When The Smartest Guys In The Room, Aren't

When Operating Partners Fail To Operate

Frequently, private equity (PE) operating partners play a critical role in driving value creation within portfolio companies, but their success is not always ensured nor guaranteed. There are several common pitfalls they must avoid in order to ensure the business thrives under their guidance. As the saying goes, "the road to hell is paved with good intentions," and it's critical for financial and operational success that the PE firm, hedge fund, or family office puts the operating responsibilities of the business in capable hands.

Avoiding Pitfalls as Operators

Let’s face it, dealmaking is inherently risky, and as we say at QORVAL, "the only constant you have is incomplete information." Even due diligence can often miss key reasons for not doing a transaction, for example. Running these companies brings a rather unique set of challenges. Below are some key pitfalls that PE operating partners should be mindful of:

1. Over-Focus on Short-Term Financials at the Expense of Long-Term Value

• Pitfall: A common mistake is prioritizing short-term financial performance—such as cutting costs or boosting EBITDA—over long-term strategic value creation. While improving profitability in the short term is often a focus of PE, overzealous cost-cutting or focusing exclusively on near-term metrics can harm the company’s ability to invest in long-term growth initiatives.
• How to Avoid: Balance short-term financial goals with investments in areas that support sustainable growth, such as innovation, talent development, and infrastructure. Maintain a long-term strategic vision while managing the immediate financial health of the business.

2. Neglecting Company Culture and Employee Engagement

• Pitfall: Many PE operating partners focus on operational efficiencies, cost reductions, or restructuring without understanding or addressing company culture. This can lead to employee disengagement, increased turnover, and a toxic work environment, which undermines overall performance.
• How to Avoid: Invest in building a strong company culture that aligns with the strategic goals. Foster open communication, employee empowerment, and retention programs to ensure that employees feel valued and motivated, particularly during periods of change.

3. Over-Leveraging the Business

• Pitfall: PE-backed companies are often highly leveraged, and operating partners can be tempted to take on even more debt to finance expansions, acquisitions, or other initiatives. Over-leveraging can put the company at risk, especially if market conditions change or the company faces unexpected challenges.
• How to Avoid: Be cautious with debt levels. Ensure that the capital structure is aligned with the company’s ability to generate cash flow and create contingency plans to weather economic downturns. Avoid taking on debt for non-strategic purposes.

4. Ignoring Customer Needs and Market Trends

• Pitfall: PE operating partners may be overly focused on operational efficiency or cost-cutting and fail to keep a close eye on evolving customer preferences, industry trends, and market demands. This can result in the company losing relevance in the market and failing to innovate.
• How to Avoid: Stay customer-centric and ensure that the company adapts to market shifts. Invest in R&D, digital transformation, and customer insights. Operating partners should understand the competitive landscape and encourage innovation to meet changing consumer needs.

5. Underestimating the Complexity of Integration (M&A)

• Pitfall: In cases where the PE firm is involved in acquisitions or mergers, operating partners often underestimate the complexity of integrating the acquired business. Poor integration can lead to operational inefficiencies, culture clashes, and missed synergies.
• How to Avoid: Develop a clear integration strategy before the acquisition. Focus on integrating key business functions like IT systems, human resources, and supply chains. Manage cultural integration carefully, ensuring that both businesses align on values and practices.

6. Failing to Retain and Attract Top Talent

• Pitfall: Operating partners sometimes make the mistake of focusing on cost-cutting and restructuring without considering the impact on key employees. Talent retention becomes an afterthought, leading to the loss of critical leaders or employees who drive performance.
• How to Avoid: Ensure that key employees are incentivized and recognized for their contributions. Offer retention bonuses, leadership development programs, and clear career progression paths. Create a positive work environment where top talent feels engaged and valued.

7. Lack of Alignment Between Financial and Operational Goals

• Pitfall: Operating partners may be skilled in financial engineering but may fail to align operational decisions with the company’s broader strategic objectives. For instance, reducing headcount or cutting marketing expenses without considering the impact on sales, brand equity, or customer satisfaction.
• How to Avoid: Ensure that all operational initiatives are aligned with the long-term strategic goals of the business. Regularly communicate with both the financial and operational teams to create cohesion and mutual understanding of how operational decisions impact financial outcomes.

