Limited Partners need to consider firm culture in their investment decisions

 

Culture is important, no matter what industry you are in. Firm culture in the Private Equity world is crucial because so much of what you do is based on building and maintaining trust. pe crm dashboardA firm’s culture is important for Limited Partners (LPs) looking to invest with a General Partner (GPs) because culture is a good predictor of long-term financial success. Culture is also a key indicator of a firm’s ethics, integrity, and trustworthiness.

LPs choosing the right GP with a proven track record is obvious, but choosing a GP that aligns in value, not as easy. Investors need to do their due diligence on a firm just as much as a GP would do for their interest in an operating company. No LP should place their investments with a firm they can’t trust, no matter what the financial performance indicators look like. Firms with poor culture are more likely to misrepresent financial reporting and are less likely to be successful. Let’s take a look at what culture is, and why firm culture is important for LPs.

What is Firm Culture?

According to Investopedia, corporate culture is “…the beliefs and behaviors that determine how a company’s employees and management interact and handle outside business transactions. Often, corporate culture is implied, not expressly defined, and develops organically over time from the cumulative traits of the people the company hires.”

Some people confuse culture with the fun things that a company does, like casual Fridays and Christmas parties. While these types of things are fun to do, culture is the underlying force that drives how the team interacts with each other, partners, customers, etc.

Firm Culture and Financial Performance

LPs that are looking for a good place to invest will do well to put at least some weight behind firm culture in their consideration. Research shows that a good, strong culture is linked to even better financial performance.

Firms with a strong culture are more likely to be strategically innovative. They embrace diversity in thought and problem-solving, they are more willing to try new things rather than stick with the “because this is how we’ve always done it” mentality. Innovation isn’t just for tech companies. The ability to innovate processes, communications, and how investment decisions are made are all examples of “small” changes that can make huge differences. The benefit to LPs is that their investment is going into a firm that is forward-thinking—a common predictor of financial success.

Firms with a strong culture are also more likely to be able to retain top talent. Recruiters are constantly tapping into the organizational talent and offering the next new opportunity. Or, talented employees could simply decide to strike out on their own and start a firm themselves. The difficulty increases substantially if working conditions in the office are less than ideal. Office politics, poor recruiting and management practices, and unfair promotion processes are all things that can drive good employees away.

When a firm is able to retain its top talent through good corporate culture (and advantageous compensation, for sure), LPs benefit significantly. Not only does the firm have the talent it needs to grow, but also to make good, data-driven decisions and continue to develop strong relationships.

Linking Firm Culture and Fraud

The dark side of firm culture is that poor culture has been linked to an increase in fraud. A recent Glassdoor study was able to link poor company culture to more deceptive financial reporting.

The report identifies two potential reasons for poor culture leading to fraudulent outcomes. The first theory is that a company with poor culture tends to set unrealistic performance goals.

The case of Wells Fargo employees opening fraudulent customer accounts is an example. Employees were under an immense amount of pressure to hit sales goals, which were tied to their compensation and career advancements. This isn’t unique to Wells Fargo in the world of sales. But, the way in which it was administered and the setting of unrealistic goals lead to the de facto acceptance of such behavior. Salespeople were more likely to get fired for not hitting their goals than they were to be caught opening fraudulent accounts and fired.

The second theory is that firms with poor company culture lack sufficient “internal controls” to safeguard them from fraudulent behavior. In the absence of institutional controls, strong company culture that is focused on good ethics and integrity acts as a safeguard. But in a company with a “winner takes all” or “cover your own butt” type culture, these safeguards quickly break down. In such a place, ethics and whistleblowers are consistently ignored.

Firm culture is important for Limited Partners because it is a predictor of financial success. A strong, ethical culture also helps build better relationships with other investors, and operating companies. The result for LPs is a better chance of seeing a strong return on their investment and opportunities for future lucrative partnerships.

Pro Tip: For General Partners, one of the best ways to develop trust with their investors today is with a secure LP-Portal. One key feature Altvia’s LP-Portal has for GPs and LPs includes file sharing quickly and accurately with investors and other users including multimedia files such as videos, audio files and recorded webinars. Schedule a demo to see more on this product.

 

 

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