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Not so long ago, when companies were looking for private equity firms to fund them, they would invariably opt for the one that offered the most cash. But entrepreneurs are changing – if you don’t share their values, they’re not selling. Most private equity firms have yet to grasp this.

Growing a business organically – being profitable from the get-go and ploughing back profits to fund expansion – is a slow process. In a competitive market, slow growth means you’re easily pushed out and risk going to the wall.

If you’re a small business, one option is to apply to a bank for a loan. But you have to put everything you own on the line, and you’d be hard pushed to find a bank that will employ its financial knowledge to help your business in a meaningful way. Their relationship with you is transactional – they give you money, you pay it back with interest, and if one month you’re struggling to make the repayment, well, don’t expect any sympathy or support.

That’s why many companies seek external investment from private equity (PE) firms. In simple terms, entrepreneurs sell part of their company and give away some of their control to get their hands on substantial PE cash to drive expansion – either by supporting organic growth or acquiring new businesses.

Unlike banks, PE companies have financial expertise that they’re only too keen to impart. In fact, sometimes they impart financial advice even when you don’t want it.

Who funds PE firms?

Although there are always risks, investing in private equity is traditionally a good way to make a high return – typically a higher return than products such as stocks and shares, savings bonds or ISAs. However, you can’t invest the odd £20,000 in a PE fund – you need to have a minimum of hundreds of thousands of pounds to invest. To make the big money, you need the big money.

Of course, as a private or institutional investor, you’re putting money into PE because you expect bigger returns. You probably don’t know anything about the companies the PE is investing in, and you most likely don’t care. It’s a purely financial transaction where you’re looking to maximise the return on your investment.

Who manages the investment?

The people who manage the fund have the same idea as the investors. Their job is to maximise the return for investors, otherwise those investors will take their money elsewhere.

So, who do they get to manage those funds? Economists, financiers, accountants, of course. Who better to manage a financial asset than a financial professional? However, they’re not only homogenous in terms of professional skills. As a group, PE fund managers are probably a less diverse bunch of people than high court judges.

I went to a gathering of PE managers recently and the only women there were serving the drinks. A diverse spectrum of age and ethnicity was also clearly lacking. I might easily have been at a luncheon for the Victorian Mill Owners Re-enactment Society.

PE fund managers are largely a monoculture focused entirely on financial returns. This is increasingly creating tension between PE firms and values-driven companies they’re looking to buy.

Who is seeking the investment?

We have investors only interested in maximising financial returns and fund managers only interested in maximising financial returns, but what about the third element in this chain, the enterprises seeking financial investment?

Well, at one time, that was largely what businesses were about too – and don’t get me wrong, making money is still an important motivation. But as someone who has started and run businesses all my professional life, I can tell you it’s not the only motivation, and in many ways, maximising profit is getting less important.

I come from a generation where the notion of working all hours to better your ‘station’ in life was considered one of the highest virtues. When you’re building a business, you think nothing of working 16- or 18-hour days. The prevailing idea was that you had a simple goal of financial success, and you did everything you could to achieve it.

But the truth is, I’ve never seen financial reward as the only goal. You’re building a culture, working on a collective endeavour, a group of people mutually supporting each other so they can better support others. Achieving success by building a vibrant, exciting culture is far more psychologically rewarding than maximising the bottom line.

Businesses are made up of people – often a very diverse group of people – and they have a culture and values that go far beyond the simple maximisation of profit. This is a largely alien concept to PE firms.

The increasing importance of culture

Since I started my first business is the mid-90s, the idea of companies having values and culture other than making money has gained massive traction. It is not surprising given the way the internet has challenged dominant cultures over the past 25 years, giving rise to a wide divergence of ideas and values.

Customers (the fourth link in the chain) have also become significantly more values driven, and many can afford to pay slightly more for a product from a company whose values they support.

Of course, this can lead to great cynicism, as corporate execs and websites boast about supporting every passing cause célèbre, while greenwashing all their activity and frantically ticking every social values box going.

But widespread cynical activity on behalf of companies masks the fact that more entrepreneurs do genuinely believe in the values they’re espousing. While it’s dangerous to over-generalise, many of the latest generation of millennial entrepreneurs have personal values they are eager to incorporate into the culture of their businesses. These include a good work–life balance (something that hardly factored into our thinking 25 years ago), employee wellbeing and having an ethical and sustainability focus.

When I was growing up, the kids who were against the values of the establishment saw themselves as the ‘counter culture’ and had little to do with the world of business. Today, those whose values differ from the traditional business culture are not shying away from business. They are jumping in and reshaping it to suit their own needs.

PE companies being left behind

Much of the finance industry would be extremely happy if all four elements in the chain – investors, PE fund managers, corporations and customers – acted like good little economic units and were only concerned with minimising costs and maximising economic value. But they’re not.

Customers are probably the most values-driven of the four, but many companies are genuinely embracing values-based cultures too. Even investors are increasingly taking an interest in where their money is going. It is the PE fund managers who are being left behind, with their lack of understanding of anything that can’t be easily put into a spreadsheet.

Of course, they’ll all employ PR people who will write a lot of guff on their website about how they care for the environment, employee wellbeing and so forth, but you need to read it with a good shake of salt.

What this means for PEs

I have been doing a lot of consulting recently with businesses that are ready to grow and are considering PE investment. The last three I worked with all had CEOs who you might consider millennials and the common theme was how much they talked about selling to a PE company that could actively demonstrate its values aligned with theirs.

It’s not that money was irrelevant to them – if they found a super-ethical company that was only offering 10 per cent of what another company was offering, I doubt they’d take it. But given the option of selling part of their company to an PE company who was offering 15 per cent less but could demonstrate genuinely ethical and environmental credentials, my hunch is they’d take it.

Don’t forget, they’re going to have to work with the PE company after the purchase and if you’re letting people buy part of your business, it’s crucial to be on the same page. When all everybody wanted was to maximise profit, the synergy was good. But the synergy is disappearing, and those PE companies who refuse to adapt will find it increasingly difficult to find attractive companies to invest in.

PE firms need to catch up. Genuinely catch up, not play lip service to environmental, social and governance issues. Start by employing a few people who are not Ivy League economists. Employ some psychologists and mental health specialists who understand how the demands you place on the companies you now part own are affecting its employees. Get some people who understand modern values-based business cultures.

In the next 5–10 years, I firmly believe that companies looking for PE partners will start to rank a PE firm’s culture and its ability to go on a constructive journey with them as highly as they rank the amount of money on offer. PE companies that embrace these more diverse values will reap the rewards. Those that continue to live and breathe the Gordon Gekko ‘Greed is Good’ culture will become increasingly irrelevant.