8. Mismanaging Risk (Operational and Regulatory)

• Pitfall: Operating partners with financial backgrounds may focus too much on profitability and overlook operational risks, including regulatory compliance, cybersecurity, or safety concerns. This could expose the business to legal issues or financial penalties.
• How to Avoid: Establish a robust risk management framework. Regularly assess both operational and regulatory risks and ensure that the company complies with all relevant laws and regulations. Create contingency plans for managing disruptions or crises.

9. Overlooking the Importance of Technology and Digital Transformation

• Pitfall: In an increasingly digital world, operating partners may fail to prioritize the modernization of the company’s technology infrastructure. This can result in missed opportunities for process automation, data analytics, and digital customer engagement.
• How to Avoid: Invest in the right technologies that enable scalability, efficiency, and enhanced customer experience. Evaluate and upgrade legacy systems, implement digital tools, and ensure the company has the capabilities to stay competitive in an evolving marketplace.

10. Underestimating the Need for Effective Communication and Stakeholder Management

• Pitfall: Poor communication with stakeholders—such as employees, customers, suppliers, and investors—can lead to misalignment, dissatisfaction, and confusion. Operating partners may fail to articulate strategic changes or involve key stakeholders in decision-making, which can result in poor execution or resistance.
• How to Avoid: Maintain transparent and open communication channels. Regularly update stakeholders on the company's performance, changes in strategy, and progress toward goals. Involve key stakeholders in important decisions and be proactive in managing expectations. 

When Operating Partners Lack the Experience to Run Businesses

Things can get sideways fast if the person or team charged with operating a business are lacking in breadth and depth of experience. Here are some typical problems that arise:

1. Failure to Understand Industry-Specific Operations: Many operating partners come from a broad generalist background but lack deep knowledge in the specific sector of the company they are overseeing. For example, a PE operating partner with a background in technology may struggle to understand the intricacies of running a manufacturing or healthcare business, which have their own unique operational challenges.
2. Neglecting Customer-Centric Operations: Operating partners with financial backgrounds may focus too much on cost-cutting and profitability, while neglecting the customer experience, product quality, or brand loyalty. This can lead to a decline in customer satisfaction, which negatively impacts long-term business performance.
3. Overemphasis on Financial Engineering: PE firms often hire operating partners with strong financial skills who focus on short-term EBITDA or margin improvements. However, they may lack experience in managing day-to-day operations or leading large teams, leading to poor operational execution and employee dissatisfaction.
4. Poor People and Talent Management: Operating partners may excel at financial management but lack the ability to effectively lead, manage, or motivate employees. This can result in high employee turnover, low morale, and difficulty attracting and retaining top talent.
5. Inability to Implement Long-Term Strategy: While operating partners may be skilled in driving short-term operational efficiency, they may lack the strategic foresight necessary to navigate long-term business transformation. This often leads to a focus on cost reduction rather than reinvesting in growth initiatives.
6. Insufficient Focus on Supply Chain and Operational Efficiency: In industries like manufacturing, retail, or logistics, operating partners who lack deep operational experience may fail to identify critical inefficiencies in the supply chain, leading to missed cost-saving opportunities and poor customer satisfaction.
7. Failure to Drive Innovation: Many PE-backed companies fail to innovate, especially in industries where product development or R&D is crucial. Operating partners with limited experience in product development or technology innovation may fail to lead necessary investments in these areas.
8. Resistance to Change Management: When implementing major changes in business operations, culture, or structure, operating partners without change management experience might struggle to communicate the vision, get buy-in from key stakeholders, and effectively transition teams.
9. Misalignment Between Financial and Operational Goals: Operating partners may prioritize cost-cutting or other financial objectives over operational health. This misalignment often leads to unsustainable practices, such as underinvesting in technology, training, or customer experience, which hurt long-term performance.
10. Overlooking Regulatory and Compliance Risks: In highly regulated industries (e.g., healthcare, finance), operating partners without specialized knowledge in the industry may overlook compliance risks or fail to manage regulatory requirements properly, leading to fines, reputational damage, or operational disruptions.

