Episode 90 – Private Equity, FOMO and Insecure Founders

MARCH 15, 2023

We are witnessing a temporary lull in private equity and V.C. investment in consumer brands. It won’t last, in part, because funds have too much dry powder on time clocks set by Wall Street LPs. They simply have to invest the money or it will be taken back and deployed elsewhere. 

Wall Street hasn’t stopped piling up these funds is my point. 

And Wall Street does NOT like un-deployed cash any more than your personal financial advisor, which, in my case, is me. 

So, probably later this year, deal making will accelerate. At least my PE sources tell me so. 

And so the craziness will start all over again, especially in the $50-$100M revenue range (that’s company revenue, not cash register sales). Otherwise known as the lower middle market. 

The one thing I’ve observed in my own client base (which sells below $50M annually on their books) and in the broader ecosystem is that well managed businesses with decent gross margins and highly efficient, fan-based acceleration don’t always need institutional investment at all. Dude Wipes. Skinny Pop. Seed money? Sure. Angels continue to help out here.

Generally speaking, my take is that PE actually doesn’t have access to the best of the best businesses folks. They work either with financially stressed growth companies OR ones with incompetent/insecure founders. Oops. You’d think a smart consultant would not display anything like a critical  judgment toward his client base. Well, I guess I’m stupid, then. Or just a bit too honest. 

The first group, the financially upside down businesses, are not hard to find. Most fast-growing CPG brands are negative EBITDA until they reach $5-10M. The private sector is wild, in part, because even smart folks focused on growth or on operational complexities can lose track of financials without strong governance in place. I didn’t set aside enough money for my April tax bill, for example, as my own business doubled. Oops. This is a punishment for pessimists like me I guess. 

Smart PE invests in manufacturing today, not just a brand asset. Because most consumer brands grow off of product-driven attributes, unlike Liquid Death. And many consumer brands will need substantial tranches of money to grow capacity if they are growing fast. No matter the category. 

The thing here is –  very fast growing brands that have their own production process requiring rapid capacity increases may need to raise sums larger than the local Chase branch will offer on a commercial loan.  And  institutional investment firms will write a big check with less due diligence than your local Chase bank branch. Yes. This is the temptation. The cocktail party at ExpoWest temptation. And they will probably write a very big check with just as much due diligence as Chase either.

But, honestly, it’s very possible to plan capacity upgrades gradually enough on a well-run business to spread your investment needs over time. And, PE firms are notorious for using your $8M real need to get you to take $30M from them and give them that much more Board control and stake in the business. It’s a game of puffing up your need into a sum they need to deploy. They love to raise the amount in a perverse kind of way. 

And this is where founders without a Jedi mind gets into trouble. They take stupid terms because the money is a) finally here or b) coming in too good a package to be denied.

And some founders also really get into the badge status of being a ____ portfolio company. Sorry, it’s a thing. And marquee firms will hope you get into this as it makes you forget the Chase branch down the street. What value add does that guy offer? He probably can’t even define CPG.

The second group of folks PE hooks up with are fast growing businesses where the capital need may be less big or less urgent but they have determined the founder can’t get the business to scale (and their team can). They come in believing the founder is not that competent. The good GPs will make this part of the deal itself – your replacement. They then install a preferred operating CEO as things kick off. If they don’t do that, but somehow gain Board control, it doesn’t matter, because they can replace you at at any time anyways. 

You can see here that the second group of folks, who don’t need a raise bigger than Chase bank would give them down the street, need to be convinced that they are incompetent or incapable of handling a growth business. Or be convinced of the ‘added ecosystem value’ of the fund’s industry network as an intangible asset in addition to the check. 

In some cases, this intangible value is worth taking more money than you need and avoiding the Chase bank branch loan officer. But honestly, by the time PE is ready to invest in you, you should already basically have an intermediate, if not veteran, understanding of CPG finance, route-to-market options, etc. You probably are already competent enough to persist. You just need to take the team’s discipline up a notch.

And that is precisely the topic PE GPs are masters at using to their advantage. 

Can you really professionalize to run a midmarket company? Or are you just a goofy entrepreneur best at starting stuff but crappy at scaling it?

Do you really understand finance well enough? Really? Really? 

The potential for extreme gaslighting here by a private equity GP knows no limits behind closed doors. If you can withstand this performance, fine, you may still want to move ahead. Although, honestly, if they’re gaslighting you, they have played their cards. They think you’re incompetent. 

Do you want to get into bed with a condescending sexual partner? Probably not, if you’re the kind of person who started and grew a business to $10M and beyond.

But, here’s the thing folks that everyone forgets. Remember the Chase bank loan officer down the street I mentioned? He really, really, really will not bother you at all ever as long as you make your monthly payments. He doesn’t want a seat on your Board. He doesn’t text you at all hours with random suggestions, mostly half-cocked and poorly thought through. He has very strong impulse control actually, which is why Chase lets him sign off on commercial loans. 

He doesn’t insist on weekly round-ups and debriefs that enable passive aggressive micro-managing either. 

The commercial loan officer wastes your time up front and then, leaves you alone. Ahh..Calgon, take me away to commercial loan land. 

Doing a Series A  with institutional funds will waste even more of your time than Chase bank would. And honestly, it might take longer too, unless you’re in one of those FOMO zones of the moment like plant-based everything was five years ago. 

When the money comes flooding back in later this year, listen to this episode again and make sure you know that institutional investment is a common, but not mandatory tool, to Ride the Ramp.