Venture capitalists: nothing ventured?

Venture capitalists have a reputation for only being interested in what they can get for their money, but they do have a people agenda too. Vicky Meek reports.

For most of us, our closest contact with private equity investors comes from watching the hit BBC series Dragon’s Den, where a group of serial entrepreneurs decide whether to invest in weird and wonderful ideas.

But the chances are, if you haven’t already worked in a business with private equity investors, you will do so at some point in your career – either because you choose to join one or because the venture capitalists have come knocking at your board directors’ door.

Private-equity-backed companies now employ 19% of the UK’s workforce, according to the British Venture Capital Association. But despite how they have grown, venture capitalists don’t have a great reputation. Many people think of them as asset strippers, seeking to squeeze every last penny out of a business – look back to the Phoenix Consortium’s £10 purchase of failing car manufacturer MG Rover in 2000, for example.

People are the key

But what does working for a private-equity-backed company mean for the HR function? In the past, venture capitalists have sought to buy distressed businesses cheaply and then dismantle them on the premise that companies can be worth less than the sum of their parts, which would make most HR professionals run a mile.

But on the whole, venture capitalists are looking for growth potential – whether this is organic or through acquisition.

“When a private equity firm invests, it is doing it to make money – either by turning a business around in a short space of time or helping it to grow faster than it would otherwise have done,” says Andy Cook, managing director of HR consultancy Marshall James. “It is much less about sweating assets these days.”

And, perhaps surprisingly, they see people as the key to this. Ask a private equity fund manager what they look for in a business, and “good management” will invariably top the list. They may look to complement existing teams with new people, but it is too risky to take on a business and put in an entirely new team.

As Julian Davison, of private equity firm 3i, says: “We back management teams, not businesses.”

Nathan Elstub, a director at Barclays Private Equity, concurs: “A key part of our job is to assess the senior management of a business. Once we have decided to back a company, our main involvement is with the directors and management level just below that,” he says.

As with any investor, the aim is to make money, says Elstub, but that doesn’t necessarily mean swingeing job cuts.

“For us, people are what determines whether an investment works for us or not. We have bought into the idea that people in businesses of all types are the key to our success,” he says.

That means HR plays a central role in most private-equity-funded businesses.

“We’ve seen two types of HR department,” says Elstub. “Some are mainly administrative functions, but others – and this is what we try to foster – are much more strategic in how they operate because they recognise how important people are. As investors, we’ve seen how much you can improve the bottom line simply by cutting staff turnover.”

Jenny Smallman, HR director at shoe retailer Kurt Geiger, needed to reassure staff that little would change when her employer did a deal with a venture capitalist – the chain was bought out from Harrods by its management team and Barclays Private Equity in 2005.

“It can be scary for some people who feel that being part of a large organisation offers a security blanket,” says Smallman. “It was also quite difficult for the team in the Harrods concession because they had always occupied a special place in the business. But, on the whole, the staff reacted well and realised that it was a matter of business as usual.”

So what, if anything, changes when venture capitalists enter the picture?

“Everything moves very quickly,” says Smallman. “You cannot afford to have any slack. You have to ensure you have the best people in place and you become less tolerant of poor performance.”

Return on investment

Martin Wright, who was hired by 3i as HR director at data systems business Azzurri in 2000 (see case study, above), says that part of his role was to make sure the venture capi­talist got a return on its investment. All investors have an ‘exit strategy’ – which could mean floating the company on the stock market or selling it on to another interested party – ideally at a multiple of their initial investment.

“It’s a very fast-moving environment. There is a clear exit point and that really focuses your mind on maximising shareholder value,” explains Wright.

Venture-capitalist-backed companies are also often able to offer some good staff retention packages. The management team, as owners of the business, have an obvious incentive for making it successful, but more often than not, share-ownership schemes are used as a way of encouraging good performance throughout the company.

“At Azzurri, 3i set up an employee share trust, which gave all employees a stake in the business according to length of service and performance,” says Wright. “The business has now been sold to another private equity house, PPM Capital, and many of the staff have come into significant sums of money as a result.” And PPM Capital is setting up a similar scheme.

Smallman also found that getting private equity backing had an interesting side-effect – publicity.

“The publicity you get when the deal is done is really helpful for recruitment,” she says. “It means people know about the company and it makes you more attractive as an employer.”

But however fast an investor may wish the pace of change to be, there are sometimes good reasons for trying to halt it.

Cook says: “Private equity firms don’t hire HR specialists before they go into a business and so may not always get the full picture. For instance, some of the US investors don’t understand UK or European employment laws. It’s important that the incumbent HR manager explains to new investors the consequences of certain actions. You have to speak up because you know the business really well.”

In this environment more than any other, HR needs to prove its commercial mettle, and HR teams will need to demonstrate good business sense if they are to persuade the board and investors to invest in a training programme, for example.

“You have to make a convincing business case for what you are trying to achieve,” says Smallman. “If you can do that you’ll probably find a receptive audience. Remember, they’ll probably want to talk more about the bottom line than some performance management process.”

Ultimately, the HR function is vital for investors – it’s at the heart of the business and any venture capitalist should at least listen to any concerns or suggestions you might make.

But it’s not an easy ride. “You learn a lot – and fast,” says Smallman. “You have to work very hard, but it’s very exciting and can be extremely rewarding.”

What is a venture capitalist?

Private equity investing is big business, with UK firms investing £11.7bn in more than 1,500 companies in 2005, according to the most recent figures from the British Venture Capital Association (BVCA).

Private equity firms, or venture capitalists, tend to invest in organisations where they see the potential for high growth. These can be companies that are early on in their development, or they can be more mature businesses where a management team is looking to buy the organisation from a founder or from a larger corporation.

The investors generally take a non-executive director seat on the board and will sometimes bring in another non-executive with expertise in a particular area to help grow the business.

Venture capitalists tend to have fairly short investment periods and will usually look to sell (or exit) their investment within five years – hence the focus on rapid expansion. The sale could be to a trade buyer, to another private equity house, or it could result in the company being floated on the stock exchange.

Case study: 3i and Azzurri

When venture capital firm 3i invested in voice and data systems business Azzurri back in 2000, the company employed just a handful of people and so had no need for a dedicated HR professional. Yet after acquiring nine businesses in the space of three years, 3i felt it was time to take on someone to deal with people matters. Enter Martin Wright.

“I was brought in as an interim manager to help integrate the businesses,” says Wright. “But 3i encouraged the board to hire me as an HR director.”

His experience has been a positive one. “I was pleasantly surprised by my dealings with the investors,” he says. “One of my first tasks was to draw up a complete training plan for the business. When I presented it to the board and investors, it was very well received and readily accepted.”

Azzurri has since made a further six acquisitions and so Wright knows first-hand how staff tend to react to the news that they are being bought out – and by a private-equity-backed business.

“As with any change, the employees often feel anxious because they don’t know how it will affect them,” he says. “We go out of our way to meet those people and explain to them what we’re trying to achieve. It’s generally well received because we’ve got a good story to tell – we’re building a business and that means more opportunities for people.”

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