Published on March 10th, 2006 by Alan L Sklover
“We’re all in this alone.”
– Lilly Tomlin
ACTUAL CASE HISTORY: Fourteen years of hard work had paid off for Enrique: he’d risen to Executive Vice President of a privately-held firm that was one of the country’s largest providers of continuing medical education for surgeons. He was number two to the firm’s founder, and the only non-family member among the senior-most executives. Enrique was considered by all to be a good prospect to run the company one day. The founder, who was 64, had been speaking of retiring for some time.
One Friday morning, in a private meeting with the firm’s founder, Enrique was notified that the family had decided to sell the company to a “private equity” [sometimes called “PE”] firm, a company that invests the capital of pension funds, endowments, trusts and wealthy individuals in companies with an eye to revitalizing them so they can later sell them or take them public at a large profit. Enrique was assured that if the sale went through, he would have job security, because the buyers were intent on hiring him to run the firm for them. Enrique would also be receiving a hefty bonus – a “success fee” – if the deal closed, to encourage him to remain through the closing, and to align his interests with the family’s.
After meeting the “PE” firm’s team, who were headquartered in Boston, Enrique was convinced he was soon to have his “day in the sun.” Not only would he become the firm’s CEO, but he was being offered a share of the PE firm’s profits on the eventual resale of the company. Enrique did all he could to make the family’s sale happen, and the transaction was slated to close in a few weeks. One problem arose: Enrique just couldn’t seem to get the attention of Jeremy, the PE firm’s partner who was shepherding the deal, to discuss his own terms of future employment. Enrique was hoping to “raise the platform” he’d enjoyed these past years, with hefty increases in base salary, incentive compensation, benefits and longer-term compensation, in line with his new, CEO-level responsibilities. However, he was unable to get Jeremy’s attention, until the day before the closing.
Just hours before the sale was to take place, Jeremy called Enrique and outlined the proposed terms of his new employment: first, his salary would be cut by “only” 20%. Second, benefits and perq’s were to be lowered significantly. Third, Enrique was to be rewarded with a share of the PE firm’s profits (as they defined them) when they sold the company in a few years, provided he was still then in his job, which was not guaranteed. Perhaps most troubling, Enrique was guaranteed only one year of employment, but his contract included a three-year “non-compete” agreement. His attorney commented, “Your contract has more loop holes than a hooked rug.”
Enrique signed his new contract, the closing took place, and he did become the company’s CEO. The “ride” was not at all what he had expected, though. It just wasn’t the same company. Significant debt was immediately added to the company’s balance sheet, which was used to reward the PE firm’s investors. Expenses, including employee compensation at every level, cherished benefits and many customary holidays, were slashed. Yes, it was a different company, with different goals, and different values. While Enrique was CEO, financial constraints left him with little say or true control over how the company was operated…It was now a “portfolio” company, one that was held, first and foremost, only to be soon sold, as “inventory.”
LESSON TO LEARN: Working for a company owned by a Private Equity firm is different in fundamental ways from working for either a privately-held company, or a publicly-held corporation. Why? Because the goals, and the values, of Private Equity firms are essentially different from those you’ve likely been used to, and those you may be expecting.
PE firms typically seek to re-energize by refocusing, restructuring, reinvigorating – and then sell firms on a short-term horizon, generally 3 to 5 years. While PE firms commonly take a management fee of 1.5% to 2% off the top each year, their primary goal is the eventual payoff: 15% to 20% of profits upon sale or public offering. Their business emphasis is not on operating businesses for a profit, or even building businesses over the long haul, but on buying-and-selling businesses for a profit. And therein lie the indicators of how they’ll seek to employ you and others: low overhead, hard-driving, with a potential opportunity for eventual riches.
Those seeking or expecting to be employed by a “portfolio company” of a Private Equity firm should not analyze their likely future employment relations from any perspective but the perspective of the PE firm. And you must understand that the business you know today is not going to be the business you will work for, for fundamental change in the entire operation will inevitably take place.
Jeffrey A. Sonenfeld, Professor of Management at Yale University has been quoted as saying, “Private equity is becoming a life-stage for CEO’s. It’s something we’ve never seen before.” Perhaps the lesson to remember best is this: the Private Equity world is now attracting the “best and the brightest” of the corporate world . . . that’s who you’ll be negotiating against.
WHAT YOU CAN DO: We’ve repeatedly encountered these “7 surprises” that we think you should expect.
