The Dialectics of Private Equity

The research behind A Self Organizing Private Equity Fund

Context: the results of my research and the process of arriving at the result are closely linked in the following prospectus. I have chosen to express the results to you as I did with the Private Equity professionals who participated in the research. You will be reading the research from their point of view. If you would like further context, please read A Self Organizing Private Equity Fund.

Hello all. I would like to thank you again for your participation, together we envisioned what this investment fund could become. Without our conversations, my investment thesis would fall flat…because of it, we have arrived at a greater sense of dynamism and synthesis. I believe an underlying value exists when organization design is applied to the development of an investment fund through advanced human-centered design informed by the cognitive sciences. The guesswork coming into this series of conversations was predicated on a fairly simple but critical algorithm; if an investment fund’s outcomes are preceded by actions, and actions are preceded by thinking, then what type of thinking is necessary to achieve competitive outcomes to investors that justify raising an investment fund?

Outcomes ← Actions ← Thinking

So if thinking is the most tangible dimension of this investment fund, it is worth exploring directly through our dialogue’s performance. In order for a thesis predicated on thinking to be brought to bare on an investment fund, it is necessary to consider how the fund operates and how each of us thinks about how the fund operations. In other words, if “how we think” preceded “what we are thinking”, then wouldn’t improving “how we are thinking” impact the results of a fund? My hunch is that improving our thinking during dialogue will lead to optimized outcomes, such as we’ve already begun to do together. I write this report for you to better understand my thinking, so that we may better understand each other going forward.

The thinking we do together can set an evaluative benchmark for us to abduce (meaning to draw away) how an investment fund should be created and what this investment fund should encompass. I hope to accomplish within this prospectus: 1.) a demonstration of how I evaluate thinking as a result of our dialogues 2.) a consideration of how the content of our dialogues impacts The Brief which brought us into connection through Toptal 3.) an introduction into how I’m evaluating the team necessary to raise a fund. Let’s review our prompt once again before looking more closely at our experience’s results…

The Brief

The client is an organizational designer that thinks about employee interactions with an organization using advanced human-centered design techniques from the cognitive sciences. He is looking to transition from working purely as a consultant to sharing risk with his clients as an investor, partnering in redesigning their organizations.

He is looking to develop an investment fund that focuses on lower mid-market companies who are valued between $5–50mil and under 1000 employees in the US. Owners in this category are looking to exit, but their ideas of succession planning often don’t align and inspire the cultural retooling necessary to reinvent these businesses for a new digital era.

He is seeking Toptal’s help to communicate how his investment and organizational transformation strategies can create a compelling future for these organizations they can’t otherwise forecast with other investors and management consulting firms.

Specifically, he is looking to model what an ideal organization might look like in which the fund would want to invest and ultimately buyout. He would like this to be accomplished in such a way that the model of the fund and the company could be translated into a Forio simulation like the Blackstone/Celanese one used at HBS.

The Design

While I’ve spoken of evaluations, evaluations are really a misnomer in the scope of this prospectus. What I am actually doing is developing the design parameters of an organization necessary to develop a fund. In evaluating these parameters, I am measuring the distance between the “thinking necessary to grasp task complexity” and the “thinking we were able to produce” during our dialogues. In other words, I’m not concerned with “your” or “my” thinking from a normative standpoint because I do not yet know the prerequisite tasks necessary to develop an investment fund. Furthermore, I do not know the prerequisite thinking requirements of the funds contributors, including myself. In this way, evaluation of these dialogues is an abductive exercise, drawing out the parameters of the fund starting on the basis of thinking complexity.

We are exploring the “process of (for) validating a given hypothesis”, also called reasoning through successive approximation (e.g. an explanation is valid if it is the best possible explanation of a set of known data). In other words, I’m attempting to use the information that was made available to me (which I can also generate from my thinking process independently of dialogues with you) to arrive at a minimally sufficient hypothesis that will drive the design of an investment fund forward. From this design, I am attempting to triangulate “thinking” and “task complexity” in a way that makes sense of the relationship between the organization design and its talent architecture.

