“Oh, I have lost my reputation! I have lost the immortal part of myself, and what remains is bestial.”
While he puts in dramatic terms, Michael Cassio, a character in Shakespeare’s Othello who sees his military career jeopardized through a drunken misdemeanor, understands the importance of reputational risk.
The concept is a slippery one; reputational risk can lurk in any corner of a private equity firm’s operations, from its succession plans to its portfolio companies’ supply chains. It is ephemeral and, for that reason, it is easily ignored. This, however, is done at a GP’s peril.
An individual private fund firm is reliant on trust to operate: the trust of its counterparties it can execute on transactions; the trust of management teams it will be a co-operative and valuable partner; and the trust of investors it will generate returns and – perhaps more importantly – not lose their capital. Maintaining trust among these three stakeholder groups – management teams, deal counterparties and investors – is essential. But they are only the start; the industry has realized that it needs to win the hearts and minds of employee groups and lawmakers in order to maintain its license to operate.
What is at risk if that trust is eroded? As a senior external affairs manager from a global firm told me last year: “Reputational risk matters, but only when it starts to curtail your ability to raise or deploy capital.”
Most private fund firms have hired some form of communications resource – whether it be internal, external or a combination of the two – to help manage and protect their reputations. Noemie de Andia is global head of communications at private equity firm Permira, which she has been with since 2007. She believes that reputation management starts not with a focus on the downside risk – managing the fallout from difficult situations – but on the positive promotion of the firm. “Origination is an important audience for us: business owners and the management teams you want to bring in,” she tells pfm. “You want to be seen as a good partner when you approach a business; this is your incentive to communicate.”
Vanessa Maydon, corporate affairs director at private equity firm Cinven, also highlights the importance of reputation to deal origination. “We obviously have a very direct dialog with our LPs. What is increasingly important is reputation management among stakeholder groups who can influence transactions. These can range from institutional investors in public markets in the case of an IPO or to trade unions where we don’t always have a direct dialog.”
De Andia is referring to “peace time” communications: communicating the firm’s successes both directly to its audience and through an active media relations campaign. “We are very positively minded. Our strategy is to back growth and we want to communicate that and promote the credibility of our expertise in our sectors.”
The advantages of such sustained communication go beyond the cumulative effect of good media coverage or happy management teams. “The proactive approach lays the groundwork with the reporters and other audiences that are important to you,” says De Andia.
“When things do go wrong, people will listen to you.”
And something will inevitably go wrong. The question is: ‘where?’
“Part of our job is to hunt down risk,” says Andrew Honnor, managing partner of Greenbrook, a London-based communications consultancy that advises a number of private fund firms. “We will look at the entirety of a firm’s operations and assess where problems may arise. [GPs] need to make sure they have a sensible understanding of where the risks reside.”
Typically with a private fund firm, this means at portfolio company level: how the investor treats the company, and how it in turn treats its employees, customers and the environment.
This reputational risk assessment starts before the investment is even made. “You might have a gating discussion,” says Ludo Bammens, managing director at KKR and head of the firm’s corporate affairs in EMEA. “Is this is a sector or a company we can be involved with? In the event that the investment goes wrong, would it affect our investors or our ability to do future deals?”
Once the deal is done, the most important way to guard against reputational damage is through preparation. Taking a holistic view of the portfolio – “hunting” and identifying risk – is step one. “You need to ensure you are aware of the issues coming down the track, regardless of how unpleasant, and be prepared,” says Honnor.
Step two is to establish your crisis team. This group of people needs to be small, senior and have the purview to act autonomously.
“In a crisis situation you won’t have time to call an all-partners meeting,” says Honnor. “You need a group of individuals available to be called on pretty much 24-7, as things can and do happen in the middle of the night.”
This group should be no more than six people, says Honnor, and typically would contain senior partners, legal counsel and communications advisors.
Crisis situations at the portfolio company level tend to be handled by that company’s communications team, and often the financial sponsor’s communications team provides background support and guidance. Cinven, for example, runs an annual communications conference for its portfolio companies and the theme of the last conference was crisis communications.
The good news for financial sponsors is that very rarely will a crisis emerge out of nowhere. “Whatever the issue is – be it fraud at a portfolio company or a covenant breach due to underperformance – you will normally have some sort of notice,” says Honnor. The key, then, is to be prepared.
The three levels of reputational risk
1. GP level
Crisis at the general partner level is uncommon, but managed poorly it can prove terminal. Situations that require careful management include succession planning, senior departures, complicated or slow fundraising processes and investment under-performance. Crisis situations can include partner level disputes and key man clause triggers.
2. Portfolio level
By far the most immediate and common source of reputational risk comes from the firm’s portfolio. Reputational risk is plainly more evident in certain sectors, such as the provision of care services to vulnerable consumers or ‘sin’ industries, such as firearms or gambling. There are also risks that cut across sectors, with the most salient at this point in time being the handling of customer data and its potential theft and abuse.
3. Industry level
The third level of reputational risk resides in the practices of the private equity industry itself. The various uses of debt, the use of international fund domiciles and tax efficiency, as well as the treatment of investors are all recurring areas of industry reputational risk. This, say sources, is most effectively dealt with by industry associations. General partners should be wary of being held up as the proponent of bad behavior when the practice is industry wide. At the same time, however, GPs should be ready to explain specific examples.