When The Competencies Are Missing From The Operating Partners' Toolbox

"Fake it till you make it" rarely works in operating complex businesses, and trying to engage a turnaround, transformation, growth plan, or rapid scaling. Her are some critical elements to success to be aware of. 

1. Industry-Specific Knowledge: The lack of deep expertise in the target company's industry can result in operational missteps and strategic blunders. Operating partners may struggle to understand the key drivers of success in sectors like manufacturing, healthcare, or retail.
2. Operational Execution Skills: Many operating partners come from strategic or financial backgrounds and may lack the hands-on experience needed to optimize day-to-day operations, manage production processes, or solve operational bottlenecks effectively.
3. People Leadership and Development: Strong leadership, coaching, and people management skills are crucial for motivating employees, aligning teams with strategic goals, and maintaining morale during periods of change. Operating partners with weak leadership skills may see higher employee turnover or disengagement.
4. Change Management Expertise: Successfully implementing business transformation or operational change requires the ability to manage both the technical and human aspects of the transition. Operating partners without change management expertise can struggle to get buy-in or align internal stakeholders.
5. Customer-Centric Mindset: A focus on customer experience and satisfaction is critical for any business, yet operating partners without a customer-first mentality may overlook the importance of brand loyalty, customer service, and product quality in favor of financial metrics.
6. Supply Chain and Logistics Expertise: In industries like manufacturing or retail, operational efficiency is often driven by optimizing the supply chain and logistics. Operating partners without this expertise might fail to identify inefficiencies or waste, leading to unnecessary costs.
7. Innovation and Product Development Leadership: Many operating partners fail to drive innovation, relying on existing products or services without pushing for product improvements or development of new offerings. This is especially true in sectors like technology, consumer goods, or pharmaceuticals.
8. Risk Management and Mitigation: In the high-stakes world of private equity, operational risk management is essential. Operating partners without experience in identifying and mitigating risks—whether they’re financial, operational, or regulatory—may expose the portfolio company to avoidable crises.
9. M&A Integration Skills: After acquisitions, operating partners may struggle with integrating new businesses, which can lead to inefficiencies, missed synergies, or culture clashes. M&A integration is a highly specialized skill set that many operating partners lack.
10. Financial Acumen vs. Operational Acumen: Many operating partners have strong financial backgrounds but lack the operational skills necessary to execute on those financial goals. The ability to translate financial strategy into actionable operational tactics is often a missing competency.

The Highlight Reel: Some Of the Worst Private Equity Management Failures in the Last 15 Years

Following are some examples of how investments, acquisitions, mergers and integrations were more “miss” than “hit:” 