The Context of Thinking

What do I really mean by thinking anyway?

We can consider thinking within this prospectus as comprising four structural categories. These maybe somewhat foriegn initially because often times we are only impliciting asking ourselves when reading, “what is the structure of thinking the author used to arrive at the text’s contents?” Where, often we are asking ourselves more explicitly, what is the author saying? In the context of this writing, we will be directing our attention in both directions.

What I would like to briefly point out before introducing you to the categories, is that in this text, “what I’m discussing” and “how I’m discussing” are mutually dependent. By this I mean “how I’m writing” and “what I’m writing about” happen together and can only be separated when the structures of thinking are looked at in the following way:

Thinking as in process having to do with unceasing change.

Thinking as in context comprising layers and parts of a larger frame of reference.

Thinking as in relationship showing how interconnected things share a common ground that isn’t necessarily evident without the relatedness of things.

Thinking as in transformation combining the aspects of thinking in process, context, and relationship about systems undergoing qualitative change.

These four structural categories can show up in moments through an interview-dialogue as they give rise to the content of what is being discussed. For example, one participant said,

“….it doesn’t necessarily have to be “raise a fund” or “don’t raise a fund”…what people are doing in order to raise capital is they’re getting the deal first. You know, it’s kind of an independent sponsor…you have a team, you have an idea, you have an expertise, you find a deal, and then you get investors to support that deal. And it’s much easier to raise capital that way than to raise capital into a fund.”

To understand the complexity of the participants thinking, I’m asking myself while reading this piece of text: “what is the difference between the concept of what they said and the structure of thinking they used to formulate their thoughts?”

In this case, my hypothesis is the participant demonstrated a process structure of thinking to formulate the concept of “raise a fund”. The concept of “raise a fund” was central to the dialogue/interview, as it was to The Brief. Even though this was the ground of our conversation, the participant shifted our attention, or its figure. By showing us that raising a fund could result from a new set of inputs, he reconfigured the design we’d discussed previously.

While the concept stayed the same, it was a novel moment in the interview because we saw the “raise a fund” concept in an entirely new light. Structurally speaking, it is similar to observing the image on the left.

What do you see? Look again, do you see something different?

What I’m doing directly above is attempting to justify my hypothesis about the structure of this piece of text by de-emphasizing its contents. While of course the content of what someone says is important (vital, actually) to the design — by emphasizing the structure of thinking, the focal point of dialogue and analysis gives me a better grasp about how a participant’s thinking is occurring. Why is that important? If the thesis is true: that thinking proceeds actions, then how someone is thinking should be an indicator of what actions they can take, ultimately leading to outcomes. While a good outcome is still unclear when it comes to the results of a fund, what we do have access to is our thinking. We can continue to draw out abductive empirical results towards answering the question: “what type of thinking is necessary to achieve the outcomes investors find attractive?” Let’s carry on…

While our structure of thinking can be measured quantitatively (more or less structure), they also appear in what can be described as phases. These phases comprise constellations or “networks of structures of thinking” that change qualitatively phase over phase, transcending and including the prior. They set broad constraints on the complexity of thinking an individual probabilistically has access to.

In order to understand complexity, it helps to make sense of 5 factors:

The Five Factors of Thinking

I’m considering these factors of complexity integral in performing tasks within an organization environment. In our case, the task we had during our dialogue was generally “envision developing an investment fund?” We can therefore ask the question, “what phase of thinking is requisite to accomplishing the task of raising an investment fund successfully, individually and as a group as an outcome?”

The Four Phases of Thinking

What I’m suggesting is that the forthcoming descriptions of qualitative phase sets a broad range for the quantitative factors that appear within a semi-structured interview. The 5 quantitative factors mentioned below arrogate to form a qualitative phase however a phase cannot be reduced just to these factor’s arrogate alone. Said differently, this logic also applies in reverse: a qualitative phase sets constraints on the quantitative factors of thinking that can probabilistically appear within a semi-structured interview.

