Partnership in private equity: Q&A with RMB Corvest's Mike Donaldson
Successful private equity is about patience, measured risk, and critically the right marriage of management and funder, says RMB Corvest CEO Mike Donaldson. It takes the same long term view and prior homework as a marriage - with the same extensive potential for mutual benefit.
Q. Tell us about your background and career to date
I’m originally from the Eastern Cape, having grown up in East London. After the navy, I went to Rhodes University where I studied for a BComm, and then Cape Town where I qualified as a chartered accountant (CA SA). Soon after I headed to London to work in corporate finance. Upon returning to South Africa, I joined Investec corporate finance in Johannesburg before moving to private equity (PE). PE was just beginning to take off in the major banks, so it was an exciting time to enter the field. I was headhunted to a position in development finance, but it wasn’t the right place for me at that time in my career. So a short while, in 2004, later I joined Corvest as a transactor and today I’m the CEO.
Q. How is the PE mind frame a better fit for you than development finance?
DFIs primarily look to Africa and have a lot of African exposure. At the time, I wanted to focus on South Africa where I felt I had the right connections and experience. Additionally, the philosophy is very different. Private equity tends to look for later stage organisations, mature businesses that are already cash positive and profitable.
At RMB Corvest we have the right shareholder and the right philosophy, and patient capital.
Q. Why is patient capital so critical?
I believe strongly that with private equity you need patience. Sadly, there are lots of teams in PE that don't have that patience, and ultimately that leads to conflict. Without patience, you almost inevitably run into the problem that a funder wants their cash back while the management team want to deploy that cash, grow the investment, or even sell the business at the right time. With limited life funding capital, you have to sell even if the business is in a down cycle, and that’s frankly value-destructive.
Choosing the right funder is as key for a PE firm as it for a management team looking for finance. There must be a shared long-term vision. At RMB Corvest, we want to deploy as much capital in quality businesses over a long time. Whether we then sell them in five, ten or thirty years’ time, it doesn’t matter because that quality is there. We have businesses that we’ve had a stake in for 29 years – and we’re still partners, we’re still invested and hopefully we’re going to be there for many more years. That’s possible because of shared vision.
Q. This naturally places a bigger burden on preparation and planning before entering into a deal. Tell us about your view on that.
It really is like a marriage. Some marriages work, some don’t. And when they don’t go right, its usually because you’ve not spent enough time getting to know and understand your partner. If you have different aspirations, different needs, different approaches to timing and risk, you will have problems. Of course, sometimes you can grow apart as these things shift. When we get involved with a business, the most important thing is the management team. If we get that right, 99 percent of the time we make money.
This also takes planning and preparation. We look at whether that team has the right age profile, the right commitment to longevity in the business, the right commitments, and ultimately mindset and vision.
Q. How does the CEO and CFO of a target business then fit into that view?
The CEO and CFO are absolutely instrumental in the success of a business and of a funding deal. That partnership between them is also critical. You need an equally strong CEO and CFO – and its those two individuals that we rely on completely. In the due diligence phase, we often have more engagement with the CFO because we need to understand the numbers. To really understand a business you need to understand their history, because history has a tendency to repeat itself. Businesses and their numbers don’t usually transform overnight. Thereafter we rely on the CEO and CFO team. We don’t generally delve into the business deeper than that – we don’t want to be micromanaging operations or marketing for example. Given this, half our job is psychology 101 – finding a way to unlock the potential of these individuals and empower them to take calculated risks and grow.
Q. Tell us more about the role of risk and managing expectations in PE.
PE in nature is always taking risk – but its measured risk. When you invest into a company, you always want to push it a little bit harder. It’s fine to invest in a nice sustainable business, but we’re not buying in to flatline. We have to return capital to the group. And that capital comes with an opportunity cost for shareholders, so we need a return out of that. You need to sweat the asset, and work with management to make the business stronger, better, faster. We believe we have the experience to guide management on measured risks, and we’ve seen unbelievable transformation when management are empowered to take risk, to live and die by their decisions.
In South Africa at the moment we can’t expect the growth rates we’ve previously seen, so we must manage these expectations and work this into the structure from the beginning of the deal. We don’t want to over-gear a company so that they are always looking over their shoulders at their debt burden. With the right mix of a solid business, the right de-gearing of that business, and selling at the right price, the value creation for all parties is normally substantial.
A lot of the management teams have never had a partner like that. All of a sudden we elevate them, we put them in a position of power to take decisions and inhabit the owner-manager mentality. Our management teams are then in charge of their own destiny, being owner-managers alongside ourselves. Their confidence grows. Their ability to take risk grows. Together we add value, and down the line we improve their prospects so we can sell a thriving, viable business onto a bigger buyer or an international one down the line.
Q. Is the owner-managers model a prerequisite for RMB Corvest?
It's not even a debate. If management is too mature in their career to take measured risks or are not willing put their own money in, there is no deal. They have to take risk too. Of course, you're not asking them to sink everything they've got into the business, but it must be meaningful in their lives so that we know they are mentally invested in the business too.
An over-exposed management team leads to short-term decisions driven by cash flow worries. We’re aware of that, and willing to lend money or manage that. In South Africa, I’ve seen that we also have a relatively high tolerance for mistakes. We don’t have the depth of management pool to be as cutthroat as PE can be internationally. So we work with our management team, guide them, and learn from mistakes. This combined with an owner-manager mentality usually leads to life-changing value creation for them.