1. Toys "R" Us (2017) – The PE-backed retailer was unable to adapt to e-commerce and changing consumer habits and was weighed down by massive debt incurred during its buyout. This once iconic brand was another casualty of over-leveraging by private equity investors. A failure to adapt to online competition, along with heavy debt, led to its bankruptcy.
2. Lehman Brothers (2008) – While a financial failure at its core, the PE divisions of Lehman Brothers were involved in aggressive acquisitions and over-leveraging, contributing to the eventual collapse of the firm during the financial crisis.
3. Chrysler (2007) – Cerberus Capital Management’s buyout of Chrysler led to poor operational execution, lack of innovation, and failure to adapt to changing consumer demands, resulting in Chrysler’s eventual bankruptcy.
4. Albertsons (2006) – The grocery chain struggled post-acquisition due to operational inefficiencies, cost-cutting measures that hurt the customer experience, and failure to innovate in the face of competition from Wal-Mart and other rivals.
5. HCA Healthcare (2006) – The $33 billion buyout was a failure to understand the complexities of the healthcare industry and led to massive debt loads, leaving the company vulnerable to regulatory and operational challenges.
6. Harrah’s Entertainment (2006) – Despite being a profitable casino business, Harrah’s PE-backed acquisition led to underinvestment in customer service and technology. Operating partners struggled with the integration of gaming assets and innovation.
7. J. Crew (2011) – The PE acquisition led to a focus on cost-cutting rather than brand development or digital transformation. The brand failed to modernize and experienced stagnation, with its financial backers ultimately writing off the investment.
8. Fairfax Media (2018) – The Australian media company was acquired by PE but faced significant challenges related to declining revenues and mismanagement of its digital transition. Operating partners failed to address the structural changes in the media industry.
9. Seadrill (2014) – This oil and gas drilling company’s PE-backed restructuring failed due to an over-leveraged balance sheet and poor operational execution during the oil price downturn.
10. T-Mobile USA (2007) – The buyout by private equity firms created more debt and operational complexity without realizing the anticipated synergies. Operating partners struggled with the integration of new technology and infrastructure, weakening the company’s position.
11. The Noodle Company (2013) – PE-backed turnaround efforts at this fast-casual restaurant chain led to operational mismanagement, including high employee turnover and difficulty scaling the business effectively.
12. Kraft Heinz (2015) – Despite aggressive cost-cutting, the merger between Kraft and Heinz failed to generate the promised synergies, with operational missteps in product innovation, marketing, and brand positioning, leading to a long-term decline in performance.
13. Petco (2000s) – After the PE buyout, Petco's management struggled with poor operational execution, including inadequate customer experience and inventory management, and failed to reinvest in growth, leading to stagnation.
14. Tandem Diabetes (2015) – A PE-backed company that failed to achieve profitability despite significant investment. Mismanagement of R&D, marketing, and commercialization of products led to significant losses.
15. Dairy Queen (2007) – The acquisition by a PE firm led to operational mismanagement, a lack of investment in brand innovation, and failure to adapt to changing consumer tastes, resulting in stagnating sales.
16. Rite Aid (2007) – PE involvement resulted in an over-leveraged structure and operational challenges related to integration and store performance, leading to significant losses and store closures.
17. Sun Microsystems (2003) – Although not the result of a recent PE investment, Sun Microsystems was heavily impacted by poor operational decisions during its PE-backed restructuring. Inadequate focus on innovation and technology resulted in a failure to compete with rivals like Oracle and IBM.
18. Presidio (2015) – Despite a PE-backed buyout, Presidio struggled to scale its operations, achieve the expected synergies, and integrate IT services across a rapidly changing market.
19. Gatehouse Media (2014) – The acquisition by PE of Gatehouse Media led to cost-cutting measures that hurt the quality of the company’s journalism and led to operational issues that stifled growth in the digital era.

Why WeWork Didn’t Work…A Case of Extreme Failure

WeWork’s collapse is often viewed as an extreme failure of private equity (PE) because it represents a unique confluence of poor management, misaligned incentives, flawed business model assumptions, and a lack of due diligence that ultimately led to a highly publicized downfall. WeWork's story serves as a cautionary tale about the risks of overhyped valuations, reckless growth, and the dangers of underestimating operational complexity, especially when private equity firms are involved in a way that emphasizes financial engineering over sustainable business operations.

1. Flawed Business Model and Overhyped Vision

WeWork’s original business model was based on the idea of leasing office space long-term, then renting it out short-term to startups, freelancers, and companies looking for flexible office space. While this "flexible workspace" model seemed appealing in a growing gig economy, the company’s core financials were deeply flawed. It had massive lease obligations (long-term liabilities) but a business that relied on the short-term rental of office space. This created a major cash-flow mismatch, especially as the company scaled aggressively.

Moreover, WeWork's founder, Adam Neumann, sold an almost cult-like vision of WeWork as a global, transformative "community" or "lifestyle" brand, far beyond a simple real estate rental company. This grand vision was a large part of what attracted PE firms, particularly SoftBank, but it was poorly grounded in realistic business fundamentals.

The Pitfall: PE firms were seduced by the hype and failed to assess the fundamental flaws in the business model. There was too much emphasis on the narrative (the "We" culture, global expansion) and not enough on profitability, unit economics, and risk management.

