are the company’s top tips on topics that can catch CEOs and management teams off guard during PE investment cycles:

1. The CEO-PE dynamic: It’s not about pleasing the investor

Many management teams assume that post-investment their main job is to keep their private equity backer happy, but this can actually create a misalignment, as successful partnerships are built on transparency, robust challenge, open debate and mutual respect. The dynamic in a good PE relationship is not parent-child, it is partner to partner. Shared alignment on increasing value is essential, and with a typical three to five year investment period, short term issues or targets are not as important as the right direction of travel and this is only achieved through transparency and shared growth focus.

The growth plan made at the start of an investment is rarely identical to the one at point of exit (Covid, Brexit, tariffs and the mini-budget were all curveballs for example), so it’s important to use the skills of both operators and investors to build better businesses over the medium to long term.

2. The J-Curve: Why things often get tougher before they get better

Post-investment, founders, managers and shareholders would ideally like a straight or accelerating line of top and bottom-line growth. However, experience shows there is often a J-curve before growth, because performance can soften after a deal, due to the distraction a M&A process can cause.

The journey is rarely linear, and CEOs need to focus on the long-term prize, not just the first few quarters of performance. PE partners understand this and have seen growing pains before over multiple entrepreneurial growth journeys. While the sector and context may vary, the challenges are often similar, such as talent acquisition, internationalisation, establishing systems, scaling and M&A.

3. Positioning and multiple arbitrage: Value is more than just numbers

How a PE-backed business business is positioned can matter as much as its growth metrics. A high multiple, which is driven by several tangible and some slightly intangible factors, is most highly correlated to a company’s growth prospects, but can also be influenced by a repositioning of a company’s strategy. This can’t just be a theoretical exercise, it has to have substance in the company’s growth plan and operational reality.

For example, Peoplesafe, one of ECI’s portfolio companies, transitioned over its investment period from a device‑led service to a modern, platform‑first tech company, leading to a successful exit delivering a 2.7x return. The business also grew substantially in its domestic market whilst expanding meaningfully in North America. The business had a great team, but that strategic repositioning enhanced its prospects, resulting in a multiple that better reflected its enhanced growth prospects in the markets within which it now operates.

The key factor is where the business sits in its market and its future prospects. The clarity of vision and market positioning ensures that a business is seen in the best possible light by the market.

4. Sweet Equity: The most misunderstood (and lucrative) PE incentive

Sweet equity is a special class of shares for management, structured to deliver outsized returns if the business outperforms (so-named because the management’s deal is sweeter than that of the investors). The catch is that it’s only realised after the investors and reinvesting individual shareholders achieve a minimum return (the ‘hurdle’) – typically +/-10% a year. This reflects the private equity mindset of rewarding management teams through capital value achieved through the growth in the value of the shares of the company. This is why investors reward management teams with sweet equity rather than large amounts of cash compensation. The advantage of this is that management teams can make generational wealth through creating long-term shareholder value through profitable growth.

High management or employee cash comp, reduces profits and therefore the value of the shares and sweet equity. The sweet equity has the potential to be far more valuable over the medium term (and is importantly is taxed at a much lower rate than salaries and bonuses). What surprises many: non-founders can build significant personal wealth through multiple PE cycles, sometimes eclipsing the capital value realised by founders if the structure is right and the business delivers and / or is highly cash compensated. The rules are nuanced, and the upside only materialises if the business performs.

5. The role of the Investment Committee

The Investment Committee (IC) is the ultimate decision-making body for approving investments in private equity firms and also has a governance responsibility for the overall funds within which individual investments (i.e. businesses) sit. This can appear as a shadowy board operating in the background that gives Roman style thumbs up or a thumbs down to individual business decisions. It isn’t uncommon to hear of Founders who have had positive mood music from their deal lead, sometimes find they get turned down at IC approval well into the process. At ECI, there is an IC member involved on every deal from the outset, to avoid that eventuality. More broadly, at ECI post deal,the ECI partner on the Board is heavily empowered, so at ECI, a company’s Board upon which an ECI Partner sits, remains the decision-making forum for the business, not the ECI investment committee.

6. Does PE want to run my company?

Absolutely not! A PE fund doesn’t have the desire, experience or capacity to be involved in day-to-day company operational decisions. It’s not their job. However, as a shareholder they do want to be consulted about the big strategic decisions a business might , such as opening an international office, completing M&A, or changing the capital structure of the company.

A PE investor may have helpful pattern recognition here and can bring its experience of across multiple businesses, to help address the challenges companies can face as they scale.