Private equity as careful steward: Is it possible?

Comment: There is a stream of thought that says private equity ownership is the second best alternative to an IPO, with a private equity takeout being the fate of failed-IPO startups.

The private equity owners of such a startup would then ruthlessly cut costs, dumping unprofitable business activities and laying off staff before flogging off the now profitable business.

Dave Zabrowski

But this view could be quite wrong, at least according to DataCore CEO Dave Zabrowski. Zabrowski believes private equity businesses are not financial raiders but careful stewards – farmers, not hunters.

We wrote in February of extreme inbetweeners – startups in a well-funded and long-life state in which they appear to have no short-term need of an IPO or acquisition by other publicly owned businesses.

At the end of that article we said: “There needs to be, we might say, some way for the holdings of the relatively short-termist VC investors to be turned into the holdings of more, benevolent and long-term investors. Perhaps a long-term view private equity acquisition, meaning not a slash-and-burn reorganising one, is one possible good outcome.”

DataCore is a profitable company and in its 14th consecutive profitable year. Insight Venture Partners invested $30 million in DataCore in 2018 and CEO Dave Zabrowski joined DataCore that year. During a briefing this month I asked him what his long term goals were for DataCore and whether an IPO was in prospect.

He responded: “The reason I came on board was to build a platform company around DataCore, and we’re on our way to doing that. And if that takes us to an IPO, great. If that takes us into a deeper private equity relationship, great.”

An IPO is not the only alternative in his view: “One of the paradigms that has changed, at least in the US is that it used to be you have to go IPO. Fine. But the PE markets are really, really helpful. And they’re huge. So there’s plenty of companies that have chosen to stay private, with a PE-backed investor group. And they’re doing extremely well. And you see a tonne of examples of that; you’d actually see companies going from public back to private just as much.”

Veeam for example. I asked if we should begin to understand that private equity ownership is not a short term, get into a distressed or semi-distressed company, make it profitable, and pass it on to somebody else type class of financial activity? Are PE companies more consistent, careful stewards than that?

Zabrowski said: “Guess who owns Veam?  Insight Venture Partners? …  Veeam  could have gone public many years ago, right. And it chose to stay private. A lot of companies are doing that.”

He listed some reasons for this: “If you look at the public regulations, there’s a tax that you have to incur. Not to mention that you get you get much more focused on short term results over long term strategy execution.”

In his view: “PE funds in the US, they’re very, very popular, and many CEOs that I know, are preferring to go the PE path over the IPO path.”

Personally “I don’t have a bias one way or the other. I’m saying right now is I want to build the most successful storage company in the industry – [for] core, edge, cloud. We think we’ve got a great opportunity to do that. And if that keeps us in the private equity world, great. If it takes us to the public world, great. I would consider both well done. These two destination are what we call an exit. It could be PE or it could be an IPO.”

The IPO, as opposed to a PE acquisition is an exit to shareholder ownership: “The company still exists. When I talk to people, I always try to separate them. The IPO is for purposes of shareholder returns. And of course, employees are shareholders too. … obviously we need to have exits for investors, of course. But for me, I want us to build out the most successful company and it’ll all be something to be proud of.”

Not all investors

We should distinguish between activist investors, such as Elliott Management and Starboard, looking to make a fast return, and private equity like Insight Venture Partners. Zabroski agreed: “We are very fortunate, the founder of Insight Venture Partners, and the managing director, Jeff Horing, is on our board, and has been our board since 2008. And he’s been a huge supporter of the company. And they’ve been great. … They are by far the best investor I’ve ever worked with.”

A successful IPO can return huge amounts of cash to founders and employees. Snowflake’s bonanza IPO made founders and employee holders of substantial stock options seriously rich. A PE acquisition would not be as excessive as that; there would be no bubble-like share-buying frenzy. It would be a more measured buying affair and a company’s PE valuation could be significantly below an investing VC group’s valuation.

Investing VCs have buying bias. They are investing, buying shares and need to confirm they have made a good decision based on their valuation. They could be being unrealistic. 

Imagine a PE acquisition of, say, Rubrik or Cohesity or other extreme inbetweeners. This need not be a disappointing outcome, a poor exit. Remember, Insight Venture Partners bought Veeam for $5 billion. It could be a good, a worthwhile exit for employee stock option holders, even if the extreme aspirations of some VC investors are not met. An IPO is not the be-all and end-all.