Our entrepreneurs, often decades-old incumbents, are getting used to the interplay of ideas, capital and talent, catalysed by their PE partners. Many PE funds itch to out-entrepreneur the entrepreneur by providing solicited and unsolicited value-add. But is it really necessary, or possible, for PE funds to match entrepreneurs?
Most PE funds (globally and in India) are not supplementing the entrepreneur with more entrepreneurship. They are, at best, performing the role of good stewards. Stewards polish grandma’s silver – they buff up the assets and capabilities, and hope to make reasonable returns. There is nothing wrong in being a steward. It is important to protect all those brands, skills, assets and customers that underpin today’s success. But stewardship can also lead to numbing bureaucratic controls that paralyse creativity in traditional businesses.
Entrepreneurs are blessed with guts, positive thinking and tremendous energy. They live in a high-complexity and high-uncertainty zone while stewards love linearity and certainty. What sets a PE fund apart is not its people or success rate but its way of doing business and relating to its partners. Indian entrepreneurs expect their PE partners to act like a coach who holds people’s feet to the fire but understands the human behaviour. Do PE funds need to transform from being stewards to being co-entrepreneurs?
Not really. What we need is generative leadership. A generative leadership “produces new sources of value which cannot be foreseen in advance” (Lane and Maxfield, 1996). There are two components to this definition. The first is that the relationship produces something which the members could not have produced alone. Second, the source of value could not have been foreseen in advance – it needs to be created. Generative relationships have the capacity to deal with complex contexts where change happens both at a structural level (industry, macro trends) and at the execution level (products, services).
But how do we know whether a relationship will be generative or not? How do we enhance the generative potential of existing PE-entrepreneur relationships? Let me illustrate this concept by using Prof Brenda Zimmerman’s model that she taught me while I was studying at McGill University. Zimmerman and Hayday used a four-pointed STAR to capture the four dimensions of a generative relationship.
S (Separateness): There needs to be the differences in the background, skills, perspective or training of the PE fund and the company. If both parties are similar, they may enjoy heated debates but critical assumptions never get challenged.
T (Tuning): There needs to be real opportunities to talk and listen, with permission to challenge sacred cows.
A (Action opportunities): Tuning is great but unless it is accompanied by action, value will not be created.
R (Reason to work together): The parties need to have a reason to share resources, ideas or to act as allies even if only for a short period. If they see each other as adversaries rather than as allies, it is unlikely that they will co-create something of substantial value.
S and T are necessary to enhance the capacity to generate unforeseen insights and sources of value. S and T operate at the conceptual level. A and R operate primarily at the structural level. It is through action that new players and products actually emerge. Extremes of ST and AR are not desirable for the ops-focused PE fund.
ST-aligned funds are different (S) and tuned in (T) but they do not necessarily work together (R) with the entrepreneur. There are no real opportunities defined by the parties (A). I have seen this happen in cases where a high-IQ-plus-low-EQ combination produces a zero-collaboration scenario that is competitive between the PE manager and the entrepreneur, and an I-told-you-so approach prevents experimentation and value creation.
An AR relationship, on the other hand, has the two sides collaborate with each other but both sides think similarly (clones). Although they have made time for T (tuning), they have so few differences that the status quo is never challenged. This is a danger when brick-and-mortar professionals run money the way they ran businesses.
There are other unique features of a PE- Entrepreneur relationship that make STAR alignment challenging:
1) PE funds tend to allocate resources based on their models/excel sheets and new ideas seldom get any allocation. A shift from ‘resource allocation’ to ‘resource attraction’ is required (sounds implausible? But there are PE funds that are already doing it).
2) PE funds sometimes get carried away by post-funding entrepreneurial impulse and interpret the first signs of success as a perpetual trend. We have seen multiple instances of good businesses coming under pressure, thanks to the euphoria-backed expansion. The fact is you can build a great nuclear plant, but if you run it too hard, it will blow up – a classic case of a failed stewardship.
3) The reverse (of sacrificing radical innovation at the altar of operational efficiency) is also not desirable. PE funds love operational efficiency (BPR, RTM, Six Sigma, ERP, etc.). Whatever the name, the goal is the same – get better at what you are already doing and cash out. This is an element which is deeply embedded in the DNA of PE funds and is clearly an impediment when PE funds want to move beyond stewardship.
4) Governance and transparency are crucially important and favourable business conditions are not enough. Entrepreneurs are expected to play by the rules. Any breach of trust leads to disorder and can potentially destroy the business and the relationship.
We all operate in complex adaptive systems and the operations function in the PE domain is evolving very fast. Prof. Zimmerman’s model, when applied to such situations, begins to make a lot of sense. In fact, I live by it. To establish STAR equilibrium does not require a Genghis Khan in the executive suite – it simply requires hard work, understanding and balance between ST and AR.
(Jaspal Singh Sabharwal is a Partner at Everstone Capital Private Equity. Jaspal has prior permission from Prof Brenda Zimmerman to use the STAR framework to illustrate his thoughts.)
