Attracting Investment Dollars in 2012

The recent recession has challenged the most seasoned entrepreneurs. You could call it the great economic stress test. Yet, there are companies and management teams that have survived and even thrived over the past couple of years.

What was their track record when the chips were down? How did they perform in a depressed environment? For example, did they acquire competitors? Have they been smart about maintaining access to outside capital? If so, these are the companies that will come back the fastest, strongest and show the most potential for attracting growth equity.

As a partner in a growth equity firm, it is those entrepreneurs and companies that attract my attention. Nothing is more impressive than a business that has been willing to invest prudently in the face of a bad economy over the past few years. Courage and vision are required to take advantage of the opportunities created by a down economy. Businesses that have capitalized on exactly the same market conditions that may have paralyzed their competitors will be well positioned to take advantage of a recovering economy.

Now it appears the U.S. economy is beginning to take off, and 2012 may mark the real beginning of the recovery, even though the recession technically ended in June 2009. The economy seems to be improving despite increasingly burdensome taxes, regulations and mandates. As it does, unemployment rates will decline, the housing market will improve and consumer confidence will rise. How soon those improvements translate into inflationary pressure on prices is anyone’s guess.

One thing is certain; a recovering economy presents different challenges that will test the skills of business leaders in new ways.

Our experience has led us to conclude that the most fundamental element in attracting growth equity dollars is the quality of the management team. One of the core dimensions along which we evaluate managers is their ability to adapt to change, and pivot in response to new market conditions.

While the pressures of a contracting economy require one set of responses, the opportunities and challenges of a rising economic tide demand different approaches toward customers, suppliers, employees and capital partners.

Successful managers anticipate changing economic conditions. They adapt quickly and appropriately, and seize the opportunities presented by whatever temporary dislocations arise in the market. They do this without sacrificing the core elements of their products and services.

Our analysis of each potential investment contains four key elements: (a) The quality of the management team; (b) the portfolio of product and/or service offerings; (c) the market into which those products and services are sold—including a thorough understanding of the competitive landscape and the sales strategy by which the target company intends to “win;” and (d) the financial terms and structure of the investment.

By far, the most important—and least quantifiable—is the quality of the management team. As we try to get a handle on such a slippery topic, we are invariably driven toward past performance. In the financial services industry, providers are required to disclaim, “past performance is no indicator of future results.” However, in providing growth capital to growing businesses, past performance—in all kinds of markets—may be the surest footing any investor can get.

Similarly, as CEOs and entrepreneurs think about where to find the best capital partners under a wide array of economic conditions, they will want to examine whether the investors have a reputation for “cutting and running” when times get tough, or whether they “stay the course” and support and refine the best strategies developed by the company’s leadership.

It’s been said that the contradictory qualities of skepticism and patience are required for investing successfully in growth-oriented companies. Management teams can pre-empt an investor’s natural skepticism by demonstrating an ability—preferably through historical performance—to thrive relative to the competition under a variety of market conditions. Satisfying that skepticism at the outset will provide a defensible basis for invoking the investor’s patience when market conditions change, and a new set of strategies and tactics is required in order to maintain performance.

In the end, our most important bets are on the character, integrity, intelligence and demonstrated leadership qualities of the management teams at the companies in which we invest. We do our best to hire for both brains and heart—within our own firm as well as at our portfolio companies. Both are required to adapt successfully to good and bad market conditions.

As business leaders consider how best to attract the capital required to grow their businesses, they would do well to emphasize their track records during a variety of economic circumstances. Although market conditions may now be improving, the right sort of capital partner is always hard to attract. A compelling story around how the business (a) performed during the recent downturn; and, (b) how it intends to capitalize on more favorable economic conditions, will help demonstrate the quality of the management team, and improve its likelihood of finding the capital partner best suited to help build the company.

Dan Peterson is a managing partner with Peterson Partners. Opinions expressed here are his own.
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