Underperformance.

It plagues nearly half of all CFO’s of PE back firms. According to a recent study by Vardis Partners, 39% of CFO’s report their portfolio company is underperforming the initial investment thesis. With underperformance comes exit: 70% expect to exit in 2 years, and 41% expect to sell to another PE. That’s up 11% compared to 2016 numbers.

What if you could harness the investment thesis and make it work for you?

You can, by looking into the culture of the company you’re about to invest in.

A separate study by the National Center for the Middle Market in 2019 tracked the growth rate of different types of corporate cultures. The results are eye-opening:

• The growth rate for middle-market companies generally tracks at 7.2%
• A customer-centric culture grows at only 5.9%
• While a company defined as innovative and creative grows at a whopping 9.4%
• Investing in a technically oriented company? Expect about a 9.0% growth
• Looking for a culture of continuous improvement? It comes at a price: only 8.8% growth
• Think efficiency is best? Think again, growth rates here are about 7.5%
• And, that ‘safe bet’ risk-averse company: it lags its other cultural counterparts at only 4.0%

Who can crystal-ball that kind of look into the future? The company’s customers can. We see it time and again. Customers are attracted by innovation, and they stay because of engaged employees.

The best way to gain insight into what a target company’s culture is, in fact, to ask customers. With a carefully crafted Customer Insights initiative, a company’s top customers will be able to tell you exactly what kind of company you are about to invest in. But, most importantly, they must not know there is a potential investment. Knowing an investment could occur ‘colors’ their perceptions. Tell too much that is negative and the deal tanks – no one wants to be a party to that. Be too generous and who knows what might happen, not the least of which a price increase is certain.

By conducting customer due diligence with a deep and insightful dive into customer relationships, performance and corporate culture, smart PE’s and the CFO’s they will put in charge after close will know what levers to pull once the deal is struck. Or, importantly, they will know when not to invest as the payback and investment thesis just won’t pan out.

The plan for protecting the investment thesis has to come before close. Where is growth expected? What innovation is the company pursuing? You’re not investing in the today of a company’s performance, you’re investing in tomorrow. Future financial projections are difficult to uncover in a QofE, but with customer insights, the emotions behind the numbers can be revealing. And, that’s exactly where culture comes to play.

Think about it. What kind of company growth do you want to have? What kind of company culture are you buying into?

Kay Cruse is a Vice President at Strategex. She can be reached at kcruse@strategex.com.