2. Massive Overvaluation Fueled by Private Equity and SoftBank

WeWork’s valuation skyrocketed from $5 billion in 2016 to a peak of nearly $47 billion by early 2019. This meteoric rise was driven in part by massive funding from SoftBank, a Japanese multinational conglomerate, and other PE investors. SoftBank, in particular, invested billions of dollars and became WeWork's largest shareholder. As investors pushed for rapid growth and expansion, WeWork became highly overvalued based on revenue projections that were unrealistic and far removed from actual profitability.

The Pitfall: PE and venture capital firms often fall into the trap of chasing "unicorn" startups, pushing for rapid scaling and growth even when the fundamentals don’t support such a valuation. In WeWork’s case, PE's obsession with market share and a "go big or go home" mentality led to a massive overvaluation without any regard for the company's inherent risks and weaknesses.

3. Unrealistic Growth Expectations and Reckless Expansion

WeWork’s rapid global expansion was another key factor in its downfall. The company was opening hundreds of locations worldwide, often in expensive real estate markets, with a business model that required large upfront capital expenditures to lease and renovate spaces. To fuel this growth, the company raised billions of dollars, but it failed to manage its cash flow adequately. WeWork expanded too quickly into markets that were not fully developed and underestimated the costs associated with building out infrastructure, managing real estate, and retaining customers. As a result, WeWork burned through cash at an unsustainable rate, further exacerbating its financial difficulties.

The Pitfall: PE investors often push for rapid growth to generate returns, but without the operational discipline to ensure sustainable scaling. In WeWork’s case, the aggressive push for growth without adequate operational checks led to an unsustainable business model that couldn’t support its capital-intensive strategy.

4. Lack of Corporate Governance and Leadership Issues

Adam Neumann, WeWork’s charismatic co-founder and former CEO, was a central figure in both the company’s rise and its ultimate downfall. Neumann’s management style, driven by a strong personality and a lack of oversight, led to a number of questionable decisions that harmed the business. These included personal conflicts of interest, lavish spending (e.g., private jets, expensive offices), and self-dealing practices like leasing properties he owned back to WeWork.

Neumann’s erratic leadership and the lack of strong corporate governance were major red flags. Despite these issues, SoftBank and other investors were complicit in letting him continue to lead the company, believing that his vision and the company’s rapid growth would eventually overcome these problems.

The Pitfall: PE firms must ensure strong corporate governance and oversight, especially when founders or leaders are highly charismatic but lack the discipline to run a sustainable business. The failure of WeWork’s board to hold Neumann accountable contributed significantly to the company’s demise. 

5. Failure to Address the Unit Economics

Despite the massive scale of its operations, WeWork was never able to achieve profitability. In 2019, the company reported losses of $1.9 billion on revenue of $1.8 billion. The core issue was its unit economics—WeWork was spending far more to acquire, lease, and build out office spaces than it was making from renting those spaces out. While PE investors were focused on top-line revenue growth, they largely ignored the fundamental issue that the company's revenue could not cover its high operating costs.

WeWork's business model was heavily reliant on massive upfront capital investment for real estate, and even though it grew its revenue, it was unable to generate enough margin to support that growth. It was operating with extremely poor unit economics, and PE firms failed to correct this as they pushed for expansion.

The Pitfall: PE investors can sometimes become so focused on top-line growth or vanity metrics (like revenue) that they fail to pay adequate attention to the underlying unit economics and profitability of the business. WeWork’s inability to demonstrate a path to profitability ultimately made its business unsustainable.

6. The IPO Fiasco and Public Scrutiny

WeWork’s highly anticipated IPO in 2019 was a disaster. The company’s financial filings revealed massive losses, weak governance, and a business model that was far from sustainable. The company also faced significant scrutiny over Neumann’s behavior, financial conflicts of interest, and extravagant spending. This public exposure of WeWork’s weaknesses led to a dramatic collapse in valuation, from $47 billion to a fraction of that figure. PE investors, particularly SoftBank, were caught off-guard by the negative reception from public market investors. The IPO fiasco not only wiped out billions in value but also raised serious questions about the oversight and governance of the business.

