Is Your Deal Sourcing Sharpe Ratio Too High?
How do you stop killing deals that end up looking great months later in hindsight?
This is a common frustration I hear from Private Equity, Growth Equity and Hedge Fund clients.
So how do you gain the conviction to swing at more pitches?
Every idea does not have to be your highest conviction setup. There are ways to creatively structure deals to engineer favorable outcomes.
If you’re lucky, you spot 1-2 amazing ideas per year. The rest are singles and doubles.
You can’t know a great idea from an ok idea without doing the work to calibrate your deal intuition via reps.
Private Equity professionals grow up focused on excellence in work quality. The junior ranks of PE are like an extension of College & MBA programs, where superior work quality and work ethic garner respect and recognition. While this foundation theoretically insulates a PE franchise from having an untrained risktaker at the Partner level, it deprives the PE Associates / VPs from acclimating their nervous systems to the feeling of having risk on.
The one merit of hedge funds is that analysts are required from day one to advocate for a position, and learn to live with the sleeplessness and worry.
It's a weird moment as a PE Principal / Partner — when suddenly, you're the one leading the charge! And seemingly, the consequence of a negative outcome is all on you. It's a new feeling, and can be paralyzing for many.
Lowering your standards is not an option. This would melt your DNA.
Instead:
Recognize: IT’S NOT ALL ON YOU!
* Your committee exists to make decisions as a team.
* While the deal has your name next to it, everyone is on the hook if it goes poorly.
* Your Partners are there to help you detect potential problems before the purchase.Abandon "Risks and Mitigants" --> Instead OWN THE ELEPHANTS (risks) and fear map... if [bad outcome] occurred:
* What would you do if that happened?
* Would you just lay there and let the worst case play out, or would you find creative ways (with your IC) to remedy the situation and improve your position?
* Write a two column table, if bad thing happened (left), what are all the ways you'd deal with it over time? (right)
The reptilian mind over-weights the a) likelihood of a bad outcome and b) final severity of that outcome. In reality, the likelihood of a terrible event is much lower, and can be mitigated through active management.
The PE illiquid liability funding structure is designed to allow you to deal with major problems in private!
In reality, the worst things that happen during an investment hold period won't be in the "risk" section of the IC memo — it will be something you never saw coming.
In order to swing at more pitches, reassure yourself you make the best decision based on the information you have at the time of the investment, and have faith that you will use your creativity to find your way out of any issues that arise.
After all, this is why you're earning all those fees.
Related Private Equity Insights Pieces
Perfectionism In Private Equity Is Useful Until It Hobbles You
Happiness Comes From Having Little Attachment To Any One Outcome
20/20 Hindsight Monday Morning Quarterbacking Is A Waste Of Time
How To Swing At More Pitches Without Your Survival Instinct Paralyzing You
