The Villagers

Charles Cherington

Most people are only vaguely aware of the private equity industry, which consists of several thousand firms buying and selling companies with investors’ money. The goal is to generate profits along the way. In the popular imagination, Gordon Gekko comes to mind: a predacious sort with pomaded coif and an appetite for dismantling family-owned businesses after loading their balance sheets with debt, dispatching their former employees to eternal hell as Walmart greeters.

            Private equity does have more than its fair share of sociopaths, narcissists, and other unsavories, but for most of us the battle is not to ace out fellow predators in the race to debt-laden prey but rather with our own novelty-seeking, magical-thinking homo sapiens brains. Doing your job well means never leaving the mental confines of your cognitive medieval village. Invest only in companies you understand. When buying a business, always follow the checklist, known as doing your “due diligence,” roughly translated as turning over every rock to ensure that the deal you are evaluating is not your last.

            Are the company’s managers honest? Competent? Inclined to stay once you’ve bought their business? After all, sellers often sell their business just once, and they want the highest price for it. Truth, or lack of embellishment, can cost them real money. If the company makes kewpie dolls, are they special in some way? Will competitors outflank you, slash prices, and wipe out your profits? Will the herd of kewpie doll enthusiasts move on to the next shiny object, leaving rows of unsold dolls in the warehouse, causing your company to go bust and your career to end?

            The list of questions that must be answered before buying a business runs for a number of single spaced pages, in small font. It’s a flight manual for the pilot whose job it is to fly new planes sold by people who have no incentive to tell you about loose flaps, faulty fuel lines or anything else that gets in the way of their once-in-a-lifetime payday.

            Do it right, follow the due-diligence checklist, and over time, you will make a good living and live to fight another day. Give in to magical thinking about eternal growth in the kewpie dolls market, get duped by the surefire winner the company has in its new line of Democratic primary bobble heads, fall in love with a charming CEO whose narcissism only becomes obvious after you’ve written your check, and things can go wrong almost instantly. Always follow the checklist, and walk away when you can’t tick every box. The conventional wisdom reminds us that nobody’s career ends because they didn’t do a deal. It ends when they do the one they shouldn’t, either because they gave in to magical thinking or because they didn’t check all the boxes.

            Trust nobody. Verify everything.  Don’t get seduced by people, products, or financial statements. Let other people cure cancer, start Airbnb, and crack nuclear fusion.  To succeed in buying companies means spending a lifetime in your small, familiar village, obeying the ancient rules. That’s doing it right in the world of private equity. It can be so stultifying that, explaining their departure from the trade after they burn out, veterans will say, “If I have to check the boxes one more time, part of me will die.”

            What happens if, rather than doing it right, you want to do it differently? Let’s say, for instance, that the planet on which your village is situated is getting hotter. Doing things the same loses its purpose if sameness means your crops wilt, your well dries up, and your cows die of heat exposure. Time to do things differently—maybe even to make it new. As a private equity practitioner in late middle age, I’ve decided to leave my village. I handed over the keys to my old firm to the smarter, younger Turks who were ready to run their own show, and launched a new one that will invest in companies decarbonizing the industrial economy.  We can still buy a kewpie doll maker, but only if it makes carbon negative dolls, meaning that the manufacturing process must consume CO2 rather than produce it. Maybe they will be made from recycled plastic, or plastic made from carbon dioxide, among other ingredients.

            The sum total of my new work won’t amount to much. Not even enough to save my cows. The size of the greenhouse gas problem is staggering. Electric cars and solar power won’t get us there. The way we make and consume everything has to change, and change fast. Beef? Out. Plastics from petroleum?  Gone. Conventional building materials? See ya.

            Here’s another problem: we need our money handlers to finance a replumbing of global civilization, but they don’t like doing things differently. All the right answers on how to decarbonize the world are out there. Cheaper, safer, next-generation nuclear power plants. Chemical companies that can make products from carbon dioxide and plants instead of gas. So are all the wrong answers. Picking the winners is not easy. Nothing ends a career faster than spending a billion dollars on a new chemical plant that doesn’t make money. Governments are famously bad at picking winners from the supermarket of new ideas. Investors around the world are better at it, but they like doing things the same, not differently, especially when different comes with a big price tag and several years of waiting to find out whether you made the right call.

            In the world of private equity, big global pools of capital have started looking for investors willing to do things differently when it comes to curbing the rise of planetary emissions. New firms are forming, and new funds are being raised. The amounts of money at stake so far are not consequential, but the trend is unmistakable. Has the global money machine finally dedicated itself to solving climate change? Not so fast. When investors put that money to work, everything boils down to doing it differently versus doing it right. Doing it differently means investing money in a new enterprise, one that has never existed before. It may be a plan in a document, or a small pilot plant ready to be scaled to ten or one hundred times bigger.

            The risk of failure in these new enterprises is substantial. Rather than buying an established business that makes money, or building another wind farm using proven turbines, private capital will have to invest in big ideas. Think of it as Silicon Valley meeting smokestack industries. Instead of an app for picking vacation houses, these investors will have to decide which chemical plant will remake, say, the polyethylene market in a sustainable way. A different kind of due diligence checklist is required.  Investors will have to rely on engineers, scientists and a host of unfamiliar experts to help choose the winner from a pile of also-rans. The size of the bets they make will be large enough to end a career if the wrong choice is made. That type of bet will have to be made several thousand times before we have the roadmap for building a carbon neutral economy.

            As our species tackles “the big problem,” it has become increasingly clear that we are at war with ourselves. Can we learn how to do things differently? Can we step back and appreciate that our deeply entrenched behavior may be fine for a small village, but that doing things right in the old-fashioned sense may well wipe out most of our species? Dunno. But when the sun rises tomorrow, I’ll be cinching up my tunic, heading out to the fields, and doing things differently.

Charles Cherington is an investor living in Texas.

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