Why Private Equity Culture Matters To Limited Partners

Company culture is the visible manifestation of an organization’s ethics, integrity, and reliability. It’s important in every industry, but private equity culture is particularly impactful because building and maintaining trust is the foundation of our industry.

For Limited Partners (LPs) looking to invest with a General Partner (GP), a positive culture is also vital because it’s a good predictor of long-term financial success.

When an LP is trying to find the right GP, the requirement of a proven track record is obvious. But the importance of choosing a GP whose values align with yours isn’t as apparent. Investors need to do “cultural due diligence” on a firm in the same way that a GP would assess an operating company.

LPs should never place investments with a firm they can’t trust, no matter what the financial performance indicators look like. That’s true for many reasons, including that firms with poor culture are more likely to misrepresent financial reporting.

Let’s take a look at what culture is, and why private equity culture is important for LPs.

What is private equity 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 mistakenly think of culture as “the fun social things firms do” like team building and celebrations. Those activities definitely contribute to a company’s culture, but investors are more concerned with the underlying forces that drive how the organization interacts on a professional level, both internally and externally with partners, clients, etc.

Private equity culture as a driver of performance

LPs that are looking for a good place to invest will do well to put at least some importance on firm culture. Research shows that a good, strong culture is linked to better financial performance.

Firms with a positive culture are more likely to be strategically innovative. They embrace diversity in thought and problem-solving and are more willing to try new approaches rather than sticking with old processes simply because “this is how we’ve always done it.”

The ability to innovate in areas like business processes, communication, and how investment decisions are made are all examples of small, often culture-driven changes that can make a big difference. 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 better at retaining top talent. Recruiters are constantly looking to “poach” the best employees by promising the next exciting and lucrative opportunity. Plus, talented employees are often tempted to strike out on their own and start a firm themselves.

The difficulty of fighting these forces 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—and with them, potential investors.

When a firm is able to retain its top talent through good corporate culture, LPs benefit significantly. Not only does the firm have the talent it needs to grow, but it also maintains the expertise necessary to make solid business decisions and nurture strong relationships.

Reduce fraud risk with positive firm culture

The dark side of firm culture is that a dysfunctional or toxic work environment has been associated with an increase in fraud. A Glassdoor study linked poor company culture to more deceptive financial reporting.

The report identifies two potential reasons for a negative 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 immense pressure to hit sales goals since compensation and career advancement were tied to those objectives.

This type of sales pressure isn’t unique to Wells Fargo, of course. But, the setting of unrealistic goals led to the de facto acceptance of unethical behavior. Salespeople believed they were more likely to get fired for not hitting their numbers than they were to get caught opening fraudulent accounts and fired for that.

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 ethics and integrity acts as a safeguard. But in a company that starts to foster a “win at all costs” attitude, these safeguards quickly break down and ethics are tossed out the window.

Better culture, better business

Ultimately, a positive firm culture isn’t simply a “nice to have” attribute. It’s a driver of better relationships and a predictor of financial success that gives investors the confidence they need to take the next step.

Pro Tip: For General Partners, one of the best ways to develop investor trust today is with a secure LP-Portal. Altvia’s LP-Portal helps GPs achieve that goal by enabling fast and secure sharing of many types of files including documents, videos, audio files, and recorded webinars.

Schedule a demo to learn more about this product and how it contributes to a culture of transparency and attentiveness that stakeholders appreciate.