Private Equity businesses exist to create value from their portfolio companies – but too often, much of the potential value is left on the table.
The sobering reality is that 70% of key strategic initiatives fail to achieve the full potential intended. For PE firms, their relatively short holding period presents additional challenges.
To explore these challenges - and how to overcome them - Genioo CEO Frederic Brunner chaired a panel at the recent Private Equity International Operating Partners Forum on driving long-term value from portfolio companies.
Along with Frederic, panellists Mark Keatley (experienced Board member and executive) and Alex Lizcano (Managing Director, Cinven) bring decades of experience in all aspects of value creation. Here are some of the lessons and insights they shared from their stellar careers on how to realize full potential.
Lesson 1: Focus on the long term
At first glance, this may seem counter-intuitive given that private equity owners typically don’t have long-term ownership. But it’s essential to balance short-term strategies with a longer term vision and make sure they are aligned.
"We're there for a short time but we can do two things,” said Mark Keatley. “We can improve margin and we can change the trajectory of growth. Really good PE firms move quickly to grab the levers that influence growth and margin – but it only works if it’s sustainable.
“Companies are valued on the future. So if there is sustainable growth at a high margin, the next owner will put a value on that and reward you. Where the project doesn’t work is when the investor is just looking for short-term wins. In my experience, they generally won’t be rewarded for that.”
“The Value Creation Plan has to be balanced,” said Alex Lizcano. “One of my learnings is that when investors are thinking about the VCP, they often focus too much on EBITDA maximisation. And of course that’s important. But they also need to think about the multiple expansion levers that impact the enterprise value of the company.
“Are there opportunities, for example, to make a fundamental shift in the business model? It might be going after a customer segment that’s more resilient or changing the revenue model from perpetual licensing to subscription revenue, or something else. It’s important to think about initiatives that are within our control that will ultimately impact our multiple at exit. We spend a lot of time in the boardroom thinking about ‘What does this look like for the next investor?’ I think that’s a critical mindset to have.”
Lesson 2: Leave a runway for the next owner
Portfolio companies that have a sustainable, predictable business model are attractive targets for new investors. But there’s often a trade-off to be made, according to Frederic Brunner.
“It’s about finding the balance between delivering a sustainable business model for the next owner but also leaving them room to grow. They are going to look for expansion and extension of whatever you hand over to them. So you need to leave enough runway for them to achieve that.
"One of the advantages of taking a long-term approach to the business is that if you do it right, there will be a natural direction and pipeline that the new owner can take advantage of in the future – which will make the business even more attractive.”
Lesson 3: Get the right team in place
“People drive growth,” said Keatley. “And it’s a really critical lesson that I’ve learned a few times now, to build or rebuild the management team that is going to carry that company during and beyond your ownership of the company.
“Talent also attracts talent, and good leaders build very strong teams underneath them. That’s why early on, in the first three to six months of the cycle, you need to assess the management team you’ve inherited and make changes if you need to.”
“There’s always the temptation that someone knows someone who they think would be good for the management or the board,” said Lizcano. “and they may be right. But ‘hire thoughtfully’ is a guiding principle for me. Running a professional search to make sure we get the best person for the role is typically worth the effort.”
Lesson 4: Enable the management team
Once you’ve put the right management team in place, it’s important to establish the right working relationship.
"Finding the balance between being problem solvers and sounding boards, but not running the business, can be difficult for PE investors” said Keatley. “You’re accountable to your shareholders, so you need to be hands-on. But in the end, it is only management that can get stuff done. You need to enable them to do their job."
"Oftentimes, as owners we’re typically not the 30-year veterans in the sub-industry of that particular company. So there has to be a partnership between management and ownership" said Lizcano
That partnership needs to be established early, according to Brunner. “Part of our approach when working with PE firms is to really enable middle management. You can’t bypass them because they’re the ones who will capture the value.
“For example, we co-create the Value Creation Plan with them from the beginning. You need to work together to design a pragmatic approach that will work for them, because they are the ones who have to deliver it. They also understand the real obstacles, the things that will get in the way of achieving your plan unless you identify and address them. So, if you are looking to achieve full potential, they hold the key to success.
“As owners it can be tempting, especially when you’re under pressure with timing, to do things in parallel with the management team and essentially bypass them. But you either take the time to involve them up front, or you take a lot more time and effort down the track.”
"There will be decisions and investments that you have to make which are essential for growth and the sooner you make them the better."
Lesson 5: Act early and fast
“If I could go back and change one thing, it would absolutely be to make changes faster, as soon as we have conviction on the change” said Lizcano.“ Once you see that things are not going as expected, it’s better to act early on. I think when in doubt, actually there is no doubt. When we’ve waited to make the change, the thought was always that we should have done it earlier.”
“Some of those decisions will be very expensive and gutsy and are going to depress EBITDA. But as soon as you’ve got the management team in place, do that stuff fast and take the hit in the P&L (if there is one) early on. When it comes to exiting, you won’t have that dilemma that might otherwise present itself between P&L performance and growth.
“It’s very important to hit the ground running. Use that precious time between signing and closing to develop your value creation plan with management. That creates momentum and that’s vital. Follow it up by getting some quick wins (but make sure they’re in the right areas and not just a flash in the pan, like a short-term accounting trick). Getting quick wins in the right areas sends a signal early on to the people within the company who will actually deliver on your plan.”
Summing up - Three takeaways from the panellists
Alex Lizcano, Managing Director, Cinven
- Hire slowly and carefully – but make changes fast.
- The window between signing and closing is critical, so don’t waste it. Use that time to set the right tone and build the right structure to set the company up for success.
- It’s not just about EBITDA and cash maximization. It’s also about how you can expand the multiple of the issues you can control.
Mark Keatley, Experienced Board Member
- Hit the ground running.
- There is always more talent lower down the company than you think. If you can find and develop it, you are building the next generation of leaders – and creating sustainable leadership within the business.
- There’s no free lunch. You can’t create growth without investing. Have those discussions with your shareholders, get them aligned and make those investments in the right areas early on.
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