The implications of what I’m saying are significant to the question, “what phase of thinking is requisite to accomplishing the task of raising an investment fund successfully, individually and as a group as an outcome?” If thinking precedes action, then every action is first considered through thinking rather than merely counting the amount of factors, or complexity, is insufficient for evaluative or design criteria. Taking this further, the actions an individual can probabilistically take towards “envisioning the development of an investment fund” can forecast with some accuracy the likelihood of investors returns based upon the inputs of thinking performed by the team managing a fund. Let’s scrutinize the implication of this thesis in a bit more detail using the following descriptions of the 4 phases of thinking.

There are 4 phases of thinking that can be summarized as follows;

These 4 phases of thinking are determined in part by the quality of the factors described above shown through a semi-structured interview much like we participated in together.

Now that I’ve begun to sketch out a conceptual framework to orient you to how I’m thinking about designing the fund based upon the results of the interviews I’ve conducted, there are three questions left unanswered:

• How has the content of our dialogues impacted The Brief?
• How am I proposing to evaluate the team necessary to raise a fund?
• What can you do to help move the thesis forward?

Before answering these three questions in detail, I will share an expanded version of this project’s vision. You may notice my persistent focus on demonstrating the thesis of this overall text over introducing you to this vision statement. I believe introducing you to the vision statement’s contents and the research that has gone into its creation is outside of the scope of this text. While important for “envisioning an invest fund” and its design, I chose to de-emphasize its importance here. Because the investment fund’s vision is qualitatively and quantitatively unlikely to succeed if I am not able to attract collaborators, I share this vision statement with you, in the context of this report, to introduce you to the design method used as it’s backdrop. Please read this statement as being in “beta”. This spectualive prototype is used in a constructive fashion to attract collaborators, while in a deconstructive fashion, stripping the insights from this text and linking them to the vision statement’s contents. Here you can practice reading this statement as, “how is Nathan thinking about raising an investment fund?” instead of “what is his vision statement?”.

The Vision

In today’s economy minds are generally measured (and subsequently human agency) much like rechargeable batteries, however we should measure minds like global warming, as complex adaptive systems.

What are the implications for private equity? If we measured minds as complex adaptive systems, we would begin thinking of organizations much like ecologies, who’s people (or species sticking to the ecologic metaphor) need to be grown not mono-farmed, weeded out, and genetically modified. What some organizations such as Bridgewater, Nextjump, and Decurian have begun to do is design their organizations to become like ecological systems, helping to grow adult minds. If we took these organizations as indicators, what appears is an entirely new business category.

Developmental organizations are predicated on an entirely new premise, that individual’s weaknesses are an organization’s greatest collective strength. For private equity to nurture developmental organizations the industry must reinvent its basic ontology. As a society, private assets which can be extracted through its means of production are sold as data in a sharing economy (e.g. Uber-cars, Airbnb-homes, GE-jet engines). It is important to critically reflect on a new possibility for employee ownership if we want to avoid something of a free-market communism where monolith organizations orchestrate our democracy. Though it might be necessary to reconsider personal sovereignty in the form of our digital avatar’s data (such as we have unconsciously begun to do with the first wave of digital platforms such as Facebook and Google) we would be remiss to think we can navigate the complexities of the 21st century without large centralized databases. However accidental or intentional they may have formed, they allow the rapid societal reorganizations that seems necessary longterm.

What private equity should be doing is not only thinking about the financial engineering but the organization design necessary to help civically adapt our organizations to meet an unprecedented set of social demands in the anthropocene. In order for private equity to help design organizations to become ecologies that nurture adult development, I’m suggesting that we consider developing a new type of private equity fund to support organizations on the road to become developmental organizations.

This fund would distribute decision making through a computational architecture which would act as an intermediary to first simulate each business in the portfolio and then the portfolio as a whole, as a complex adaptive system. A recommendation engine would be produced, through simulations, to act as a regulatory layer informing the fund and supporting all participating economic actors. This simulation would suggest interventions within its portfolio businesses that align with the parameters of developmental organizations.

