This (long) letter is written for all those entrepreneurs and founders out there who are contemplating the idea of taking investment from an outside party, including from us. We hope it is also helpful to anyone who is trying to get a better understanding of Cow Corner.
Our Motivations
We started Cow Corner because investing in growing businesses is great fun and, done well, it’s a great way of making money. We also think that what we do - the ‘product’ or ‘service’ that we provide - is fundamentally a valuable one and that it generates a social good. We want to feel good about how we make our money, and we think that creating high quality businesses and jobs is of enormous value to us all.
We also love working with business owners, particularly in an investment capacity. The combination of a deep trusting relationship between company and investor, real expertise and content, a renewed appetite for risk and experimentation, and an obsessive focus on long term growth can generate spectacular outcomes for both businesses and individuals. Making money and having fun in a way that adds value to society – that’s as good as it gets. However, we are also extremely conscious of the fact that there are many aspects of private equity that are unattractive to business owners. Let’s not pretend otherwise. Many founders think that private equity wants to rip them off, then rip the soul out of their business and then sell their business on as fast as possible. We think that’s an unfair characterisation of an entire industry; but as the saying goes, “there’s no smoke without fire”. So, if you are considering taking investment from someone like us, how do you get the good bits - the friendship, the help, the content, the renewed sense of purpose - without the rubbish bits? How can you make it work for you?
How does private equity work?
If you are considering working with a private equity firm it is important to understand the business model of private equity, and the motivations of the people who work within the industry. Private equity firms invest third-party money and take a (big) cut of the profits if the investments go well. They usually invest some money alongside their investors, but because they get paid fees as well as a profit share, their downside is limited. It’s not completely ‘heads I win, tails you lose’, but it’s not far off. We were both very lucky to benefit from that model in the past. No getting away from that fact.
That business model means that private equity is a hugely attractive industry to work in if your main motivation is to make a lot of money. Which of course is the main motivation for most incomers to in the industry, however much they protest that it is really because of their deep interest in business. If it wasn’t so well-paid they wouldn’t come, and they would pursue their ‘interest’ elsewhere. Most private equity investors are motivated to make money for themselves first, then their investors second, because that will keep them in business, and unfortunately the managers and founders they work with are last in the batting order.
However, the lucrative ‘profit share’, which is the main source of wealth for people working in private equity (it’s called carried interest in the trade) only gets paid when investments get sold. The profit share or carried interest isn’t paid on the way through, only at the end of an investment (or fund) and that is the fundamental reason the private equity industry has such an unhealthy obsession with selling businesses. As soon as they have invested, normally even before they have invested, most private equity investors are thinking about how quickly they can sell it because that is how they get paid. That obsessive focus on pace, 100-day plans and margin maximisation is all driven by that desire to sell sooner rather than later and cash in that carry cheque.
The problem this creates is that real value creation or business building takes time whereas ‘rent extraction’ (an ugly economic term meaning how can you extract extra value out of something) can be done much more quickly. Cutting costs and investment, jacking up prices to customers and bolting on some cheap M&A can all be done quickly and will enable a decent short-term profit and a high IRR (an arithmetic measure of the success of a private equity investment). Rent extraction is a much easier strategy to adopt if you want a low risk route to a quick profit share, which is why it is very rational for most people working within our industry to go down that route. This misalignment - business building versus rent extraction, long term versus short term, is normally the biggest issue that arises between founders and their potential private equity investors.
The alternative route to making money - an obsessive focus on long term value creation and genuine business building - is what most founders and business owners have. It requires the recruitment and the training of a great team; that normally takes years. It requires the development and optimisation of new products and services; that typically takes even longer. And it requires the winning and nurturing of deep and loyal customer relationships. In many of the businesses that we are invested in that can take a lifetime. Building great businesses is hard work and takes time, and is often riskier because you are always reinvesting profits. But it does ultimately deliver the greatest financial reward and personal satisfaction.
