Biggest (avoidable) failures in PE Investments?
What were your biggest failures that could have easily been avoided? Why have you not captured it before?
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Completely wrong value driver assumption leading to wrong deal assumptions. Reduced the headline price by nearly 30% after we found out. Nobody noticed. Could have been avoidable by challenging external assessments more detailed
AI slop sentence
One that happened to a deal we had was commodity prices going down. The core commodity in the companys products had been seeing tons of inflation last couple years prior to deal. The team spent so much of diligence focusing on ability to continue passing through price increases that deflation barely registered... Ultimately company had to give back a ton on price and even though margin % was flat as expected, margin $ decreased significantly
Can you explain how margin $ decreased in this scenario? Wouldn't a $1 decrease in commodity cost (in COGS) reduce your revenue by $1 (assuming 1:1 ratio) - so gross profit $ is flat?
Wasn't 1:1, as the industry turned down the business ultimately acted more like cost-plus/T&M. So $1 decline in commodity cost more like $1.20 decline in revenue.
Wrong thread
Buying a dogshit business with no moat and high churn at 15x run-rate adjusted EBITDA with 10 turns of debt
That you sold?
Misjudging management and the team
no transparency? Or what happened?
One deal the investment team took max leverage after buying into an industry doing ATH performance during COVID. Lesson: If you're buying into a market doing ATH, give yourself some breathing room on purchase multiple and leverage.
Another deal was a rollup where the investment team bought a bunch of small companies and failed to account for the inherent dyssynergies from owners that were heavily involved in the operations. Lesson: We're in the business of buying companies, not buying jobs.
CEO commited fraud, all the financials were fake + forged audits. We kept doing add-ons, should have questioned the too good to be true deals. Main diligence takeaway: call the auditor. Founders are taken aback at first by some of our diligence questions now, but the assumption of trust has been totally broken in the valley. Non negotiable now and we’re turning down deals if the financials look squirrelly. Founder also outsourced the finance team to a global satellite office - another red flag.
What steps do you take to avoid this in the future? Fwiw, we've had our QOE provider do cash reconciliations for smaller companies (ie checking bank statement cash movements against reported financials) when the financials are squirrelly.
Yeah QOE is the right move. We’re being more rigorous overall and requesting more docs and meeting a lot more different stakeholders in person, beyond the CEO. The main shift is not being able to assume signed legal docs are real without additional confirmation, which is a shame but a necessary precaution now. As a minority investor we’re getting a little pushback but they’re all conditions to close now.
Small family office sponsor... we bought a company that benefitted from a once-in-forever generational pull forward of demand during covid, peak earnings on peak multiple (topped the winning bid in the 11th hour). The worst part was that this was in early/mid 2022 after the covid bubble started to deflate. I was screaming that public comps were down 60%+ and that of course none of the financials would reflect a downturn yet, but I was told that the public comps were "an aberration". It was a small deal that we bought debt-free, but it would have been a 0 if we used normal leverage. Four years later, performance is finally surpassing those levels due to operational improvements.
Second, someone became enamored with a SOTP thesis where we were buying a company at a slight discount to comps due to the real estate that we got "for free". The real estate, though, were class F dilapidated buildings located next to a trailer park. This company was a covid-induced supply chain beneficiary during which the previous mgmt team really pushed pricing that we had to reverse (similar to story above). Shut down that location and sold the RE at a loss, company's future is dubious.
Not speaking up loudly enough.
The company had been put together through merging two standalone businesses in two different regions, of which one was a carveout from a very large business whose CEO was a known savvy dude (side note: if you're buying from a very acquisitive company, ask yourself why they are selling... usually not a good idea to buy). It was clearly a spreadsheet exercise cooked up by a partner who was subsequently fired: the customer size mix and product mix were not overlapping at all.
It became clear to me very quickly that this should've been divested as two separate businesses, with different natural buyers. My team agreed, our co-owners wavered though. We should've pushed through with the breakup, now the business we should've sold first is suffering from terminal value concerns (body shop). The CEO of the combined entity agreed these should've been sold separately. Had I spoken up a bit louder, we might've done it...
+1 on this. You can get dragged into bad investments by senior folks and then wake up a few years later holding the bag and taking the blame for something they sleepwalked you into. Be careful. Don't just go along with bad ideas.
Definitely agree here - you have to voice your views clearly but politely, in the end you are probably not the one making the call.
In this case, I joined the deal team 7 years after the initial deal and we were angling for an exit though.
I've seen multiple instances of ICs forcing through bad deals at the end of a fund just to get to the next raise. I'm sure their lawyers would have tons of sneaky outs for them on this, but if their actual behavior ever met real public scrutiny, history would not remember them well..
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