1. Limited Review Time: You can almost count on being given very little time to review and negotiate the terms of your future employment. We don’t know if it’s intentional, but almost every time we’ve negotiated employment for senior executives with PE-purchased firms, we’ve been pressured by time, with urgency at the last minute, and pressured also by the notion that “the deal will fail” if we don’t give in on critical points. A related hint: expect an onerous non-compete provision.
2. Lower Base Salary: When it comes to your base salary, you can expect two things: slim and slimmer. Private Equity firms compete with each other on overall “return on investment,” often called “ROI.” Since they commonly invest significant sums to revitalize companies, that reinvestment capital has to come from somewhere, and it often comes from your paycheck. Many times we’ve been told “compensation must be consistent with our other portfolio companies.”
3. Reduced Benefits: Don’t expect to know the details of your benefit plans, your insurance plans, your bonus plan, or any other incentive or equity plans when you “sign on” for your deal. Either they won’t yet be “finalized” or inevitably they will be changed later. You must, though, be prepared for a significant, if not drastic, cut in all such benefits.
4. New Debt: PE portfolio companies commonly borrow large sums of money for capital improvements and investor payoff. If any of your bonus, commission or incentive plans are based on company profits, anticipate that company profits will be lower in the future for one big reason: the added interest costs of new leverage on the company’s balance sheet. This commonly yields lower bonus payouts for those whose bonuses are calculated on “profits.”
5. Expect Change, Maybe Your Own: Expect change, and understand that the “change” may be your own. It’s not uncommon at all for PE firms to hire “turnaround consultants” to advise on their refocusing, retooling and restructuring efforts. Even if you have 15 years of experience with the company, you may be asked to leave. In fact, chances are you may be asked to leave because you have 15 years of experience with the company.
6. Solicitation of Investment: Don’t be surprised if you’re asked, pressured or even required to invest your own money in the new company. This is especially common for long-tenured executives who are entitled to a large cash payout on the closing of the purchase by the PE firm. Some PE firms require that a percentage of salary be deferred as an investment. It’s all a matter of your – and their – cash flow.
7. Carefully Watch the Dealer’s Hands: Your future “pot of gold” may not be quite as golden as hoped, and it’s possible it may never even arrive. First, the definitions and calculations of “return on investment” or similar expressions may be very subjective, and may serve to diminish your share of their returns. For example, the ROI may be calculated to first deduct all sorts of financial items that you wouldn’t likely expect. Likewise, your entitlement to share in the eventual return on investment may be entirely dependent on your employment on a certain date. If your employment contract doesn’t guarantee you any job security at all, you may not be around long enough to collect your “prize.” Lastly, there are many who believe a “bubble” of sorts is developing in the prices being paid by PE firms for the companies they’re all competing to buy. This doesn’t bode well for eventual payout terms.
The Private Equity world is a very freewheeling world. It is entrepreneurial, competitive, hard-driving, and unforgiving, in part because it is both numbers-oriented and short-term. Employment in the PE world is not likely to be what you’ve experienced before in either publicly-held or privately-owned businesses. And for that reason, it presents its own challenges.
Our “7 Surprises to Expect” list is not exhaustive, but instead describes the “surprises” we’ve encountered with most frequency. Every person, every circumstance, every opportunity and every challenge is unique, and must be treated as such.
SkloverWorkingWisdom™ emphasizes smart negotiating – and navigating – for yourself at work. Transitioning from one job to the next requires more thought and consideration than most believe. But everyone should know that more than luck is always necessary. It always takes care and prudence to avoiding costly errors and mistakes.
Always be proactive. Always be creative. Always be persistent. And always do what you can to achieve for yourself, your family, and your career. Take all available steps to increase and secure employment “reward” and eliminate or reduce employment “risk.” That’s what SkloverWorkingWisdom™ is all about.
*A Note About Our Actual Case Histories: In order to preserve client confidences, and protect client identities, we alter certain facts, including the name, age, gender, position, date, geographical location, and industry of our clients. The essential facts, the point illustrated and the lesson to be learned, remain actual.
Please Note: This Newsletter is not legal advice, but only an effort to provide generalized information about important topics related to employment and the law. Legal advice can only be rendered after formal retention of counsel, and must take into account the facts and circumstances of a particular case. Those in need of legal advice, counsel or representation should retain competent legal counsel licensed to practice law in their locale.
© 2011, Alan L. Sklover All Rights Reserved. Commercial Use Prohibited. [Attorney Advertisement]
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