The discovery and diligence of assessing a businesses transformal fit as a developmental organization would be self-service. The simulation developed through Forio would be designed to help a CEO and board of directors determine whether the risks associated with transformation would be worth the return. Under its guidance, returns measured today in the classical PE sense would need to be reconsidered in light of the simulations Developmental Economics metrics. Using a performance management feed that includes developmental data from within each management layer, the underlying premise of the fund is predicated on measuring minds and therefore labor processes. This includes decision making, collaboration, and problem solving. With that said, the business model of the portfolio companies would have to be reinvented as platforms. Going from pipeline to platforms organizations means inverting dimensions of each business organization in the portfolio. This means taking what was once internal as administrative practices and externalizing those practices as user experiences for new service designs of the platform (similar to what Apple did in the early 2000’s with the Apple Store…since becoming a heavily used platform design pattern).

Each business in the portfolio would operate on the simulation by adapting the simulation to fit their unique organization. In this way the simulation is a shared service to help with decision making in each business. This would also lead to the creation of other shared services stemming from the database the simulation accrues through its portfolio inputs. This fund would look to help cover the cost of acquiring business entities through the labor force acting with banks though shared ownership opportunities. The labor force within the portfolio companies would become a carrier of convertible debt. In this way the fund would develop a groundswell of support from the labor force enabling them to become owners of their means of production, expanding its profit to pay back the banks and freeing the labor force to develop as people through their work in the organization.

The Structure of the Vision Statement

When reading this vision statement, like reading an interview script, we can ask what structurally relevant patterns emerge like in the interviews? In this case, the text is staying mostly in the context structure of thinking having to do with comprising layers and parts of a larger frame of reference. The factors which determine the quality of thinking expressed stand out in Discrepancy, Fluidity, and Hierarchical Conceptual Complexity of thinking.

From a discrepancy stand point this text is overly dependent on constructive factors such that the narrative isn’t balancing criticizing itself and resolving those critiques nor is it standing in much conscious opposition with the status quo related to raising and running a fund. While there are moments where the statement is critical, these represent mostly context of criticality but don’t move structurally in that direction very far.

The fluidity of the text is also limited significantly because it does not balance constructive and critical structures of thinking, meaning, there isn’t a structural dialectic in the thinking behind the text which inter relates process, context, relationship thinking into transformation. The text is rather entombed in its own complication lacking depth and complexity because it merely points to complexity but does not elaborate its concepts adequately nor links them to have much fluidity. From a hierarchical conceptual complexity standpoint the text operates in the advance systems spectrum not yet reaching a principled level.

The Content of the Vision Statement

Independent of whether you or I like this vision statement, its structural factors for the purpose of this text should be kept in view because it is those structural factors which will ultimately determine the quality of thinking necessary to produce the fund’s results. Quality set by both quantitative factors and qualitative phase.

Simply, what I’m suggesting is that in order to make this vision, or a deveration of the vision a reality, the individuals and the team as a whole need to be sufficiently capable and competent. These considerations can be evaluated for the purpose of design, quantitatively and qualitatively going forward. I’m suggesting measuring and designing for thinking be kept as a first principle of the fund going forward.

Vision statements like articulated above should change as more people collaborate with one another as they join the venture. Therefore the sketch of the talent architecture, demonstrated in part by the thinking requirements which I focused on so heavily within this document, are necessary but insufficient even if the talent architecture is requistely designed. What I’m saying is that even though the team might be able to produce an updated vision statement that meets some threshold of structural factors for example, that doesn’t mean the vision statement (a representation for any work product) is good, qualitatively speaking. Good enough for investors to want to invest or business owners to want to sell.

