DALLAS—Get past the spreadsheets and project details, and success in a private equity fund/management team relationship comes down to pretty much what your mom used to tell you: be nice.

“Treat each other with courtesy and respect,” Ben Davis, partner at Energy Spectrum Capital, told attendees at the recent Midstream Finance conference. “No financial success is worth short-cutting that, in our view. In our 23 years, we’ve found that this is a cornerstone.”

But the etiquette of a successful partnership between a management team and a private equity sponsor transcends acting in a pleasant manner—though that aspect is important. It also involves finding the right fit in terms of finance and aligning economic interests.

“Most private equity funds have what we call a waterfall structure, whereby the management team, who are doing most of the day-to-day work, receives a disproportionate percentage of the proceeds once certain return hurdles are reached by the project and by the fund,” Davis said. “I think that’s an important part of the model.”

He also wants the management team to have some skin in the game. Most private equity funds will ask management to put some of their own capital alongside the equity fund into the deal, Davis said. Specifically, he is asking for a “material” investment but it’s not a one-way deal.

“On the part of the sponsor, we think it’s important to treat the team as partners, not as employees,” he said. “These are executives, entrepreneurs that you are backing to form their own company. We culturally believe that it’s important that those teams be treated as partners. Our most successful teams are the ones who have viewed themselves as owners in the business, which they are.”

The relationship component touches many elements of how Davis defines success. Allowing management to run the business without having to endure micromanagement from the sponsor is important, but so is transparency on the part of management when things go wrong.

“There will be bumps along the road,” he said. “We have found that those bumps are best addressed and a relationship is best fostered when they are communicated pretty quickly to the private equity sponsor.”

To that end, the sponsor should respond quickly and candidly. “We as a sponsor should add value in a lot of different ways,” Davis said. “One of those ways is to give counsel, of course one of those ways is to provide funding.”

Davis listed several traits that he looks for when evaluating a management team:

  • Judgment: “My personal experience is that good judgment comes from experience;”
  • Character: “Is the team honest and ethical? Probably their reputation is known if you ask around;”
  • Commercial acumen: “This is a critical one. Do they have the salesmanship to win business?”
  • Operational expertise: “We must be able to engineer, construct and operate assets for that customer at the highest standards and thereby earn their confidence;” and
  • Culture: “The team needs to be entrepreneurial and hard working. They need to be pleasant. These relationships should be fulfilling, they should be enjoyable. I think we all can probably picture in our minds some pleasant people we’ve worked with and some unpleasant people we’ve worked with. I, for one, prefer the former.”

On the flip side, Davis listed questions that management teams should ask when shopping in a private equity sponsor. Do you like working with them? How much experience do they have? How is their investment track record? How is their culture—empowering or heavy-handed? Do other teams stick with them or do they move on to other sponsors?

The pillars that define success at Energy Spectrum are profitability, positive relationships and achieving success while maintaining high ethical standards.

“I absolutely would propose that is possible to have all three of these things,” Davis said, “and having that last one as a foundation is important.”

Joseph Markman can be reached at jmarkman@hartenergy.com or @JHMarkman.

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