In reality, the two money making methodologies outlined above are not really that binary. Many business plans will encompass an element of both. Most private equity investors are smart enough to realise that transparently under investing in a business is normally a risky route to adopt. Unfortunately however, it is still the case that most private equity investors are focused on the shorter term (3-4 years) rather than the longer term, and fundamentally they view your business as an ‘asset’ that they can sell on. Your business, that you have built, brick by brick, ends up being viewed as a financial instrument to be monetised.
At this point we should pause and note that it is rational for most private equity investors to behave like this. It doesn’t make them bad people, it’s just them reacting to the incentives that are built into their business model. Most people are good people, but we all react to circumstances and the incentives that are in front of us. The same logic applies to people who work in Private Equity. Most of them are fundamentally decent people, but they face a very particular set of incentives, which inevitably impacts behaviour. It is also true that the combination of money, a sense of power (or at the very least, a position at the top of the financial food chain), as well as a false sense of achievement as a result of one decent investment, can create monsters. It can happen to anyone, including us, which is why we are so aware of it.
Incidentally, the last point in that paragraph about ‘one decent investment’ is an important one. Most investments made by most sensible PE firms are at least modestly successful. Maybe one in five is a real duffer. So how many investments do you need to make as an individual before you can be confident that you actually know what you are doing? We think that maybe around 20 investments gets you to the point where you can start to have that confidence. We are only just approaching that number now, and we have been doing this a long time.
Why are we different?
So why are we different; why do we focus on long term value creation more than others? The simple answer is because we can. We are lucky to have made money before. Which means we aren’t incentivised to sell your business in order to make a quick buck. Which means that we can really behave like partners and investors who want to create the most amount of value over the longer term.
The Cow Corner partners are the largest investors in every investment that we make. We haven’t just invested in our fund, we are by some distance the largest investor in our fund. When you receive an investment from Cow Corner the biggest part of it comes directly from us. What that means is that we behave like real investors. We want your business to succeed in the long run. We certainly don’t want to sell our shares if the business is going well because then we have to find another business just as good as yours to reinvest our money in. Selling early or within a defined time period doesn’t help us at all. Sometimes it is the right thing to do, and of course we are financially motivated to generate cash out of investments so we can then reinvest it. But we are not incentivised just to sell your business to earn a profit share. That means we can and do behave differently.
What do we offer you?
What do we think that you, the entrepreneurs and business owners, really want, and what are we offering you? Some of you just want to sell your business and walk away. If that is your plan it makes total sense to hire an advisor, run an auction process and get the highest price possible. That is a very sensible and proper motive, and we admire the people who just get on and do it.
In our experience however, many of you want something else. It might be as simple as friendship. Running a business can be a lonely occupation and sharing the journey with an empathetic investor can make life a lot more enjoyable. Other business owners, particularly those who have been going a long time, lose their ‘mojo’. They get knackered, they stop taking risks, they worry too much about the downside. They want a reset, to take some money off the table, to ensure financial security for their family, and they want to start enjoying business again. Another category of founder or business owner reaches a conclusion that whilst they are great at starting businesses, they aren’t so hot at managing them when they get bigger. Managerial skills and entrepreneurial skills are very different. They overlap a bit but not completely, and probably less than most entrepreneurs realise. Those founders recognise that they need help in developing and growing the business as managerial skills become more important.
Incidentally, the needs outlined above apply equally to us, and explain why we have built a team of which we are very proud. When each of us left our previous jobs we were looking for a reset, and an opportunity to enjoy business again. We are also very aware of our limitations and know that a team can compensate for those weaknesses. But mostly we also know that a team can provide friendship as well as support as you build a new business, and we have found that in spades with the colleagues that have joined us. Working with people you like is a great privilege, and we are lucky to do so.
All those different motivations described above need identifying, articulating and debating, and then addressing and solving. Lots of founders don’t really know what they want, but instinctively feel that they need to do something. A cookie cutter approach to investing isn’t going to work for them. A personalised solution is what is needed. That is where we can help. Whilst the investment needs of business owners might differ, the thing that they nearly all have in common is a deep pride in their business. Pride in their people, their customers and the service or product that they provide. Which means that it is entirely natural that you want to find an investment partner who will take equal pride in your business and all the people in it who make it special. Again, that is where we can help.
