Case studies: How Growth Private Equity Funds Transform Companies
Growth Private Equity (PE) funds invest in late-stage companies that still have significant growth potential. Compared to venture capital firms, PEs are more behind the scenes. However, their influence on companies is significant. In total, they have 1.2 trillion USD assets under management according to McKinsey.
In the past 7 years, I had the chance to take a close look at how Growth Private Equity transforms companies by working closely with two prominent funds, one based in London and one based in New York, on two different occasions.
On the first occasion, I was the right hand of the entrepreneur who sold partially his family stakes in the company (Company One) to the PE based in London, while retaining 10% as a minority shareholder. On the second occasion, I was in charge of M&A for the company (Company Two) who just been bought out (51%) by the PE based in New York.
There are many similarities between the two companies:
They were both founder-led late-stage companies.
None of them had an experienced corporate management team or corporate governance.
They were both in transformation from startups to mature companies.
They both had more potential to grow in their space.
Both PEs had majority control.
They were both in travel and tourism.
They were both heading towards one billion+ EUR valuation.
They were both impacted by COVID-19 before the PEs' exit.
There are some differences:
Company One: strong family management footprint, centralized culture, real estate-supply-driven in the hospitality space
Company Two: strong engineering culture, decentralized management, asset-light, and tech-driven in the travel distribution sector
I have observed a common transformation playbook:
Bring in a more experienced management team
Align management interests with shareholders' interests through equity
Put in place corporate governance
Use debt to fuel growth (usually through M&As)
Case study Company One:
Company One was founded in 2003 in France to own and operate open-air vacation clubs by the entrepreneur and his father. who also owned a real estate development group. During 12 years, the company has rapidly expanded in France and Europe by consolidating other open-air vacation clubs.
The London-based PE fund took over the company at a valuation of 300M EUR in 2015. The entrepreneur was the CEO at that time and stayed as the CEO for two more years for the transition.
Four years of transformation:
Right after the buy-out process, the PE set up a management incentive package of 2% of the company's equity for middle management above to align the interests.
A new corporate governance structure was set up to separate the management (management board) from the control (supervisory board).
After two years, in 2017, a professional CEO was hired with the background of being the regional CEO of one of the largest hotel chains in the world.
In the following two years, Company One acquired three competitors, mainly financed by debt.
The PE sold also the company's real estate to pay back partially the debt and to increase the company valuation multiples (a common practice in the hotel industry).
In 2019, the first hired professional CEO didn't manage to deliver the business plan. He was replaced by another professional CEO who also invested 35M EUR when joining the company.
The PE fund fully exited the company by selling it to a larger group at a valuation of 1 billion EUR in 2022. The total holding period was 7 years in line with PE industry practice with an annualized return of 18%.
Case study Company Two:
Company Two was founded in 2012 to combine and sell flight tickets of airlines that don't work together. Its technical cofounder has built the tech stack to enable the storage of huge amounts of flight data and the combination of the flights. The company has a very strong engineering culture since tech is the foundation. It had the product-market fit very early and has been profitable since then. It has enjoyed a hyper-growth until 2019. The New York-based PE bought out some existing shareholders in June 2019 and obtained 51% of the company.
Before the PE's takeover, like many high-growth companies, it was chaotic, opportunistic, lacked strategy and processes:
Many important processes were missing (e.g. annual budgeting process)
No clear go-to-market (GTM) strategy, inside the company few understood BtoC distribution.
No clear product strategy, no people strategy, no data strategy
The absence of management training for internally promoted managers led to the lack of the middle management layer
The company was hoping to fix the issue with OKR methodology but it made it more chaotic. They have also overpromoted some people to VPs and C levels, which led to the demotion of certain among them later.
Four years of transformation:
Same as the first case, right after the take-over, the PE have set up a proper board with one experienced independent board member. It established also the executive board for key management decisions. It has set up a hurdle share program to incentivize VPs above management.
It was the PE's priority to set up the GTM strategy and shift the company to BtoC for a higher valuation. It brought in an experienced Chief Commercial Officer as the first executive hire.
During 2020, the transformation was on hold to deal with COVID-19. End of 2020, it hired the CFO from an airline to bring process and discipline to the company as well as to prepare for its eventual IPO in 3 ~ 5 years.
In 2021, it hired the Chief Product Officer (CPO) to further shift the strategy to BtoC from the product perspective. It didn't work; that executive left some months later.
Sidebar, the product vision was owned by the CEO and heavily influenced by the Chief of Strategy Officer who became the CPO later. In this hiring case, a CPO who is strong in execution would have been a better fit.
The last executive brought on board was the Chief HR Officer with experience in multinational corporations. It was the position that took the longest to fill in.
This completed the executive team transformation, which took in total of 4 years to hire 4 of 8 of their current top management (C levels).
The more experienced executives from outside built their own teams and processes, which derisked the company with stability.
Sidebar, arguably, compared to VCs, PEs are more financial-driven. They are generally very good at hiring professional CEOs and CFOs. Hiring a capable CPO, especially in the travel tech space, is tricky for them.
We have explored several M&A opportunities. One was to acquire a major competitor in the same region, especially for its direct customer acquisition capability. But it was stopped due to the pandemic. After that, several attempts were made but either it was too expensive for the PE or the target was too risky.
Similar to the first case, the company also leveraged debt to finance its growth, raising 100M EUR in early 2022.
The second case is particular because of the degree of the executive team transformation. The New York-based PE took over basically a chaotic startup and transformed it in 4 years' time into a stable mature company by hiring new and more experienced executives. To illustrate the level of lack of strategy and process, the company didn't have a bonus policy until the end of 2022 (10 years after its launch).
In case the company goes public next year with 1.5Bn EUR, that means ~x7 / 46% annualized return, a pretty good investment pick for the PE.
Growth PE funds are very good at transforming companies through setting up corporate governance, aligning interests, building executive teams, and expanding through M&As.
It might also charge the companies' balance sheet by more debt. It could fuel the companies' growth during good times but destabilize the company when the forecast is uncertain.
And one more thing about PEs, their money is expensive. They generally require 15% to 25% of return on capital, the higher, the better.
For late-stage companies, growth PEs can be a good choice for financing or exit, but the founders and entrepreneurs need to know what they are getting into.
Be aware of what you want for your company and yourself, and then you will know if growth PEs are a fit.
Postscript:
There are financial upsides to partnering with PEs when things work. The entrepreneur that I have worked for, cashed out in total 100M+ EUR.
Create a company that works and then sell your shares, you shall be rich.