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In my previous post, I outlined why, in the wake of the covid-19 pandemic, PE funds are likely to be investing more in portfolio improvement efforts. As we emerge from the immediate impact of the pandemic, into a politically, socially and economically more complex world, these improvement efforts will need to be more structured and systematic. And, in many cases, these efforts will need to be undertaken with a broader perspective on the impact on the wider world.
While some private equity funds have adopted a systematic approach to portfolio company improvement, many have been less structured. Instead they rely on hiring the “best and brightest” operators, giving them the right incentives and just letting them get the job done.
This can be a complex delivery model to manage and a key reason why some Value Creation Plans (VCP) fail to deliver. It’s hardly surprising as there are now so many parties involved: management, the deal team, the portfolio team, external advisers, operating partners and inhouse improvement teams. Indeed, with so many parties involved, it can be difficult to know who is accountable and to maintain visibility on progress. Sometimes, problems aren’t detected until it is too late to course correct.
The lack of a structured onboarding process can also lead to misalignment and tension. For example, there are often differences between the business plan presented by management and the fund’s business plan. If these sometimes-trivial differences are not debated openly and reconciled as part of a structured onboarding process, they can lead to significant ramp-up delays or, worse still, deeper chasms in the relationship.
Some GPs struggle to institutionalise performance improvement as a core capability. While external advisers and operating partners play a crucial role due to their specialised knowledge and expertise, surely performance improvement has become important enough to warrant greater inhouse investment. Despite this, to keep fixed operating costs as low as possible, the ratio of inhouse operating to deal personnel remains low.
Even with the correct incentives in place, which the PE industry is very good at, management teams sometimes do not allocate enough time to delivering the VCP, preferring to stay in their comfort zone running the business.
Under the stress of COVID-19, a growing number of improvement projects and increasing project complexity, a less structured approach may not deliver the desired results.
PE portfolios are expanding as institutional investors continue their search for yield. As portfolios expand, so does the number of improvement projects. GPs typically choose to focus on 4-8 major improvement initiatives through the life of an investment. Even for a relatively small fund managing a portfolio of just twenty companies, that’s more than one hundred initiatives to execute. That’s a lot of complexity to manage.
Furthermore, as most PE deals are secondary, quick wins have already been realised by previous owners. Hence, today’s projects are more complex. For example, to generate value, GPs are taking on more risk, embarking on distressed business turnarounds, carveouts, major acquisition integrations, digital transformation and IT system upgrades. For an overview of improvement initiatives and their risk profiles, see Graham Oldroyd’s article. Graham's article also considers the extent of the risk or opportunity from the perspective of the broader impact on the community and stakeholders surrounding the portfolio company.
With public-to-private deals becoming more prevalent in recent years the transformations required are often more complex due to the size of the assets and the breadth of the improvement areas to be tackled. Indeed, in the wake of the Brexit malaise and the COVID-19 crisis, AlixPartners expects more public-to-private deals as public equity market valuations are depressed, activist investors are seeking ways to address poor performance and GPs are under pressure to deploy vast quantities of dry powder.
Add to this increasing public and investor focus on ESG goals and the impact of business on society, the already complex world of value creation is likely to get even more so.