The Team

We need to consider both the capability of the team working towards this vision and its competency. In other words, the quantity of desirable factors (as documented above) when thinking about matching the fund and its talent. Culminating in over 55 years of research, the Requisite Organization International Institute (ROII), with its focus on a “science based management”, sponsored a 2011 study led by the Scandinavian investment fund Sjätte AP-fonden. This study explores the possibility of predicting future performance, within PE, measured by “phases” of thinking complexity of fund management and executives involved in deals. Their research suggests that matching the level of capability (commensurate with “phase” in the model outlined above) of a CEO with the level of the CEO’s role, will have a significant impact on the PE firms ROI. It also suggests that investors in PE firms should consider the level of the PE firm’s partners when making an investment decision.” Let’s unpack that a bit.

What Sjätte AP-fonden is saying in our terms is confirming the hypothesis: as there are minimally sufficient requirements for CEO’s of companies PE firms invest in, there are similar criteria for partners with the PE firm. What I’m putting forward is that we can start from these minimally sufficient criteria, discussed here as complex thinking broadly speaking, and in addition to using the criteria as input for evaluation of investment decisions down the road, we use these criteria now as the design parameters in thinking about the talent architecture of the fund we’re contemplating. How would we do that?

The Sjätte AP-fonden report states “that if partners in PE firms operate at level V or higher, as measured on the Jaquesian scale of levels of work/levels of capability, it will have a positive impact on the fund’s returns. If partners in PE firms operate on a lower level than level V, it is assumed that it will have a negative impact on the fund’s returns.” Going along these lines, we’d need to make a parallel with the Jaquesian scale used in the study.

What this diagram above begins to show us, in addition to a comparison with the Jaquesian scale, the relationship between task complexity discussed in the study as “level” and phase in our version can also be brought into a direct relationship. What does this mean for the team?

What this means is that not only do CEO and fund managers need to operate at a minimally sufficient level of complexity and capability but that the team as a whole does as well. Therefore as we consider linking the talent architecture with the organization design we can begin to consider the team relationship to the mission and the individual’s relationship to their role on the team as well as in the organization as a whole.

What I’m suggesting is that we reflect on the team less anyone in specific, however the results from the interviews we held with one another were insufficient to garner much more than an opinion of our collective capability. While the results from the interviews were able to produce an entry point into the discussion I’m having here with you through this text, they have not produced the specific design parameter that can be used for specific evaluation in either team or organization design. Just because the results of the interviews provided inconclusive data for specific evaluative or design parameters, the overall research design has come into view.

Furthermore, what is also hidden from view at this point in time is the notion of team as a result of those whom I’ve interviewed because of the format my original interview was conductive one on one so the unit of “team” never appeared from an organization design point of view. Recognizing a team is greater than the sum of its parts, we’d need to form a team, or at least attempt forming a team for a realization of that team or the team capability necessary to operate at or beyond level V referencing the Sjätte AP-fonden research.

Without losing sight of our agenda in this section of the text, its important to now consider the recommendation themes which emerged from the interviews as they suggest a variety of pathways forward, some of which are complementary others which are at odds and therefore need to be prioritized between.

The Content of the Interviews

The basis pathways forward, e.g. actions, that we contemplated during our interviews can be organization in the following ways.

Conclusion

As you have now begun to understand the process of self organization I am attempting to define through building an investment fund is incomplete and the results from this speculative exercise are inconclusive.

Incomplete and inconclusiveness are design features of my approach to developing a self organizing investment fund.

Should you wish to continue to uplift a Self Organizing Private Equity Fund utilizing a constructive critique of the findings of this initial performance, here is how you can participate going forward.

Please schedule a time with me for a Semi-Structured Interview where I will experientially demonstrate the usefulness of applying dialectical thinking to your existing workplace as it relates to the field of Private Equity.

https://calendly.com/nathansnyder/60

References

Sjätte AP-fonden and Enhancer Consulting (2011) Predictability of Investment Performance and the Impact of the Level of CEO’s and Partners: Prospective study of 24 companies and 6 private equity firms. Sourced from ROII Featured Research, July-September 2011

De Visch, J., & Laske, O. (2020). Practices of Dynamic Collaboration. Springer.

Diagrams made possible by works of Otto Laske and Theo Dawson