The Pitfall: In some cases, PE firms focus so much on exiting their investments through an IPO or sale that they fail to adequately prepare the company for the scrutiny of the public markets. WeWork’s inability to transition into a public company was a failure of governance, financial transparency, and operational readiness.

7. Misaligned Incentives Between Private Equity and Company Leadership

Private equity firms and founders sometimes have misaligned incentives. In WeWork’s case, SoftBank and other investors were primarily interested in quick returns, while Neumann’s interests seemed more aligned with personal gain and empire-building. This misalignment manifested in reckless decision-making, such as Neumann's controversial self-dealing and spending habits, which were not checked by investors.

The Pitfall: PE firms must ensure that they are aligned with company leadership in terms of long-term goals and incentives. Misaligned incentives can lead to decisions that prioritize short-term gains (or personal enrichment) at the expense of the company’s long-term sustainability. 

8. Ignoring the Importance of Sustainable Growth

WeWork's growth was fueled by cheap capital and an almost manic drive to capture market share. This led to the company expanding into markets without fully understanding the risks and realities of managing a real estate business at scale. When the business began to slow, the company’s financials and its operational structure were exposed as unsustainable.

The Pitfall: PE investors sometimes push companies to grow rapidly without considering the importance of building a strong foundation for sustainable growth. In WeWork's case, the rush to expand without sufficient operational discipline led to a massive collapse when the growth slowed.

WeWork’s rise and fall is a textbook example of how private equity can contribute to a company’s extreme failure when key risks are ignored, governance structures are weak, and the business model is fundamentally flawed. In WeWork’s case, PE investors, led by SoftBank, chased a narrative-driven valuation, fueled by an unprofitable growth-at-all-costs mindset, without sufficient regard for the company’s unit economics or operational risks.

The failure is a cautionary tale that highlights several critical mistakes: an over-reliance on financial engineering without operational due diligence, the danger of overvaluing a company based on market trends rather than fundamentals, and the importance of strong leadership and governance. For private equity firms, WeWork serves as a stark reminder of the importance of balance—between financial strategy and operational execution, between growth ambitions and financial sustainability, and between visionary leadership and prudent oversight.

Recap

These failures highlight the risks involved in private equity operations when the operating partners lack experience in the specific industries, day-to-day management, and long-term strategic vision required to successfully execute complex turnarounds.

Private equity operating partners must balance the need for financial performance with the broader long-term health of the business. The key is not just cutting costs and improving financials but ensuring that operations, talent, and innovation are aligned to create lasting value. Avoiding these pitfalls will help operating partners lead companies through successful transformations and avoid the mistakes that can derail a portfolio company’s growth trajectory.

By focusing on culture, customer-centric strategies, effective risk management, and smart integration practices, PE operating partners can maximize the value they create and navigate the complexities of running a business in a dynamic market environment.

Hiring experienced practitioners can ensure objective perspective in managing private equity operations. It’s not an OJT job; it’s one that calls for both depth and breadth.

Paul Fioravanti, MBA, MPA, CTP, is the CEO & Managing Partner of QORVAL Partners, LLC, a FL-based advisory firm (founded 1996 by Jim Malone, six-time Fortune 100/500 CEO) Qorval is a US-based turnaround, restructuring, business optimization and interim management firm. Fioravanti is a proven turnaround CEO with experience in more than 90 situations in more than 40 industries. He earned his MBA and MPA from the University of Rhode Island and completed advanced post-master’s research in finance and marketing at Bryant University. He is a Certified Turnaround Professional and member of the Turnaround Management Association, the Private Directors Association, Association for Corporate Growth (ACG), Association of Merger & Acquisition Advisors (AM&MA), the American Bankruptcy Institute, and IMCUSA. Copyright 2024, Qorval Partners LLC and/or Paul Fioravanti, MBA, MPA, CTP. All rights reserved. No reproduction or redistribution without permission.

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