However, there is still the question of money, which should never be avoided. Over the years we have lost count of the times a business owner tells us ‘It’s not about the money’. We always push back when we hear that statement, as we think it is a bit misleading. A better statement would be ‘it’s not JUST about the money’. Because the money does matter. We have never met an entrepreneur who would sell shares in their business at a level below what they thought was a fair price. However, the combination of a fair price and a great partnership is attractive and meets the twin needs of providing a great home for the business and solving the money question. That is what we try and offer.
What are those ‘rubbish bits’ that we reference?
Over many years of being in this industry, we have learned that, aside from the fundamental misalignment referenced above, there are many other aspects of the standard private equity operational model that get right up the noses of many business owners. Here are some of the least popular features of private equity, but we have a much longer list that we can talk you through.
Fees.
Most private equity firms charge you a fee for investing in your business, they charge you a fee for turning up at meetings and a fee for providing any operational support. With one hand they giveth, and the other they taketh away. What starts out as an eye-catching headline price looks a lot less attractive when you read the small print. We never charge a portfolio investment company a fee for anything, ever.
Due diligence advisors.
Hundreds of them. Crawling all over you and asking idiotic questions which don’t really matter. And then you get sent the bill. We do 95% of all due diligence work ourselves, along-side you, in a super focused manner. You might even quite enjoy it.
Dodgy capital structures.
“We are all in it together as partners apart from the fact that we will have this type of shares, and you will have these slightly different ones, but you don’t need to worry about that”. But you should worry. One of the main problems with private equity people is that they are normally very clever, which means they keep coming up with new ways of putting their money ahead of yours. We will only ever invest in exactly the same type of shares that you are invested in. It is essential that we win or lose together. Misalignment is death to an investment relationship.
Overbearing governance and boring board meetings.
We hardly ever work with chairpeople. Most private equity firms hire chairs to supervise junior investment staff, and to ensure that the relationship between the parties remains civil. Why would we outsource that role to someone else? As for board meetings! Most CEOs and founders hate board meetings. All that powerpoint preparation, endless questions and no value added. We feel the same way. Little and often is our engagement model.
Consultants.
The last thing you will need after completing an investment process is a ‘high flying’ management consultant arriving at your door as a present from your new private equity investor. It is usually well meaning and their way of trying to help you. But the reality is that many of these consultants have never worked in the gritty, imperfect, and chaotic world of a growing SME. They have lots of models to share and playbooks for you to deploy, but very few in our experience are prepared to roll up their sleeves and actually help you with the things you really need help with. Which is why we have people in our team who have done all the key jobs in businesses like yours before.
Lock-ins and leaver provisions.
You built your business over years, maybe decades. You are deeply loyal to it, and you want it to succeed. You don’t want to leave, but you might want to change your role, or develop other interests, or just chill a bit. And let’s be honest, you might not enjoy working with an investor so you might want to leave in the future. The typical private equity approach to managing the ‘risk’ of the founder leaving is a great big ball and chain, or in legal terms, ‘leaver provisions’ that make it expensive or punitive to leave. We think that leaver provisions being applied to roll-over equity is one of the nastiest bits of ‘small print’ that you can ever find in a contract. Our view is that if you like working with us you will stay. And if you want to leave, for whatever reason, you shouldn’t be penalised. You have spent years building a business and you have now achieved financial security. Why should you be ‘compelled’ to come to work?
To wrap it up
There is a lot in this letter. If you have made it this far you must be at least half interested in what we do and who we are. We are big believers in not overcomplicating business. Most businesses succeed by having a good product or service that is fit for purpose, which is sold at a fair price, and where customers feel that they are being looked after by people that they like dealing with and who they believe to be on their side. Our business is no different. We have a simple product (money, knowledge and friendship), which we try and sell at a fair price (by investing at a fair price), and we try and look after both our investment clients and our portfolio partners. And we only work with people we like. Which is why we enjoy it so much.
We would love to meet you
Matthew & Stephen